3 Investing Strategies to Survive the Dramatic Oil Crash

Oil tumbled 24.6% on Monday, the most since 1991, as tensions between Russia and Saudi Arabia combined with continued panic over the spreading coronavirus (COVID-19) sent the commodity crashing. U.S. benchmark WTI prices for April delivery settled at $31.13 a barrel, up marginally from an intraday low of around $29, its weakest since February 2016.

The Dramatic Crash

Crude was already on a downward path from the growing risks of the coronavirus outbreak that has restricted travel, stalled factory activity and squeezed businesses worldwide.

The health scare, which reportedly emerged in Wuhan, China, has spread rapidly to every continent barring Antarctica, since being first identified back in late last year. As of now, the infectious disease has killed over 4,000 people so far and infected in excess of 100,000 globally. It’s no surprise then that the virus has led to expectations for sluggish corporate earnings in the future and added to the downbeat mood in the oil industry, which tumbled into a bear market last month.  

The carnage deepened after Saudi Arabia (the OPEC cartel’s biggest producer and exporter) and Russia (leader of the non-OPEC contingent) failed to agree on additional production cuts to boost oil market fundamentals and prop up prices.

The so-called OPEC+ deal, in place since the start of 2017, is aimed to tackle supply/demand imbalances and bolster prices. In last week’s Vienna meeting, Russia rebuffed Riyadh’s proposal to restrict output by as much as 1.5 million barrels per day. This is in addition to the existing production curbs of 1.2 million barrels per day by OPEC, Russia and other non-member oil producers.

This was met with quick retaliation from Saudi Arabia, who undercut its official crude pricing, apart from threatening to unleash record production.  

The price of oil predictably plunged on this impasse.

3 Strategies to Survive

While one needs to have an appetite for risk in order to invest in the energy sector at this point of time, there are still opportunities for savvy investors to earn big returns. Let’s see how:

Prioritize Debt-Light Companies

It seems there is no end to the oil industry’s woes. The number of defaults is mounting for the beleaguered sector and the latest victim of this trend is oilfield services provider Pioneer Energy Services. Last week, it filed for chapter 11 bankruptcy, which will erase a substantial amount for its investors.

Several others are lined up for a similar fate. In fact, with scores of energy companies struggling to manage debt, find new sources of money and refinance outstanding debt, U.S. bank Morgan Stanley sees defaults in the energy space exceeding the 2016 peak, when the commodity dipped down to $26 a barrel.  

However, some energy companies may still have the ability to withstand falling prices for a long period. These entities have restructured costs or taken other measures to deal with the prevailing situation. In this event, it may be a good idea to look at energy companies that have low debt capital ratios, which make debt servicing relatively easier for them.

We advocate the likes of Imperial Oil, Pioneer Natural Resources PXD and EOG Resources EOG, all large-cap companies.

Integrated Majors’ Diversification Minimizes Risk

Despite Big Oil’s struggles with returns, they are the ones that are best in adapting their business model to the prevailing momentum. Therefore, in this current turbulent market environment, we advocate the relatively low-risk energy conglomerate business structures of the large-cap integrateds, with their fortress-like balance sheets, ample free cash flows even in a low oil price environment and steady dividends.

Thanks to their integrated structures, companies like ExxonMobil XOM, Chevron CVX, Royal Dutch Shell RDS.A are able to withstand plunging oil prices better than the rest and protect their top and bottom lines to a certain extent. With the refining unit of these carrying a Zacks Rank #3 (Hold) conglomerates being buyers of crude – whose price is in a freefall – their profitability improves due to a fall in the input cost.

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

The companies’ financial flexibility and strong balance sheet provide them with a larger war chest to draw upon in this highly-uncertain period for the economy. Most of them remain in excellent financial health, with ample cash on hand and investment-grade credit ratings with a manageable debt-to-capitalization ratio. On top of this, managements have established quite a track record of conservative capital management and cash returns to shareholders. They also pay a safe dividend, yielding attractive returns.

While most of them are near 52-week lows after enduring the crude carnage over the past few months, holding on to them can still prove to be an astute move.

Stay Positive on the Midstream/MLP Space

A safer way of playing the sector would be to utilize Master Limited Partnerships (MLPs), which offer considerable returns at significantly lower risk.

Most MLPs are involved in storage, processing and transportation of energy commodities such as natural gas, crude oil, and refined products (like diesel and gasoline), under long-term contracts. As such, they have relatively consistent and predictable cash flows with minimal commodity price sensitivity – unlike the E&P companies, whose profits are highly correlated with energy prices.

Ramping up oil production during the past few years has caused the commodity market to enter oversupply territory. Still, there is no slowdown in the crude production as all the big players are competing for their own share. This definitely calls for storage and transportation services, especially when the analysts are expecting the oversupplied market to continue in 2020.

Importantly, the collapse in crude has markedly reduced the average price of U.S. gasoline, the most widely used petroleum product. This is expected to result in massive gasoline volumes across pipeline systems and a boon for operators whose compensation is based on the quantity moving through their system.

Given the current weaknesses in petroleum stocks, MLPs are probably the best method of investing in the sector. They also offer liquidity and tax benefits, which add to their appeal. This is why these stocks would make good additions to your portfolio.

We suggest Phillips 66 Partners PSXP, BP Midstream Partners BPMP and Hess Midstream Partners - MLPs with Zacks Rank #1 (Strong Buy) or 2 (Buy), low cost of capital and an investment grade credit rating.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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