New OPEC Oil Agreement Changes Every Thing
First time in 8 years OPEC has come together and agreed to a reduction in production by 750,000 bpd. This is remarkable for the Saudi and Iranians to come together. While the deal may unravel, it seems unlikely. Saudi Arabia in particular bought themselves some time in the last 2 years to start restructuring their economy to survive the end of the desert oil.
We investors on the other hand, became comfortable with declining oil prices in the last couple of years. Now things will reverse. Costs will go up, inflation will increase, goods will become more expensive, and people will have less money to spend.
There is a glut in the market with excess oil. However, this glut can be easily worked off. Also remember, the global demand for oil continues to increase. Currently, oil is oversupplied to the extent of 0.31 million bpd, so a 0.75 m bpd reduction is not enough to cut into the accumulated oversupply as it exists, but over time it will chip away on the oil buffers. There are also demand increases projected and if Russia and other non OPEC producers join in, we are looking at a very quick tightening of the oil market. I listed my reasons way back in March of this year (Huffington Post: Why Oil Stocks Will be the Best Investment in 2016)
Many businesses and their stock prices have suffered in the low oil environment in the last few years. These businesses will now see new growth and stock prices will therefore appreciate.
Although it is likely that the OPEC agreement may still unravel, it is not very probable.
How to Invest in Oil and Stocks in Related Industries to Profit from the Rising Oil Prices
Key to note here is that while oil companies (of all kind) will be direct beneficiaries of the OPEC production cuts, some other related and ancilliary stocks will also benefit.
1. Oil Drilling and Exploration
Normally, the cost structures are the lowest in traditional E&P, followed by Oil Sands and Shale. Deep water drilling tends to be most expensive. As oil price recovers, deep water drillers will be the last to return to profitability. Shale will recover faster.
Remember shale – we will come back to this theme again in this article.
Last year as the oil prices bottomed, we invested in what was the cheapest oil stock in the market with one of the strongest balance sheets around. The company was small. As it happens with strong companies with pre ponderance of cash and little to no debt, in a cyclical downturn, especially if the company operates at a cost structure that is lower than most of the industry, this company started buying up cheap assets from other struggling competitors. As a result, now that the prices are poised to improve, the company sits on reserves that is more than twice the size of last year. Increased market share, better cost structure and increasing margins due to better prices – what else one wants in an investment.
Stock is cheap too.
Premium members of course know which stock I am talking about.
These are the Exxons and Shells of the world. They will improve their margins. Higher prices means the revenues will go up, but so will the cost, so margins are more important in these cases. Keep an eye out. Many of these stocks were darlings of the dividend income investors and may have lost shine as their dividends came under pressure in the last couple of years. When the dividends start rising or re-instated, there will be renewed investment interested and more dollars will come chasing these stocks.
We own one of the large global conglomerates that is also exposed to petroleum which stands to benefit from the new price improvement cycle.
3. Suppliers to the Oil Industry
What these could be?
I am talking about companies both earlier and later in the value chain. So these can be geological and surveying firms, rig suppliers, consultants, etc. In the later stages, we are looking at pipeline operators, and other transporters.
Coming back to Shale – Keystone pipeline is kaput. So we are left with transportation by tanker cars. We own one of these too that will do very well as the shale production starts coming on line.
4. Ocean Oil Tankers and Shippers
These are a little bit hard to analyze and predict that they will benefit. Rising global oil demand certainly calls for more oil to be transported, and the oil companies will be better able to pay higher shipping rates, if that were to happen. Worth a speculative dollar but keep in mind that many of these oil tanker shipper stocks have actually been doing quite well in the past couple of years.
5. Grocery Stores
If you have paid attention, there is a war going on in the grocery aisles.
Groceries are becoming cheaper as the stores compete with each other to get the consumers in the store. In some cases, the margins have gone down to nothing and some products are sitting at negative margins. This is a typical price warfare where any one firm is unable to raise prices to even protect its margin.
A rising oil price makes everything expensive and is a trigger to raise prices. The price war fare will stop and the consumers will be back to paying through the nose for groceries.
We investors may benefit.
– Oil Market Report
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