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Oil: OPEC Finally Agrees And Investor Takeaways

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Dividend Income: 5 October 2016

Summary

  • OPEC has agreed to put a ceiling on oil production at 32.5 million barrels per day, representing a 900k cut from its current output at 33.4 million.
  • The news supported oil’s rise by nearly 10 percent, and benefits some companies significantly more than others.
  • The author still recommends to stay away from offshore, but upstream producers with lower break even cost could be an attractive investment. Integrated majors’ dividends are also safer than ever.

News Summary

To the surprise of everyone, the Organization of Petroleum Exporting Nations (OPEC) has agreed to put a ceiling on oil production at 32.5 million barrels per day, which is significantly less than its current 33.4 million barrels per day of production. The news has helped oil price rally nearly 10% to almost $51.50 per barrel Brent.

In this article, I will try to dissect the news and its effect on integrated majors, upstream producers and offshore producers. Of course, the news benefit some of these companies significantly more than others, which are actually unaffected or evenly negatively affected by the news. Similarly, I will analyze how it will affect the United State Oil ETF (NYSEARCA:USO) and other oil related ETFs going forward.

Effect on Integrated Majors

Since the price of oil has risen around $4.00 since the announcement, integrated majors such as Exxon Mobil (NYSE:XOM), Chevron (NYSE:CVX), BP (NYSE:BP) and Royal Dutch Shell (NYSE:RDS.A) will likely welcome such a change. Some of these companies pay hefty dividends and their sustainability has been called into question lately. With the announcement, these companies will likely have additional upstream profits ranging from $150 million to $400 million per quarter, which will significantly help with cash flow and strengthen its ability to pay its dividends going forward.

More specifically, holding onto Royal Dutch Shell (RDS.A) and BP (BP) is becoming a better idea as the likelihood of a dividend cut for the companies has just disappeared.

In conclusion, look to continue holding onto integrated majors such as Exxon and Chevron.

Effect on Larger Independent Producers

Larger independent producers and those with lower costs such as ConocoPhillips (NYSE:COP) are becoming a more attractive and viable investment as the price of Brent rising to $51.50. Earlier this year, the company has aggressively cut costs in order to survive in the low oil price environment, and its break-even costs have reached around $49 per barrel Brent. As the company’s profits have a sensitivity of around ~$120 million dollars per year per dollar of Brent change, the announcement has helped the company’s cash flow by around $0.5 billion, which is quite significant. In addition, the news allow ConocoPhillips to stop the bleeding and turn profitable as it waits for crude demand to pickup and eliminate excess inventory.

Generalizing, any upstream producer with breakeven lower than $50 is a good investment opportunity at the moment as the producers turn profitable from a former loss. These producers are on the “right side of the fence” as oil stalls around $51.00, and will be able to start paying off some debt rather than continue to lose money.

Effect on Producers With Higher Costs

For producers with higher costs such as Hess Corp (NYSE:HES), the production cut news has a very limited positive effect. Granted, the production cut has boosted oil price and helped limit the negative cash flow for the company, but its breakeven cost of $60+ is still too high and its losses are still coming. Since North American shale players are likely to pump more oil and press oil prices below $55 per barrel.

As a result, companies stuck in shale and deep-water plays such as Hess Corp are not companies worth looking at currently. Look for alternative companies with lower break even costs instead.

Effect on Offshore Drillers

Frankly, the production cut has nearly no effect on offshore drillers, as the companies need significantly higher prices ($65) in order to sign new contracts. Granted, the production cut has brought oil prices higher, but it just does not relieve enough pressure off of producers to consider offshore drilling. In addition, the shale industry will likely pump more oil at this price point and keep up the production, pushing oil prices below $55 per barrel.

As a result, the author recommends investors to stay away from offshore drillers, such as Seadrill and Transocean for now. Be particularly mindful of Seadrill and its high debt load.

Conclusion

In conclusion, the OPEC announcement benefited integrated majors and lower cost independent producers significantly more than higher cost producers and offshore drillers. In fact, the news generally only benefits producers with breakeven around $45 to $52 per barrel, as the incremental oil price is likely to bring more shale producers online, preventing oil’s advance beyond $55 for a very long time. Hence, look to purchase or hold integrated majors and low cost upstream producers with the news.

Disclosure: I am/we are long XOM, CVX, COP.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

SOURCE

royaldutchshellplc.com and its also non-profit sister websites royaldutchshellgroup.com, shellenergy.website, shellnazihistory.com, royaldutchshell.website, johndonovan.website, shellnews.net and shell2004.com are all owned by John Donovan. There is also a Wikipedia article.

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