It makes sense to be bearish on oil prices right now. The sharp pencils agree that the U.S. is headed for imminent recession, prodded by a crisis of confidence in our banking system. The price of oil has plunged by 17% since the first week of March, to $67 per barrel. Natural gas is down 50% since December. Shares in the companies that drill for the stuff have sold off by about 20% in recent weeks.
Meanwhile, supplies are plentiful. We’re still seeing the supply response from a 40% surge in oilfield capital spending, triggered by last year’s $100+ oil prices. Domestic oil production is set to grow 500,000 bpd to 12.9 million this year. And even oil production out of Russia has been resilient; at 11.3 million barrels per day, just a touch lower than when Putin launched the Ukraine invasion.
But is is time to be scared, or brave?
“Oil markets have turned excessively pessimistic about the outlook,” writes Goldman Sachs analyst Daan Struyven and his team in a research note, which lowered its 12-month price target to $94/bbl from $100. “Historically after such scarring events, positioning and prices recover only gradually.”
Still, his $94 is a good sight higher than where we are today. Is such price bullishness at all realistic?
Warren Buffett seems to think so. This month he took advantage of 6-months lows to acquire another 13 million shares in Occidental for nearly $800 million. That raises Berkshire Hathaway’s
equity stake in Oxy to 23%, worth $12.5 billion. Berkshire also holds warrants to buy about 9% of the company for $5 billion, plus $10 billion of preferred stock, on which it receives $200 million in dividends per quarter.
The best passage from Buffett’s recent annual letter made it clear that he doesn’t have any oil price crystal ball, but recognizes the diversification power of fossil fuels to Berkshire’s long-term health, especially given massive federal government deficits.
Though economists, politicians and many of the public have opinions about the consequences of that huge imbalance, Charlie and I plead ignorance and firmly believe that near-term economic and market forecasts are worse than useless. Our job is to manage Berkshire’s operations and finances in a manner that will achieve an acceptable result over time and that will preserve the company’s unmatched staying power when financial panics or severe worldwide recessions occur. Berkshire also offers some modest protection from runaway inflation, but this attribute is far from perfect. Huge and entrenched fiscal deficits have consequences.
Oxy trades at 14 times Jefferies & Co. analyst Lloyd Byrne’s forecast for 2023 earnings based on current commodity prices. There are cheaper options for those of us not buying in on Berkshire’s terms. According to Jefferies’ data the average independent oil producer trades at 11 times earnings. Among the cheapest look to be Northern Oil & Gas with a p/e of 3 and Diamondback Energy
The sector is far stronger than, say, 2020 — when pandemic lockdowns gutted energy demand to the point where U.S. oil prices went negative. Since then companies have sliced out costs and whittled down debt to a manageable 25% of capitalization. Byrne figures the average company needs an oil price of at least $53/bbl to “break even” after paying out for dividends and capital investment.
Among the integrated Canadian oil sands producers, Suncor Energy looks especially interesting, trading at 8 times earnings, 4 times times cash flow, with a dividend yield of 5.3%. Suncor pumps 750,000 barrels per day and traded down nearly 15% last week. For the past year Suncor has been negotiating with activist investor Elliott Management on management changes and safety improvements after five workers died on the job since 2020. If turnaround stories aren’t for you, oil sands peers Canadian Natural Resources and Cenovus Energy look nearly as cheap.
Analysts at THP & Co. say energy sector uncertainty is an opportunity, not reason to panic. Supporting prices, they see China adding 1 million bpd to demand and India up 250,000 bpd this year. Worldwide there exists worryingly small amounts of spare oil production capacity. With Iran still sidelined and Russian output expected to decline by half a million barrels, they see tighter oil markets later in the year.
Now that the price of oil is down to his target level, there’s one person who certainly should be buying oil hand over fist: President Joe Biden. He’s so far sold more than 250 million barrels from the Strategic Petroleum Reserve, which he promised to refill when prices went below $70. Get it while it lasts.