Oil prices have hit dangerous levels for many Canadian producers, and nobody seems to know what to expect next.
Brent crude, the global benchmark, is trading near US$53 per barrel. West Texas Intermediate (WTI) has broken through the US$50 mark, and Western Canadian Select (WCS), the price that many Canadian companies actually get, has dipped well below US$40 per barrel.
Where do we go from here?
Investors can be forgiven for venting their frustrations regarding the outlook for oil prices this year. Producers are sending mixed messages about the probable severity of the oil rout and, despite their best efforts, media sources and the “experts” aren’t helping make the picture any clearer. Much of the volatility is being driven by discrepancies in opinions regarding the price Saudi Arabia is using for its 2015 budget.
Here are some examples.
$80 oil?
On December 26, Bloomberg ran a story right after Saudi Arabia announced its 2015 budget. The article quoted John Sfakianakis, a former advisor to Saudi Arabia’s Ministry of Finance, who said the Saudi budget assumes a fiscal break-even price of $80 per barrel.
The article also referred to a December 21 statement made by Ali Al-Naimi, Saudi Arabia’s oil minister, who said he believes oil prices will move higher from current levels.
Conclusion: oil is definitely headed higher. Well, maybe not.
$60 oil?
On December 28, Reuters published an article that suggests the Saudi budget is based on an expectation of $60 oil for 2015. The article cited opinions from three analysts working for financial institutions based in Saudi Arabia and the United Arab Emirates.
The article also highlighted a comment made by Ibrahim Al-Assaf, Saudi Arabia’s finance minister, who said the low estimates made by the analysts don’t necessarily reflect Saudi Arabia’s expectation for prices in 2015.
$55 oil?
To make things even more confusing, Istanbul-based World Bulletin published a piece on January 4 that suggests Saudi Arabia is using $55 per barrel as its expected average oil price for 2015. The quoted expert is Naser al-Tamimi, a U.K.-based Middle East analyst.
What should investors do?
There is a lot going on behind the scenes in the oil market. Global producers are battling to maintain market share amid a U.S. supply boom. Some analysts believe the Saudis are trying to push U.S. shale producers out of the market. Other pundits think the lower prices are a ploy to punish Russia.
At the end of the day, producers in the Arabian Gulf will require strong oil prices to support their generous social programs. Saudi Arabia’s 2015 budget is about US$229 billion, but the country is only expecting revenues of approximately $190 billion.
Saudi Arabia has substantial capital reserves that will have to make up for a projected 2015 shortfall, but it’s unclear how long the Saudi government is willing to eat through its cash hoard to protect market share.
In 2014, the Saudis overspent their budget of $228 billion by roughly 28%. Oil sales represented nearly 90% of total 2014 revenue.
If lower prices are a short-term phenomenon, the beaten-up oil patch is probably a good buy right now. If $50-or-lower oil is here to stay for the next two, five, or 10 years, investors should be looking elsewhere for opportunities.
If you believe the price of oil will recover by the end of the year, it’s probably best to focus on low-cost producers with solid balance sheets, safe dividends, and integrated business models. Two of the better picks are Suncor Energy Inc. (TSX:SU)(NYSE:SU) and Cenovus Energy Inc. (TSX:CVE)(NYSE:CVE).
Ideally, the best option is to invest in a company that wins no matter which direction the price of oil goes, and our top analyst has put together the following special report on one such stock.
