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Monday, December 1, 2014

Oil drop sends bloodbath across the O&G market

Oil prices continue its downward spiral following OPEC decision to maintain production at the current level. Year to date, it has dropped more than 35% from its peak at $110/barrel to its current of $68/barrel.

As a result, this has send O&G stocks going spiral downwards and bloodbaths across the market. If you must buy an O&G stocks during this period of uncertainty, at least choose those companies with strong balance sheet and track records in going through the uncertainty.



Oil is a volatile commodity and over the years it has seen its ups and downs over the various economic cycle. The data below shows the historical biggest oil movements since 1876 till today.


What is interesting about the data was that there was mostly negative correlation between oil prices and equity performance. Equity was mostly up during the drop in oil prices, except for the 3 occasions in red. It is not surprising to see that lower oil prices drives consumption as a result of lower energy and gas prices, hence boosting economic activity and reducing inflationary pressures.

The 3 exceptions in red was due to the forces of global recessions, which impacted across all sectors from consumers to banks, and this is the very same reason why we need to look at the impact of the drop in oil prices. For now, it appears that the situation is contained. However, further inaction from the OPEC may send its prices further downward and caused a spiral wave of catastrophic event which may impact the high yield market, banks and then consumers.

Then it will be interesting.

36 comments:

  1. Over production in any commodity will self correct when those naked ones were caught.

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    1. Hi Uncle CW

      Lucky that we were wearing pants swimming in the oil pool :)

      Delete
  2. I do not think less profitable oil industries will cause us to go into recession but the other way will. Is a keen to the industry becoming more competitive rather. Since when this is not better for consumer ?

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    1. Hi Cory

      Yes during oil downturn, producers suffer and consumers rejoice.

      Just ensure that this downturn does not result in a vicious cycle where oil companies go bankrupt, high yield debt defaults, banks affected and consumers impacted.

      Delete
    2. Hi B,

      I don't think the oil producers will bankrupt...just earn lesser profits.

      But the companies who do oil trading and hedging will likely be at severe risks due to the volatility...already claimed victims (Dynamic Oil Trading and OW Bunker). If there are bond defaults, the affected parties are from private banking clients and investment holding companies. Banks might do a margin call and only affected if the borrowers have no assets to pay them back.

      MS

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    3. Another thing is people maybe too young to remember about the 1973 & 1979 oil crisis which cause the oil prices shot up that led to hyperinflation. That lead to recession because company profit margins are eroded. Hence its not low oil prices that lead to recession but high oil prices that lead to recession.

      MS

      Delete
  3. I'm watching on the sideline for now as the oil market is just too volatile for my taste. There are other well valued plays not in the energy sector to consider. I like many financial names such as AFL, CB, WFC, TD, BNS and RY. I have been adding there.

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    1. Hi Divhut

      Those are great counters at steep discounts right now.

      I saw that you have been busy adding them into your portfolio for Nov. I guess Christmas is for shopping ;)

      Delete
  4. I read somewhere that it cost around $20-30 to produce a barrel of oil. So the major oil producer will still be profitable. I think it cost around $1,200 to extract an ounce of gold. Gold is trading for around $1,200 so a lot of companies are losing money in that industry. Have you looked at the metals sector lately? I don't know how to properly value the industry so I just watch from the sidelines.

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    1. Hi Henry

      I will agree that it will be a matter of time before OPEC says something about the production and they've got to limit the supply before it becomes worse for the producers.They probably won't go under but dropping margins.

      I am looking for Aluminium and Copper and tracking their price as well. Seems like there are over supply for these metals as well.

      Delete
    2. Hi B,

      You may have missed this piece of news. The OPEC meeting already happened a few days back. The conclusion is they will stick with the production quota despite declining oil prices. That is why the oil producing countries are reviewing and revising their Budget (ie Msia' PETRONAS already announced 20% cut to capex expenditure, hence the fall in their currencies) or some countries are taking the opportunity to reduce their petrol subsidies (increase in their currencies).

      MS

      Delete
    3. Hi MS

      Thanks for the update.

