Did morale improve? Doesn't look like it. Saudi Arabia moved aggressively this weekend to increase oil production moving forward while offering large discounts to key markets. Instead of cutting back production to 9 million bpd, some believe production could eventually approach or even exceed 11 million bpd. The move that coincided with "consolidation of power" moves within the Saudi royal family, targets Russia, as Russia led non-OPEC oil producers that normally align with the cartel away from agreeing to last week's proposed reductions to production. Russia, it appears, has other ideas, instead choosing to target higher cost producers that would include the U.S. shale industry.
Hence, an oil price war is born. Saudi Aramco traded 9% lower on Sunday. That selloff does not appear to be a factor in the Saudis' plan to move forward. Russia, for its part, can fall back on a $170 billion national wealth fund if need be, in order to sustain efforts to remove weaker hands from oil markets. The fact that these moves occur simultaneously with a demand shock already being experienced across not just energy markets, but global economies, due to the negative impacts of the spreading Covid-19.
Ancillary markets have all been impacted. As demand for oil declines, so does demand for U.S. dollars, which may just be what Russia is getting at in the first place. In addition, Asian and European equity markets have all taken a pasting, as investors poured into the perceived safety of U.S., UK, and German sovereign debt securities among others.
Here in the U.S., where the shale industry has broadly struggled to produce profitability, there will at these market prices be difficulty in servicing existing debt, which will in turn harm lenders... not to mention make accessing further financing far more difficult.
The Question
One has to ask... in this era of a slower pace in the velocity of transaction, just what level if there is one, will produce greater demand for oil? There has to be a price where someone either sees opportunity or simply stores product in anticipation of a better day down the road. While that day is probably not today, and may not be tomorrow, there is a silver lining.
The Fed, for its part, increased the size of its daily repurchase operations to at least $150 billion. Why that's important is that it sends the signal that the Fed will not allow a liquidity crunch should the banks exposed get into a jam. In addition, and this is just me thinking out loud, as investors pressure the long end of the U.S. Treasury curve, the Fed will feel compelled to pressure the short end. While many will not like that, with similar behavior at other central banks, the attempt to maintain - even if flattened - some integrity on the slope of the yield curve is important as both growth and inflation become suspect.
Energy
As readers know, for the most part, I did evacuate the Energy sector not too long ago after taking a series of lumps in the space. This was not because I saw any of this coming, or even the severity of the Covid-19 virus ahead of time. This rotation for me was simply caused by the behavior of other portfolio managers. As that subset of market participants grew younger and more socially conscious, it became as obvious as watching demand and supply that the oil patch would never command the high PE ratios of years past.
As I closed what used to be my Energy book, I moved my lone position, that of BP plc (BP) over to my dividend book. I foolishly did not want to take my exposure to the sector down to zero. At these prices I still do not. As I write this piece, I must consider the future of that "not very large" position. The temptation is to jettison that name and wash my hands (for more reasons than one). I've been washing my hands a lot lately.
BP pays an annual dividend of $2.52. At a last sale of $26, that's a yield of 9.7%. Given the firm's past projections for production and cash flows, I had held the belief that this firm could sustain it's dividend at current levels. That's why I held on here when I sold off my shares of Chevron (CVX) , Exxon Mobil (XOM) , and Royal Dutch Shell (RDS.A) . I really do not know how well cash flow holds up in an environment that pays so much less for a barrel of oil.
That said, I am not... I repeat, I am not selling BP today. In fact, I am more likely to add to that position at some point this week. Perhaps investors would be wise to invoke the Jim Cramer "three day rule" where energy is concerned. At least Clorox (CLX) is up today.
(BP and Clorox are holdings in Jim Cramer's Action Alerts PLUS member club. Want to be alerted before Jim Cramer buys or sells these stocks? Learn more now.)
