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Oil Demand Could Fall the Equivalent of Saudi Arabia AND Russia's Production: What It Means for Oil Stocks

By Jason Hall - Mar 31, 2020 at 11:06AM

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It's not good.

2020 has been one of the worst years for oil that most people have experienced. Since oil prices peaked in early January, West Texas crude futures have fallen 70%, and are threatening to fall below $20 for the first time in almost two decades. We are one bad day away from U.S. crude prices being at the lowest levels since the 1990s. 

This sharp, hard drop is largely due to Saudi Arabia going to war over oil against Russia and U.S. producers, with a full-out attack to flood the world with crude and drive prices down for a sustained period of time.

Miniature oil barrel and pumpjack on U.S. currency.

Image source: Getty Images.

And as bad as things are already, it could get much, much worse. On April 1, when Saudi Arabia starts pumping crude exports 43% higher, global demand is expected to have dropped as much as 20 million barrels per day.

That's the equivalent of both 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 supply-demand balance gets further out of whack. 

Unprecedented times for U.S. oil companies

U.S. producers in particular are at risk in this environment. Many are already burdened with substantial debt and minimal access to additional liquidity. Crude oil is now selling for about half what it costs many producers to get it out of the ground and onto the market. 

As a result, oil producer stocks have plummeted. The SPDR S&P Oil & Gas Exploration and Production ETF (XOP 0.92%) has lost more than two-thirds of its value from the 2020 high. 

It could easily get much, much worse. After years of aggressive spending to grow output, independent producers have started gutting their budgets. Apache (APA -0.40%) and Pioneer Natural Resources (PXD 1.96%) were some of the earliest to announce plans to cut spending by 40% or more. Other major shale producers like EOG Resources (EOG 0.84%) and Occidental Petroleum (OXY 0.06%) have also announced major cuts, saying their goals were to get to cash-flow breakeven with oil prices in the mid-$30 range. 

Russia Crude Oil Production Chart

Russia Crude Oil Production data by YCharts

Oil was trading close to $30 when those spending cuts were announced; they won't come anywhere close to bridging the gap now, with Saudi Arabia intent on flooding even more oil into a market that's not only consuming less, but about to run out of places to store all the excess.

Additional spending cuts are starting to come out. Occidental announced last week that it would take more drastic action, further reducing its capital spending plans as well as adding $600 million in corporate and operating expense cuts to the plan. 

Just the first domino set to fall

Independent oil producers are the most exposed part of the energy sector, but not the only part that will be affected by a protracted period of massive oversupply and falling demand. As oil producers start to run out of cash -- and it will happen more quickly than expected -- in the months ahead, we will see a domino effect as all the service providers and suppliers stop getting paid. 

This includes drilling contractors, companies that frack and complete the wells so they can be brought online, companies that sell everything from drill bits to fracking sand to pipes, truck drivers that deliver the goods, and a litany of others. 

XLE Chart

XLE data by YCharts

Even many of the 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 across the oil and gas value chain in cutting payouts. More midstream stocks will be forced to cut dividends in the near future, too. 

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

I've gone on the record that there will be winners in the 2020 oil crash. And I still expect plenty of the best companies in the industry will survive, and many will thrive for years to come. The ones with the best prospects are diversified giants like Chevron (CVX 0.14%)Royal Dutch Shell (RDS.A) (RDS.B), and Phillips 66 (PSX 1.89%) (my pick for the biggest winner). These companies all carry substantial cash balances, and have ample additional liquidity and manageable debt levels that should help them ride out what could be a very ugly year ahead. 

Man lighting 100 dollar bill on fire.

Image source: Getty Images.

But most importantly, all three have something that independent producers and many of the companies that do the work in the oilfields don't: diversification. Chevron and Shell are going to report huge losses from their oil production segments this year, but unlike pure-play independent producers, they will be able to rely on their other segments, such as petrochemical manufacturing, to help offset some of those losses. 

That's not to say they won't suffer; my expectation is that at least one of the three will probably end up cutting dividend payouts, and I expect they will all lose money for multiple quarters in 2020. But they have the balance sheet strength and multiple segments in their businesses to help stave off the worst of the losses that will happen in the oil patch.

I'm not willing to predict when things will start to improve, but when they do, it's the biggest, best capitalized and most diverse companies in the oil and gas industry that will come out the other side. If you decide to invest in any oil stocks, I'd suggest keeping that in mind -- and accepting there's massive risk ahead -- before buying. 

Jason Hall has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Occidental Petroleum Corporation Stock Quote
Occidental Petroleum Corporation
$65.73 (0.06%) $0.04
Apache Corporation Stock Quote
Apache Corporation
$34.70 (-0.40%) $0.14
Royal Dutch Shell plc Stock Quote
Royal Dutch Shell plc
Chevron Corporation Stock Quote
Chevron Corporation
$159.85 (0.14%) $0.23
Phillips 66 Stock Quote
Phillips 66
$90.00 (1.89%) $1.67
EOG Resources, Inc. Stock Quote
EOG Resources, Inc.
$114.49 (0.84%) $0.95
Pioneer Natural Resources Company Stock Quote
Pioneer Natural Resources Company
$232.95 (1.96%) $4.47
Royal Dutch Shell plc Stock Quote
Royal Dutch Shell plc
SPDR Series Trust - SPDR S&P Oil & Gas Exploration & Production ETF Stock Quote
SPDR Series Trust - SPDR S&P Oil & Gas Exploration & Production ETF
$140.25 (0.92%) $1.28

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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