      I guess I must have missed the news. Looks like pressure is on the downwards now. Don't see it back up anytime soon unless there's unrest somewhere somehow.

      Delete
  5. Hi B, my oil stocks have taken a major tank! Hopefully it is on the verge to recovery soon, so I can get rid of some of them. : )

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    1. Hi Jeff

      I think every financial bloggers are adding energy stocks into their counter right now. I just saw Divhut, Henry, DM and a few others adding them and over here we have many doing the same thing too.

      I guess oil price will bounce back eventually. The important thing is to choose a strong company to withstand and ride all these volatility at the moment.

      Hmm, curious why would you want to get rid of them? Change of strategy or allocation?

      Delete
    2. Hi B, I have recently added a lot of shares from the energy stocks too. However, a large portion of my portfolio is allocated to energy and Im considering trying to balance them out a little bit.

      Delete
    3. Hi Jeff

      Ahh I see.

      I am watching out on my allocation as well to make sure I dont over subscribe to the energy stocks even though they may be irresistible to own at the moment.

      Delete
  6. Hi B,

    There is always winners n losers in the market.
    Biz operating costs which spend a lot on oil n transports will benefit. Consumers will benefits due to lower inflation and higher disposable income.

    Its vice versa for high oil prices.

    MS

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    1. Hi MS

      Economies go in cycles so does those industries.

      I guess it's good time to be in transport and consumers industries at these periods ;)

      Delete
    2. Hi B,

      As a consumer myself, I certainly don't mind to have more disposable income in my pockets. Lets hope that the shale oil production in US and strength in USD keep the oil prices down (biz operating costs) down that lead to growth and increase in interest rates which will normalise the whole economy.

      MS

      Delete
    3. Hi MS

      Strong USD plus lower oil prices. Keep inflation downwards. I certainly don't mind that too since I am a consumer myself ;)

      Delete
  7. Hi B,

    Unless the prices plunge further, I wouldn't be adding more of the oil-related stocks (MTQ & Semb Corp). Have to limit the exposure to the industry just in case a black swan happens.

    Nonetheless, I would bet that oil would definitely be more expensive rather than the other way round in 10 years' time. =)

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    1. Hi 15Hww

      My only exposure to the related stocks are also in Sembcorp.

      Hmm, I am just going to go in a little easier. I think 2015 could be the year they would underperform the market, but also a good place to pick up some decent stuff right there. I am also looking into MTQ since they have fallen since Jul and now at a slightly more attractive price.

      Delete
  8. I certainly hope the oil prices don't continue to spiral out of control from here - I couldn't hold back and had to snap up a couple of stocks while they are getting slaughtered! I can never resist jumping into the thick of a market which is filled with fear of what will happen next - it often works out pretty well in the long run!

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  9. Hi Jason

    Thanks for stopping by.

    I just read your article on drinking which ties back to the oil fiasco. Great read there and im on the same page as you. Get in early while these stocks are unloved and move on to finding the next one. It works pretty well in the long run.

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  10. Hi B,
    A side question. May I know your opinion on Hutchison Port Trust and the reason why you have not vested yourself into this counter? The yield is rather high!

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  11. Hi Dividends101

    Hph is a good trust with great backing name.

    They are not in an industry where I see potential growth opportunities having worked in the same industry for the past 7 years. They are being set up in such a way that they can dishes out dividends more than what they hv in earnings. Much of their assets in the form of capex are also depreciated every year leaving reducing book value in terms to come.

    If you are interested in this counter only because of the dividends there are much more plenty of stocks that yield better risk adjusted return profile imo ;)

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    1. Thanks for your kindest reply! Appreciate how i always learn a thing or two from you. Another question if you don't mind! Personally, I'm picking stocks with an emphasis on the dividend yield and thus my decision on Sembcorp Marine instead of Sembcorp Industries. But most people, including your good self, chose Sembcorp Industries instead. May i know the reason why? Is it due to the higher dividends against the share price that Industries can pay out as compared to Marine? With the data I have, i.e. total dividends from 2014 for Industries is 0.24, and 0.13 for Marine. But share price wise, for every lot of Marine, we can only buy 0.75 of an Industries lot. Thus, it seems that money will be better put on Industries cos of the higher dividends and lower share price. But yield is much lower.. How do we reconcile this? Thanks for your advice, Mr. B!

