Tuesday, March 15, 2016

Oil company debt will lead to opportunities in energy stocks (But we have to be patient)

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Regardless of where the crude oil price moves from here, there is little likelihood that any rise in the level will be large (or happen soon) enough to save most companies mired in a vicious cycle of ever more debt.

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You see, even with oil recovering of late – WTI, the Benchmark crude rate set in New York is up 47.69% over the last month – prices are still way too low for companies to make enough revenue to make ends meet. Instead, producers increasingly rely on debt. As credit increases and net cash flows (that is, operating cash minus interest payments and capital expenditures) decline, a significant and expanding gap has emerged.

I pointed out in earlier post about a month ago that even at $100 per barrel oil most of these oil and gas exploration and development companies were cashflow negative. The whole shale boom was predicated on low interest rates and plentiful loans enabled by the central planners at the Federal Reserve. 

The longer prices stay low the more companies go out of business and the more cutbacks to capital expenditure for future production. The good thing for us is that the surviving companies will be able to pick up assets on the cheap and will benefit enormously when prices inevitably go back up in a couple of years. 

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