Stock Market Comment: US oil producers at risk

• Oil prices plummeted after Saudi Arabia and Russia started price war

• Shares of US oil companies dived

• Enormous debt pile poses risk for the US shale sector

• Dividend cuts may be the first sign of major problems

When OPEC+ talks collapsed on Friday and oil price plummeted around 9%, investors had no clue what will come next week. Massive oil market crash that occurred on Monday caught investors off guard and has raised questions about what will be the impact of Saudi-Russian price war on the US shale sector. In this commentary we will take a look at US oil companies and outlook for the sector in this difficult landscape.

What has caused the oil market crash on Monday?

First of all, it may be wise to recall how we get here. Oil prices declined amid coronavirus outbreak as demand from airlines plummeted. OPEC was expected to respond to the situation with additional output cuts last week. However, the cartel failed to reach agreement with Russia. In a sort of punishment, Saudi Arabia announced it will reduce prices for its crude and boost production to over 12 mbpd. Russia also reduced pricing and decided to boost production launching an outright price war. Both countries are dependent on oil but have the ability to survive periods of lower prices. However, are US oil companies, especially in the shale sector, as resilient?

Dow Jones (US30) dropped more than 20% from the all-time high and has entered bear market territory. 22,000 pts looks to be a final chance for buyers to halt declines as the next major support is as low as 18,000 pts. Source: xStation5

US shale production looks unprofitable at current price levels

The US shale sector expanded very rapidly in the previous decade. In turn, the United States became the world’s biggest oil producer and moved from the position of net importer to a position of net oil exporter. However, rapid expansion was funded with huge amounts of debt and this debt will need to be repaid one day. Needless to say, a lower crude price makes the task of repaying debt much more difficult. According to Dallas Fed research from May 2019, break-even oil price for most US shale producers sits between $48 and $54 per barrel. Even if those companies managed to achieve some cost efficiencies since the report was released it is unlikely that they managed to lower their break-evens to less than $35. Summing up, the US shale sector is operating at a loss at current prices.

Selected financial data from 2019 for US oil producers. Source: Bloomberg, XTB Research

Some of the US oil companies are more vulnerable than others. In the table above we have presented selected financial data for 2019 for the biggest US oil producers. As one can see Occidental (OXY.US) stands out among the rest due to very high debt-to-equity ratio. This is the fallout of last year’s acquisition of Anadarko - Occidental hoped that higher crude prices will pay for the takeover. Note that the company managed to generate EBIT of $429 million in full-2019 putting its interest coverage ratio at just 0.43.

Significant amount of debt makes the US shale sector highly vulnerable to deterioration in business. However, those that hold this debt are vulnerable as well. We have looked at top holders of US oil companies bonds. Asset managers Vanguard, Prudential Financial and BlackRock are in the lead. Apart from those companies, bonds are held mainly by insurers, what may cause some problems in case crude prices remain low.

As Occidental (OXY.US) has a very poor balance sheet structure, one should not be surprised that it is one of the worst impacted US oil companies. Share price broke below support marked with 2008 low ($39 area) in February and continues to lose ground in March. The company is trading over 70% lower YTD. Source: xStation5

Look out for dividend cuts!

What will be the first signs that US oil companies are feeling pain of lower prices? These are likely to be dividend cuts as paying back debt has a priority over sharing profits with investors. While European investors are more used to dividends being volatile, this is not the case for the United States. Dividends are sacred on Wall Street and any change other than increasing payout meets with poor reception of the market. There is some talk that the United States may bail out shale companies in case the situation does not improve but it is unlikely that such a move would save dividends.

Chevron (CVX.US) and ExxonMobil (XOM.US) are US oil companies with broad international presence. Thanks to this they are less dependant on US shale production that has higher break-even rates. Both companies had high interest coverage ratios in 2019 and their size may make them somewhat more resilient.

ExxonMobil (XOM.US) has reached 127.2% Fibo retracement of the 2010-2014 upward move. This is also an important point in a butterfly pattern and should a bullish candlestick pattern surface there, the stock may start recovery with resistance at $57.00 being a key level to watch. On the other hand, break below the 127.2% Fibo level paves the way towards zone at $31.00. Source: xStation5