Strap In: It’s Going to Get Bumpy

The big news over the weekend was not the coronavirus, contrary to what you might think from watching the news. The most consequential story of the weekend is the oil price war that has broken out between Saudi Arabia and Russia. Saudi Arabia has decided to increase its production and slash its price to punish Russia for not going along with OPEC quotas designed to prop up the price of oil, which has fallen by more than half over the last few months including today’s price collapse. (Can’t help reminding that all the certified “smart people” like John Kerry and Al Gore were telling us 15 years ago that we had reached “peak oil,” and more specifically that Saudi Arabia had likely reached its production peak and would be unable to increase its production over 10 million barrels a day. Heh.)

On the surface this Saudi move will impose significant pain on Russia, which depends on high oil prices to prop up its economy, and will also increase pressure on Iran for the same reason. Likewise American consumers, and oil-consuming sectors like the airlines, can likely look forward to some lower prices. And while the story of the Saudi-Russia feud may be entirely true, keep in mind that a protracted period of low oil prices is going to devastate America’s oil production from fracking in Texas and elsewhere. A lot of the smaller and mid-sized independent producers who have been behind a lot of the increase in domestic oil production were already under a lot of pressure from falling oil prices. If the price stays down around the $30 level it is near today, a lot of the highly leveraged firms will default on loans or head to bankruptcy. Production will start to fall in a few months. How fast could the industry come back again once the price cycle swings back up? Hard to say. The industry is much more nimble than it used to be, and technological progress continues, allowing more and more firms to turn a profit, or at least remain solvent, at lower prices.

A collapse of America’s domestic oil production would benefit Russia and Saudi Arabia in the long run, so it is impossible to rule out the idea that in fact Russia and Saudi Arabia are working in concert with the goal of squeezing American energy capacity, which in turn will hurt the re-election prospects of President Trump. I am always suspicious of “our friends, the Saudis.” The timing is highly suspect. With global oil demand already slack, the current reduction because of reduced air travel and other factors makes the Saudi decision highly opportunistic and most effective on the price point. We know Democrats have been hoping for a recession to damage Trump for a while now, and the media is doing its part to talk us into a recession with the bludgeon of the coronavirus. Now the oil price shock. Who would have thought that low oil prices would be a problem.

Meanwhile, remembering Warren Buffett’s adage (adapted from Ben Graham I think) that the time to buy stocks is when everyone else is panicking, today is a great day to scoop up energy stocks—but only if you have patience and some steady nerves. At current prices, for example, ExxonMobil is yielding nearly 8% on its dividend, and although Exxon faces some tough years ahead and may have to cut its dividend, even a 5% dividend beats the hell out of the near-0% yield that Treasury notes will soon be offering. But don’t buy anything unless you have at least a three- to five-year time horizon.

Prediction: Speaking of Buffett, who is sitting on something like $100 billion in cash, I wouldn’t be surprised to see him take a major stake in an oil company this week, perhaps ConocoPhillips, whose price is down 23 percent today, with total market cap this morning of about $40 billion. Almost pocket change for the Sage of Omaha.

As for California, well, the beatings will continue until morale improves (pic taken over the weekend here):