American Money: Is There Hidden Value in the Energy Sector?

By David Lee Smith, Ph.D

While you probably haven’t done much driving of late, it likely has nothing to do with inflated gasoline prices. In fact, if you’ve effectively turned your staying-at-home time into to what now seems like a full-time incarceration, you may not have realized that petrol prices in most of the U.S. have plummeted to well below $2.00 per gallon.

The war that was

Saudi Arabia and Russia launched a crude oil price war as the pair began flooding the market sending prices cascading to levels not seen in years.

That, of course, is attributable to the crude price war that began last month, after the world’s second- and third-largest oil producing nations, Saudi Arabia and Russia, came to loggerheads. When that occurred, rather than cutting production to support global crude prices in the face of the expanding global coronavirus, the pair began independently flooding the world’s market, sending those prices cascading to levels not seen in years.

To be precise, within a matter of hours after the war broke out, West Texas Intermediate crude had plummeted from the middle-$40s to the mid-$30s. And as this is written, they’ve since dived further to the point that they’re now spending time in the teens. Amazing though it may seem, earlier this year a barrel of crude fetched slightly more than $70 on the world markets.

Can this help?

So, you’ve heard that there’s been an agreement reached during the past weekend that could nudge prices back to the levels at which producing companies and countries can stave off financial disaster. That would be somewhere north of $50 a barrel. Unfortunately, however, the information that you received was only half correct.

You see, after the United States, which has become the world’s biggest producer in recent years, much of the remainder of the world’s crude output is generated by the somewhat infamous Organization of Petroleum Exporting Countries (OPEC). Three years ago, that cartel joined with Russia and some smaller producing countries to form what has come to be called OPEC+. That arrangement worked fine until March, when the uproar described above fostered the pummeling of prices.

There is speculation that the agreement reached during the past weekend could nudge prices back to the levels which could stave off financial disaster. Unfortunately, however, the information that you received was only half correct.

The specifics

This past weekend, however, the Saudi-led OPEC nations, along with Russia, agreed to a deal wherein the OPEC+ group would trim production by a total of 9.7 million barrels a day in May and June. As has been unreported by the mainstream media, the deal was effectively brokered by President Donald Trump.

As the deal is structured, in addition to the OPEC+ contributions, other countries in what is called the Group of 20, or G-20, nations, will also participate. In total, the U.S., Canada, and Brazil will trim their production by 3.7 million barrels a day. And, not to be outdone, other members of the G-20 will pull back by a combined 1.3 million daily barrels. But what also hasn’t been heavily advertised is that the reductions could require as much as a year or more to be accomplishments and will only last for about two years.

Mexico came out as at least a technical winner as the deal was structured. The country had initially been asked to reduce its output by about 400,000 barrels a day. But when its President Andres Manuel Lopez Obrador balked, President Trump was forced to negotiate a side-deal that would have the U.S. cutting 250,000 barrels a day and Mexico’s reduction lowered to 100,000 barrels a day. As a rider, the plan calls for Mexico to reimburse the U.S. for its contribution at a later date.

Down but not out?

With all of this as a backdrop, the key question for investors becomes one of the desirability of participating in the energy sector at current levels. In reality, even the larger, more stable companies in the group have made for a wild ride for quite a while now. For instance, ExxonMobil (XOM) shares have fallen by about 47% since a year ago, while Occidental Petroleum’s (OXY) have given up 76%. Among the service folks, Schlumberger (SLB) has made a 66% retreat year-over-year, and Halliburton (HAL) shares are 75% lower than a year ago.

So, the picture that’s been painted for energy would have us all believe that it’s over for energy as a viable area for investors. But that may not be entirely correct. We’ll discuss some more specific aspects of the group’s potential future in a coming piece.

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