Oil Stocks: Searching for the Bottom

Oil stocks continue their slide as American energy firms cut major projects and pay down debts. Billions of dollars have been pumped into exchange-traded funds (ETFs) by investors expecting a plateau in the price of Brent crude oil, the global benchmark, currently at its lowest in years. Now, one week before many companies report fourth quarter earnings, many investors are asking, where is the bottom?

On the New York Stock Exchange, big-name players like BP, ConocoPhillips, and Chevron are selling shares at rates sometimes more than 25 percent below mid-summer highs, when oil prices hovered steadily over $100 per barrel. Investors eager to earn high yields on long-term purchases are pumping billions of dollars into stocks and ETFs anticipating an oil price rebound. Since November, four of the largest U.S. ETFs have received money, even while oil futures plunged 41 percent. “It’s a testament that after such a wild selloff people are more eager to step in and wait for this eventual rebound,” Stoyan Bojinov, an analyst for ETF Database told Bloomberg.

The floor for oil industry stock prices is largely dependent on the price of oil, which has shown little sign of impending recovery. Last November, the Organization of the Petroleum Exporting Countries (OPEC) agreed to maintain current production levels, despite growing non-OPEC supply and shrinking global demand. High oil prices make capital expenditures worthwhile, which influences the value of publicly traded companies on the stock market. In one longitudinal study, the U.S. Energy Information Administration (EIA) found that crude oil futures on the S&P 500 and the price of West Texas Intermediate crude were positively correlated at various times since 2008. The risk tolerance of investors, the EIA says, helps determine the strength of this relationship.

The agency cautions that crude oil prices are frequently correlated with other macroeconomic indicators that simultaneously affect oil futures. The depreciation of the U.S. dollar, for instance, influences the price of oil outside the U.S., as well as the profits of non-U.S. oil producers. This has led some commentators, like John Authers, to caution against a U.S. stock bubble largely driven by low inflation and greater foreign investment. Conversely, the oil price affects the U.S. trade deficit, which places downward pressure on the value of the U.S. dollar.

Capital Expenditures

The brunt of the oil price slump affects investment in capital-intense projects. On Wednesday, the Canadian Association of Petroleum Producers said that capex spending in Western Canada would fall by one-third. "We don't know exactly where oil is going to go, but all capital spending related to the energy sector is going to be very impaired this year," Paul Karos, senior portfolio manager at Whitebox Advisors, told CNBC. French international oil company Total announced that it would trim capex spending by ten percent as it rolled back costly ventures in the U.K. North Sea and the Canadian oil sands. U.S.-based Chevron indefinitely suspended high-cost exploratory operations in the Arctic last month, and uncharacteristically delayed announcing its 2015 capital budget as it reassessed its financial position later this month.

The capex downturn is particularly pronounced in North America where small and medium-sized U.S. and Canadian shale oil producers incur higher costs. IHS, a global energy research consultancy, says 80 percent of tight oil capacity additions in 2015 will require a West Texas Intermediate price of $50 to $69 per barrel to break even and generate a ten percent rate of return. Writing in the Financial Times, Ed Crooks observes that American shale is flexible, meaning—compared with significantly more costly ventures in deep water or oil sands—shale can be “ramped up and down more quickly.” However, many of these companies, Crooks adds, have accumulated significant debts during the American energy boom—upwards of $200 billion since 2010—a 55 percent increase.

The table below indexes the adjusted closing stock prices for five oil majors (BP, Chevron, ExxonMobil, Shell, ConocoPhillips) and five smaller oil and gas companies (EOG, Anadarko, Goodrich, Continental, Occidental) against the daily average price of West Texas Intermediate (WTI) crude oil. As of this writing, WTI has fallen by 55 percent since its $104.59/bbl price six months ago. In the intervening time, shares for Goodrich Petroleum, which drills for oil and gas in the Tuscaloosa Marine Shale, saw an 88 percent drop in share price, or $20.59. Continental Resources, a major petroleum liquids producer with large holdings in the Bakken shale region, saw shares fall $110.77, or 73 percent over the same period.

More insulated by integrated and diversified assets, large international oil companies (IOCs) have seen more modest declines in per share stock values. ConocoPhillips was the hardest hit of the IOCs examined here. Its stock fell by $22.22, or 26 percent, over this six month period. The company recently cut its capital budget by one-fifth, or $3 billion, following a review of its lower-margin assets. ExxonMobil, meanwhile, saw less movement in its stock price and recently indicated that it plans to stick with its capex budget of $37 billion this year.

All of this leaves the question: With oil prices, where is the bottom?

Time will tell. Saudi Arabia and other OPEC nations have so far refused to scale back production, and the future remains unclear for now. Companies with less diversified assets will keep scaling back operations to meet break-even costs. Several smaller and mid-size oil and gas producers will drill in a sub-$50/bbl price environment to pay down debts. And larger IOCs will trim back expensive capital plans, while the oil price decline steadily sniffs out competition at the margins. “[Investors] are not leaving the sector,” Lamar Villere, a portfolio manager at Villere & Co. told the Associated Press, “but there’s just this massive, uncontrollable question mark in terms of the price of oil.”