The Oil Market Has a Secret, and Most Investors Know Nothing About It.
Last week, Matt Badiali mentioned that investors ran from the markets because the oil markets were so volatile. From October to December last year, the SPDR S&P Oil & Gas Exploration & Production ETF decreased by 50 percent.
Some investors are learning the secret, and these shares are starting to come back.
Analysts are predicting that oil production will continue to increase at the rapid pace that was set in 2018, and crude prices will remain low because there is so much extra crude oil at the moment. In fact, oil companies have been priced as if oil prices will remain in the $50 range throughout 2019.
Matt Badiali says that these investors are wrong. He believes that oil prices will rise at a faster rate than the investors think they will. That’s because U.S. oil production is experiencing a decline.
Let’s take shale oil production as an example. It fell by approximately 200,000 barrels per day after hitting its peak. That may not be much, but it is telling us that we can expect to see more of this. That’s because when oil prices are low, the shale producer gets hurt. In order to break even, producers need oil prices to be more than $45 per barrel.
During the fourth quarter, prices were so low that they gave the oil industry a chance to expand. In a survey done by the Federal Reserve Bank of Dallas, growth was practically not detected from the third quarter to the fourth quarter. This doesn’t mean that the sector is contracting, but it does mean that the contraction could be coming soon.
When the shale sector is not growing, production will have to stop. The fact is that shale wells produce a majority of the oil that they ever produce in the first 18 months of their existence. After that, production decreases dramatically, and as production in the United States begins to fall, oil prices will start to rise.
The secret is the fact that most people in the oil industry know that oil prices wil be higher this year than the market thinks they will be. The Dallas Fed learned that a percentage of the participants in the aforementioned survey believe that oil prices will be lower than $50 per barrel this year.
As a matter of fact, 33 percent of these respondents believe that oil prices will be between $50 and $60 per barrel. In addition to that, a full 64 percent of respondents believe that oil prices will be higher than $60 per barrel. People in the latter group obviously know something that we do not know, but their interests are greater than ours. They wholeheartedly believe that oil prices will be higher in the future than they are today.
The optimism being expressed by these companies means that the market is undervaluing oil companies at this moment. In fact, analysts are saying that prices will begin to recover in the first six months of this year. Nearly 24 analysts took a survey that was given by Bloomberg, and these analysts predicted that Brent crude would rise to $70 per barrel. In addition to that, the median forecast for West Texas Intermediate crude will be $61.13. Analysts made predictions for U.S. crude as well, and they predicted that it will rise to between $59 and $66 per barrel.
In order to ensure that his followers are knowledgeable about the stocks that they will be purchasing this year, Matt likes to give them a lot of information. Matt Badiali has a long background in the industry. He started out as a scientist after he graduated with a Bachelor of Science in Earth Sciences from Penn State University and a Master of Science in Geology from Florida Atlantic University. He was working on his doctorate at the University of North Carolina when he became acquainted with finance.
Because Matt Badiali’s background was in science, a friend of his wanted to work with him to develop new methods of investing. The methodology the two friends developed was put to use to help average people become investors. Now, Matt is dedicated to helping regular people find the best investments in natural resources, metals and energy. His students regularly publish gains that are in the double and triple digits.
During 2018, crude oil prices were hovering around $50 per barrel, but when the Trump administration granted waivers to Iran’s key buyers, crude oil dropped to lower than $50 a barrel. This drop could significantly hurt smaller oil companies this year, so Matt suggests that investors only focus on those that can survive with the crude oil price as low as it is now.
We must also differentiate between the crude oil stocks that we are able to purchase. An oil stock is one that deals with barrels of oil in some capacity, but the stock also involves oil’s byproduct that is known as “natural gas.” These stocks must be traded publicly on the stock markets with each share that is purchased giving the investor ownership in the company. The money is to be used to further the business objectives of the company.
Oil stocks fall under the umbrella of “energy stocks,” but energy stocks are not necessarily oil stocks. One example is public utilities. These stocks do not deal with oil or gas. Gas stations are considered to be retail establishments. Lastly, Saudi Arabia’s national oil company is not an oil stock because it isn’t being publicly traded.
Now that crude oil prices are below $50 per barrel, the outlook began to be a little confusing to people. The growing demand for oil that was increasing in the past has finally begun to slow down. That was after the International Energy Agency predicted that the demand for crude oil would increase to more than 1.5 million barrels per day this year. By the end of 2018, it had lowered this estimate by 110,000 barrels per day for several reasons.
The growing demand for oil was dissipating, but the crude oil supply was still going up with the United States contributing by setting an oil production record last year. The U.S. Energy Information Agency expects production to average 12.1 million barrels per day this year.
Matt Badiali also teaches is students how to find the best oil stocks, and he reminds us that some oil companies can prosper in a climate such as the one we are experiencing now, but others cannot do this. The crisis that began at the end of 2014 is still affecting some of these companies, but there are others that have found a way to continue operating through these days of lower oil prices. These are companies that have healthy balance sheets that are prepared to withstand the current economic climate, and you can find them by looking for the following:
- The first thing you must ask of a company is whether or not it has an “investment-grade credit rating.” This score tells you whether or not a company could meet all of its financial obligations in the event that its debts all came due after an economic crisis.
- A comparison between a company’s earnings or assets and the amount of its debts is known as the “leverage ratio.” Oil investors will need to check the company’s debt-to-EBITDA or earnings before interest, taxes, appreciation, and amortization. Oil companies should have a debt-to-EBITDA that is below 2.0 times. In addition to that, companies that have exposure to commodity prices must have a debt-to-capital ratio that is less than 30 percent.
- The last measurement is the company’s liquidity. These companies must have enough cash to be able to finance the business for several months.
Matt Badiali suggests that we participate in this climate by purchasing the SPDR S&P Oil & Gas Exploration & Production ETF. The exchange-traded fund or ETF contains a mixture of production companies as well as exploration companies. The shares bottomed last month at $24 per share, but they have climbed 25 percent since then, and Matt Badiali expects them to climb even higher.