      Delete
    2. Hi Dividends101

      The dividends for the full year for Sembcorp Industries is 17 cents/share, which translates into about 33% payout ratio the company is earning. Based on the data I have, Sembcorp Marine is giving out 11 cents/share, which translates into about 40% payout ratio the company is earning. In terms of the payout ratio, they are doing fine and the yield on the marines is higher (similar to Keppel).

      I noticed that you have bought into Sembcorp Marine at $2.97 recently. I feel that's quite a decent entry price for the long term. Yield for the price should also extend beyond 4% if everything else remains the same. I think people who get into Sembcorp Marine will get exposure into the oil rigging industry and should be bullish about them in the long term. Even though the order books and revenue are increasing, topline margins have dropped from 24% in 2010 to 13% in 2014 and bottomline margins have dropped from 20% in 2010 to 11% in 2014. Competition is rising up so future is rather a concern for me. In fact, with regards to oil rig, I prefer the Keppel brand more than Sembcorp Marine.

      Sembcorp industries holds about 60% of Marines, while the utilities segment are now contributing 53% of the overall net profit. So a little bit of the both but have their own utilities segment. The best thing about SCI is even without the marines contribution, they are still able to maintain the dividends of 17 cents/share if they want to. So that gives a little bit of the breathing space.

      Hope it helps :)

      Delete
  12. B,

    I expected nothing less of dropping oil prices. Even though oil companies perform bad, it makes a lot of sense for other equities to increase dramatically. Not only is consumer spending up, most companies are also able to cut their operating costs because of cheaper oil.

    It'll be interesting to see where we stand in a couple of months.

    Best wishes,
    NMW

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    1. Hi NWS

      Thanks for stopping by.

      Dropping oil prices like you said is indeed a good thing for the economy. So as long as our portfolio consists of the other industries, it should do fine. I'm doing a bit of rotational play at the moment where I accumulate these unloved oil counters. When oil bounce back, it's time to move on and focus elsewhere.

      Take care :)

      Delete
  13. Hi b, Having bought your sembcorp shares at a rather 'high' price compare to now. Aren't you worried that the oil price continue to drop and cause a recession?

    What is your take on that? or rather what strategy do you have in place if sembcorp shares continue to fall?

    ps. invested in SCI as well

    Cheers,
    always a avid reader of yours

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    1. Hi Anonymous

      Thanks for the reading and support.

      I last added SCI at $4.72 last month and a month now it has dropped to $4.20 today. What a fast downturn. I see more value coming up from this counter, though some near term pressure might cause it more to fall. The key is probably to watch out the oil price sentiments. As long as it keeps going down, there will be downward pressure on Keppel, SCI and Semb Marine.

      My personal strategy is to add to this conglomerate slowly at a time. The price makes it not very easy to do constant dollar averaging but I will try my best to accommodate them. I would also watch out on my exposure on SCI so that it won't overwhelmed the rest of the portfolio.

      For long term investors, this is such a great buy still imo.

      Delete
    2. Hi thanks for your reply. always love your informative post. Yes the price doesn't make it easy for me to average it down as well. I am thinking about averaging it down when it dip further down but worried about the whole oil saga will bring another financial crisis.

      Delete
    3. Hi Anonymous

      Good news is starting 15 Jan, we can average down easier with 100 share rather than 1000 shares at a go.

      We can spread our wings much easier with 100 shares :D

      Delete
  14. Hi B,

    I am in this industry for more than 10 years and talked to people with many more years than me. It is just cycles. Companies long enough in the industry knows how to deal with it.

    As you know, I blogged about O&G quite a lot www.rolfsuey.com. It is critical to know when enter/entry for cyclical stocks and also the dynamics within the industry and company.

    If there is a need to cut loss for cyclical stocks, do it! Oil price should tank some more. My portfolio took a hit and I did sell to prevent over tanking.

    Overall my O&G exposure is 15-20% of my portfolio so still not so bad. Diversify is critical.

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