The Oil Bear Market is Back
Will we see dividend cuts?
The oil bear market is back.
A bear market occurs when prices fall by 20% — and that's what we have for West Texas Intermediate crude as of yesterday.
After a near 20% gain in the month of April, oil traded around the $60 per barrel mark for most of May and June but saw sharp declines throughout July.
WTI prices fell 18% this month, while Brent crude fell 13%.
On June 10, WTI traded at $61.43 per barrel, but on Thursday, July 23rd, it closed at $48.45 — a 21% drop in a little more than a month.
This chart tells the story well:
The month of July erased three previous months of recovery for WTI, as several colliding factors ushered in low prices.
It began with the Greek referendum and a quick 10% drop on fears of a “Grexit.”
Then a stronger dollar, a weak Chinese economy, and a dramatic boost in crude oil in storage in the U.S. prompted deeper cuts.
However, the biggest factor, and what may well cause a long-term lag in world crude markets, was a deal between Iran and the United States that would lift sanctions on the Islamic Republic and deepen a global glut of crude.
Iran Plans $185 Billion in Oil and Gas Projects
Although I just mentioned several catalysts for oil's decline in June and July, the real reason remains the same: Supply outweighs demand.
Because of the fracking boom, U.S. oil production is at its highest point in several decades. Saudi Arabia, largely in response to U.S. shale production, has boosted its production to all-time highs. Iraqi production is breaching records, too.
But now that Iran will legally be able to resume exports to Europe and all other countries that followed the sanctions, the glut looks like it could become even worse.
As you can see, Iran's oil exports had been hit hard by sanctions:
From a high of 3 million barrels per day to a low of 1 million, it looks like a reinvigorated Iranian oil industry will hurtle debt-ridden U.S. and Russian oil producers into dangerous territory, lest some other catalyst usher in a bull market.
Not only will Iran resume exports, but the country will also be able to resume new drilling and production programs with foreign oil majors like Total, Chevron, and others.
According to Iran's Minister of Industry, Mines, and Trade, Reza Nematzadeh, Iran will focus on the oil, gas, and auto industries. The country holds the world's largest proved reserves of natural gas and fourth-largest reserve of oil.
On Thursday, the country announced it planned to finalize $185 billion in new oil and gas projects by 2020 and had already sealed the deal on $2 billion worth.
Once sanctions are officially lifted next year (the U.S. Congress still has to have its say), Iran will begin exploring, producing, and exporting crude and natural gas at full bore.
Fears that new Iranian supply will prolong the glut indefinitely run rampant within the U.S. oil industry.
And some companies may take drastic measures to cut costs...
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Dividend Cuts are Coming
After the bear market last fall, oil companies big and small went to great lengths to reduce costs and sustain some profit.
Oil majors slashed anywhere from 10% to 15% of their workforces, while small players slashed new drilling programs and pressured services companies to reduce the cost of tools, services, and equipment.
And this strategy worked insofar as it caused the recovery in April, May, and early June. However, with oil back down to March lows, it seems companies will go even further.
Yet untouchable, but now more tenuous, are dividends.
The only major oil company to cut its dividend payment to investors was Italian major Eni (NYSE: E). But now that a bear market has resumed at a time in the fiscal year when oil and gas companies simply do not cut costs, it seems dividend payments may be an easy bandage on the low price wounds.
I wouldn't be surprised to see major firms cut dividends until oil returns to a reasonable level. Doing so will hurt income that many investors depend on and will almost certainly crush share prices.
As soon as a company cuts its dividend, you can bet investors will flee.
To avoid such a calamity, it makes sense for investors to exit before these drastic cuts take place and re-enter after the sell-off.
For investors who still want income, though, the solution should be master limited partnerships. Like REITs, MLPs pay out 90% of income as dividends in order to avoid corporate income taxes.
MLP companies also have safe business structures that produce stable cash flow from oil, natural gas, and other natural resources.
Because these companies pay dividends that are very high — sometimes over 10% per share — income investors should flock to them when oil majors cut payouts.
Until next time,
A true insider in the energy markets, Keith is one of few financial reporters to have visited the Alberta oil sands. His research has helped thousands of investors capitalize from the rapidly changing face of energy. Keith connects with hundreds of thousands of readers as the Managing Editor of Energy & Capital as well as Investment Director of Angel Publishing's Energy Investor. For years, Keith has been providing in-depth coverage of the Bakken, the Haynesville Shale, and the Marcellus natural gas formations — all ahead of the mainstream media. For more on Keith, go to his editor's page.
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