Over the past couple of months, there’s been a general belief that oil prices have bottomed out at US$50 per barrel. There’s also been a belief that prices will rebound, perhaps in the second half of this year. After all, producers are cutting back on drilling, and low prices may lead to increased demand.
Those forecasts are not looking too good right now. Despite reduced drilling, production remains very healthy. Demand has not been able to pick up the slack. The oil price has fallen to US$43, well below the supposed US$50 support level, and there’s plenty more room for this number to fall.
There are two major scenarios in which the oil price will collapse even further. One is a nuclear deal with Iran, which would allow for more oil exports from the country. The other scenario concerns oil storage capacity in the United States, which is running out. If full capacity is indeed reached, then oil prices could fall lower than previously imaginable. To illustrate, we’ve heard forecasts as low as US$20 per barrel.
So, what happened the last time we had a supply-driven price collapse in the oil market? To answer that question, we need to look back to 1986.
What happened last time?
In 1986, oil production around the world was surging and Saudi Arabia was not happy about this. In response, it increased production too in order to defend its market share. The move sent oil prices crashing by 67% over four months down to just over US$10 per barrel.
Did oil prices recover afterwards? Well, not really. There were some price spikes (for example during the first Iraq war), but otherwise the oil price remained stagnant for years. By late June 1998, the price had once again fallen to US$11.69.
How should you prepare for this collapse?
In order to prepare yourself, step one is very simple: sell all your Canadian oil stocks. These companies are clearly not prepared for any collapse. For example, Suncor Energy Inc. is pressing ahead with its Fort Hills oil sands project, even though it needs oil prices of US$90+ to be economic.
Step two, you should own companies that actually benefit from low oil prices. One is Magna International Inc. (TSX:MG)(NYSE:MGA), Canada’s largest auto parts manufacturer. Magna specializes in making parts for large vehicles, and is thus perfectly positioned for lower gasoline prices, which these vehicles depend on.
Another is CAE Inc. (TSX:CAE)(NYSE:CAE), a provider of simulation products and services, mainly to airplanes. The aviation industry is reaping the rewards of low fuel prices, which bodes very well for air travel and aircraft orders. So, there should be plenty of demand for CAE’s products for a long time.
