The meltdown of the oil market has sent tremors through the oil and gas industry, where companies have already begun slashing budgets, laying off staff, and idling rigs.
On Monday, the value of the US oil benchmark, West Texas Intermediate, plunged into the negative double digits as traders raced to off-load May futures contracts that expired on Tuesday.
On Wednesday morning, WTI that will be delivered in June was trading at about $15 a barrel — down more than 75% since the start of the year.
To no surprise, energy stocks have slipped as well.
In the first three months of 2020, they fell by more than 50%, Business Insider previously reported, while the broader S&P 500 slid by about 20%.
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Now with energy stocks so cheap, many people are asking: Is it a good time to invest in oil? In fact, “how to invest in oil” is one of the top Google searches right now, according to Google Trends.
Morgan Stanley, for one, recommended in a note on Tuesday a “defensive positioning” across North American energy companies.
“While the US supply response suggests the worst may soon be behind us, we anticipate a protracted recovery where stock picking is key,” the bank’s analysts wrote. “Across our North American Energy coverage, we believe high quality, well-capitalized companies are best positioned to navigate through the cycle.”
Here are the insights the bank offered on investing in US oil and gas companies in a transformed energy economy.
The coronavirus pandemic has cratered demand for refined oil products like gasoline and jet fuel, as few people are traveling.
“In many regions, jet fuel and gasoline cracks have reached zero-to-even negative prices,” the analysts said. “In response, refineries have made significant economic run cuts to reduce supply and save costs,”
US refineries have pared back production by as much as 30%, which amounts to a drop of 3.5 million barrels a day, the analysts said.
“Combined with planned maintenance activity not deferred, US refining utilization recently reached 69.1%, the lowest since 2008,” they wrote.
Nonetheless, Morgan Stanley said that over the medium term, oil refineries would “lead energy when demand recovers.”
“An environment of improving product prices and low relative crude feedstock price provide opportunity for attractive margin expansion,” the analysts wrote.
Of the refiners, the bank said Valero Energy (VLO), Phillips 66 (PSX), and Marathon Petroleum (MPC) were strong picks, as they “offer the scale and durability to best weather the current environment.”
“With product storage congestion being a key near-term risk, we also believe these names are relatively better positioned with ability to place barrels either through export or through the retail chain,” the bank said.
Oil-field companies, which construct and operate rigs, are among those hit first when the price of oil tanks.
“The extreme pressure on US producers will lead to substantial spending reductions,” the analysts said, adding that oil-field activity could fall by more than 45% compared with last year. “Therefore, we prefer service companies with global scale, strong balance sheets, and limited revenue exposure to players themselves.”
The bank rated three companies overweight — Baker Hughes (BKR), Schlumberger (SLB), and Tenaris (TS) — while it said the stocks of Halliburton (HAL) and National Oilwell Varco (NOV) “are more challenged.”
Morgan Stanley favors integrated oil firms — those involved in both upstream (exploration and production) and downstream (refining and petrochemicals) activities — that are resilient “from a liquidity and operational standpoint.”
Essentially, the bank is focused on companies that generate a lot of revenue — no surprises there.
Among the companies focused on exploration and production, oil supermajor Chevron (CVX) is an overweight, as are ConocoPhillips (COP), Noble Energy (NBL), and Hess (HES), the analysts wrote.
The bank also gave overweight ratings to a handful of oil producers that operate in the Permian Basin, including Pioneer Natural Resources (PXD) and Cimarex Energy (XEC).
Meanwhile, Concho Resources (CXO), EOG Resources (EOG), and Parsley Energy (PE) are equal weight but “screen well,” the bank said.
“Conversely, steps to preserve near-term liquidity may leave other with meaningful production declines, a higher cost structure, and rising leverage over time — an unsustainable strategy that effectively impairs the business,” the bank said.
Those include Occidental Petroleum (OXY), Continental Resources (CLR), and Marathon Oil (MRO), in addition to most smaller high-yield firms — including Callon Petroleum (CPE), Chesapeake Energy (CHK), Oasis Petroleum (OAS), and Murphy Oil (MUR).
As oil tanks fill up, and producers are forced to shut down wells and restructure their businesses, a “challenged near-term path” is created for midstream companies, which are involved in processing, storing, and transporting oil, the analysts said.
Again, Morgan Stanley is focused on “balance sheet strength and cash flow durability.”
Strong picks are Enterprise Products Partners (EPD) and Magellan Midstream Partners (MMP), whereas the “headwinds” mentioned above will challenge Oneok (OKE), Plains All American Pipeline (PAA), and Targa Resources (TRGP), according to the analysts.