The fourth-quarter numbers are rolling in, and things are looking great for oil and gas companies… considering the crash in oil prices.
But we must be careful…
The numbers are based on fourth-quarter production, and oil prices only began to crash hard in early December.
In other words, the current quarter’s numbers are going to be much, much lower. And in order to survive, companies are severely cutting spending.
That’s fine for now… But if prices stay low, major energy firms won’t have any qualms about taking the next step – sacrificing investors by cutting energy sector dividends to save their own skin!
Cutting to Save
We’re in the midst of what’s likely to be the most interesting earnings season in a decade for the oil and gas industry.
But in anticipation of low numbers for the next few quarters, many companies are already tightening their belts.
You see, if we experience a low-price environment for over a year, energy sector dividends will definitely start getting cut.
Fortunately, I do think prices will start to rise before the year is done. But before that happens, companies will adjust their spending to keep their earnings up in the meantime.
It’s a tried-and-tested strategy. Many companies can cut costs quickly and put off future spending by delaying projects that were on the table. Layoffs and rig cancellations are also picking up.
But there’s an upside for investors here…
Oil Austerity’s Silver Lining
Some companies – like BP and Chevron (CVX), for example – are already curtailing spending by billions of dollars, which is more than enough to cover dividends in the short term.
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Now, while these tactics may be bad for employees and oil services companies, they are good for investors.
And although it may not seem like it, cost-cutting, project delays or cancellations, rig cancellations, and cuts in research and development are good news for the industry in the long term, too. Why?
Because they all point to the same thing: steady (or less) future production.
This is important, because production is the key to a price recovery. If production is cut or maintained, it gives time for demand to catch up. It’s really the only way out, and that also spells opportunity for those willing to take risks early in an uncertain environment.
Prices for these energy companies’ shares will rise well before actual demand and supply are again at equilibrium…
Ready for a Price Rollercoaster?
Once companies announce that production growth is slowing or falling in the second and third quarters, prices will pick up again.
Indeed, the market is already showing signs of recovery, but the current volatile geopolitical state of affairs means prices are in for a bumpy ride in the meantime. For example…
Prices spiked when Russia announced a ceasefire with Ukraine (although firing hasn’t ceased much at all). But this actually may result in more oil on the global market, not less, as the threat of sanctions is reduced.
Iraq is exporting a million barrels per day more this year than last year.
The Saudis, who started this price spiral, won’t be happy with a quick recovery in prices, as it will keep their competition – namely, U.S. shale producers – alive. However, while Saudi Arabia has the capacity to increase production and wipe out U.S. shale, I doubt it will actually pull the trigger since it needs the revenue as much as other OPEC countries in order to maintain social stability.
Ultimately, the energy sector isn’t at harried as it was, but we still need to pay close attention…
Price pullbacks – especially to the $40-per-barrel level or lower – should be viewed as buying opportunities.
In the meantime, cutbacks are coming – and the price of oil and oil company shares will react well in advance of equilibrium being achieved.
I’m off to San Francisco this week, where I’ll be getting up close and personal with many energy sector executives at the EnerCom Conference. It will be interesting to say the least! Look out for my real-time findings from the scene.
And the chase continues,