Oil Demand Could Fall By The Equivalent Of Saudi Arabia AND Russia’s Production: What This Means For Oil Inventories

2020 has been one of the worst years for oil that most people have seen. Since oil prices peaked in early January, West Texas crude futures have fallen 70% and threaten to fall below $20 for the first time in nearly two decades. We are on a bad day with US crude prices at the lowest levels since the 1990s.

This sharp and brutal fall is largely due to Saudi Arabia going to war for oil against Russia and American producers, with an all-out attack to flood the world with crude and depress prices for a period prolonged.

Image source: Getty Images.

And as bad as things are already, it could get a whole lot worse. By April 1, when Saudi Arabia begins to increase crude exports by 43%, global demand is expected to have fallen by 20 million barrels per day.

It is the equivalent of Saudi Arabia and Russia’s average oil production in 2019. And with Saudi Arabia and Russia both planning to open the taps on April 1, oil prices could continue to fall as the balance between the supply and demand are further disrupted.

Unprecedented times for US oil companies

American producers in particular are threatened in this environment. Many are already burdened with substantial debt and minimal access to additional cash. Crude oil now sells for about half of what it costs many producers to get it out of the ground and bring it to market.

As a result, oil producers’ inventories fell. the SPDR S&P Oil & Gas Exploration & Production ETF (NYSEMKT:XOP) has lost more than two-thirds of its value from the 2020 peak.

It could easily get much worse. After years of aggressive spending to increase production, independent producers began to cut their budgets. apache (NASDAQ:APA) and Pioneer of natural resources (NYSE:PXD) were among the first to announce plans to cut spending by 40% or more. Other major shale producers like EOG Resources (NYSE: EOG) and western oil (NYSE:OXY) also announced deep cuts, saying their goals were to achieve cash flow equilibrium with oil prices around $30.

Graph of crude oil production in Russia

Crude oil production in Russia given by Y-Charts

Oil was trading near $30 when these spending cuts were announced; they won’t be close to closing the gap now, with Saudi Arabia intent on flooding even more oil into a market that not only consumes less, but is about to run out of places to store everything the excess.

Additional spending cuts are starting to show. Occidental announced last week that it would take more drastic measures, further cutting its capital spending plans and adding $600 million in corporate and operating spending cuts to the plan.

Just the first set of dominoes to fall

Independent oil producers are the most exposed part of the energy sector, but not the only one that will be affected by an extended period of massive excess supply and falling demand. As oil producers begin to run out of cash – and it will happen faster than expected – in the coming months, we will see a domino effect as all service providers and suppliers stop being paid.

This includes drilling contractors, companies that fracture and complete wells so they can come online, companies that sell everything from drill bits to frac sand to pipes, truck drivers who deliver goods and a litany of others.

XL Chart

XLE given by Y-Charts

Even many midstream companies, the so-called “safe” sector of the oil industry, will feel the effects. It doesn’t matter how firm your contract is if the oil producer is insolvent. As a result, many have already started cutting their dividends, joining companies in the oil and gas value chain to cut payouts. More mid-stocks will also be forced to cut their dividends in the near future.

What’s an investor to do? Invest with caution and avoid pure-plays

I have publicly stated that there will be winners in the 2020 oil crash. And I still expect many of the best companies in the industry to survive, and many to thrive in the years to come. Those with the best prospects are diversified giants like Chevron (NYSE: CVX), Royal Dutch Shell (NYSE:RDS.A)(NYSE:RDS.B)and Phillips 66 (NYSE:PSX) (my pick for biggest winner). These companies all have substantial cash balances, ample additional liquidity and manageable debt levels which should help them weather what could be a very ugly year ahead.

Man lighting a 100 dollar bill on fire.

Image source: Getty Images.

Importantly, all three have something that independent producers and many companies that work in the oilfield don’t: diversification. Chevron and Shell will report huge losses in their oil producing segments this year, but unlike pure independent producers, they will be able to rely on their other segments, such as petrochemical manufacturing, to help offset some of those losses.

That doesn’t mean they won’t suffer; my expectation is that at least one of the three will likely end up cutting dividend payouts, and I expect them all to lose money for several quarters in 2020. But they have the balance sheet strength and multiple segments in their businesses to help avoid the worst losses that happen in the oil field.

I am not prepared to predict when things will start to improve, but when they do, it will be the biggest, best capitalized and most diversified companies in the oil and gas industry that will emerge from the other side. If you decide to invest in oil stocks, I suggest you keep this in mind – and accept that there is huge risk ahead – before you buy.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end advice service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.


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Felix J. Dixon