Why This Could Be Just the Beginning Of the Oil Rout

Oil prices are plunging, but could fall much further. But if you want to buy an energy company, go with Canadian Natural Resources Ltd. (TSX:CNQ)(NYSE:CNQ) over Suncor Energy Inc. (TSX:SU)(NYSE:SU).

| More on:
The Motley Fool

Well, it’s official. The Organization of the Petroleum Exporting Countries (OPEC) has decided not to cut production. Both oil prices and the Canadian dollar are plunging as a result.
Does the news get better from here? Well, not necessarily. Below are two big reasons why this could only be the beginning.

1. A war of attrition

First of all, there’s an obvious question that needs answering: why isn’t OPEC cutting production? After all, the cartel has cut production in the past, and gotten oil prices to stabilize as a result.

One reason is that OPEC’s influence is clearly waning, mainly thanks to increased production from the United States. As it stands, the market is clearly in oversupply. So if any producer cuts production, then that may only result in reduced market share. This fact is not lost on Saudi Arabia, OPEC’s most important member.

Instead, the Saudis look set for a war of attrition. After all, the country can afford a long period of depressed oil prices – its foreign currency reserves totalled US$737 billion in August, over three years’ spending. Meanwhile, other OPEC members (such as Venezuela, Nigeria and Iraq) may be in deeper trouble. Russia as well could get squeezed. And many doubt the economic viability of North American oil at current prices.

So the Saudis may benefit more by letting other producers suffer. Perhaps that strategy will strengthen its hand in the long term. But in the meantime, the oil rout could get very ugly for a lot of producers – and investors.

2. Further problems in China

Remember, another main cause of lower oil prices has been slowing growth in China. And the country’s economic problems could get a lot worse.

What makes China scary is its reliance on debt. In fact, private debt has grown by 80% per year from 2007 to 2013. Bad loans have already risen by over 20% in 2014. Frankly, this sounds more like a story from Southern Europe.

If China suffers further, this could be disastrous for the oil market. China has likely become the world’s largest oil importer this year, and eventually will become the largest oil consumer. So energy companies, beware.

Buy CNQ instead of Suncor

Let’s suppose you’re still insistent on some exposure to Canada’s energy sector. Where should you look?

Well, you should go with a company like Canadian Natural Resources Ltd. (TSX: CNQ)(NYSE: CNQ). CNRL has shown an ability over the years to allocate capital effectively, and keep costs under control. It’s probably the company best-positioned to survive a war of attrition.

Meanwhile, Suncor Energy Inc. (TSX: SU)(NYSE: SU) has improved greatly in this area, and is much more disciplined than in years past. Its balance sheet is also strong, a big plus in this environment. But Suncor is not as disciplined as CNRL – just look at the Fort Hills project, which the company is ploughing ahead with, despite marginal economics.

Then again, given the macro winds that are swirling, I wouldn’t blame you for avoiding the sector altogether.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Benjamin Sinclair has no position in any stocks mentioned.

More on Energy Stocks

Canadian flag
Energy Stocks

The Top TSX Stock to Buy Now As Canadians Shift Investments Back Home

Energy stocks are a solid buy, and Cameco stock is one of the best Canadian stocks out there for long-term…

Read more »

nuclear power plant
Energy Stocks

AtkinsRéalis Goes Nuclear: Is This a Turning Point for the Stock?

Could AtkinsRéalis's investment in nuclear power be what sends this stock sky high?

Read more »

Hourglass and stock price chart
Energy Stocks

Should You Buy Cenovus Energy While It’s Below $20?

Cenovus is up more than 25% from its April low. Are more gains on the way?

Read more »

Nuclear power station cooling tower
Energy Stocks

1 Magnificent Canadian Stock Down 13% to Buy and Hold Forever

Canadian stocks can be tough when it comes to choosing the right option, but this one is a no brainer.

Read more »

Aerial view of a wind farm
Energy Stocks

5.8% Dividend Yield! I’m Buying This Dividend Stock and Holding for Decades

There are energy stocks, and then there's this undervalued dividend stock for long-term income.

Read more »

An engineer works at a hydroelectric power station, which creates renewable energy.
Energy Stocks

Should You Buy Hydro One While It’s Below $50?

Given its rate-regulated business, healthy growth prospects, and consistent dividend growth, I believe Hydro One would be an excellent buy…

Read more »

how to save money
Energy Stocks

The Best Energy Stock to Invest $500 in Right Now 

Discover how the tariff situation affects the Canadian energy market and find potential investment opportunities in energy stocks.

Read more »

Dam of hydroelectric power plant in Canadian Rockies
Energy Stocks

Got $3,000? Here’s Why I Would Invest It in These 2 TSX Utility Stocks

Consider investing in these two TSX utility stocks if you want to make the best of your investment capital in…

Read more »