Enbridge Inc (TSX: ENB)(NYSE: ENB) is known for its stability. During the 2008 financial crisis, shares escaped unscathed. During the 2014 oil rout, which saw oil prices cut in half, Enbridge stock was again unfazed.
The coronavirus bear market of 2020 is different. Shares lost 35% in a matter of days. The dividend yield has hit 8.4%.
Is now the time to buy?
This story has two parts
The coronavirus has certainly had an impact on shares. Valuations across the board have come down, Enbridge included. Air and ground traffic has screeched to a halt, causing a sudden dip in oil demand, a fossil fuel that Enbridge transports using its pipeline network. Lower demand for oil means lower demand for Enbridge’s services.
But there’s another factor at play: a war between Saudi Arabia and Russia. I don’t mean an actual war. Instead, it’s a pricing war.
In years past, U.S. shale producers played the villain. Oil prices were hovering around US$100 per barrel in early 2014. By the end of 2014, they had slumped below US$50 per barrel. Surging U.S. shale production was flooding the market with projects that could break even at prices below US$30 per barrel. The higher end of the cost curve didn’t stand a chance.
Since that drop, oil prices haven’t come anywhere close to US$100 per barrel, but they had been improving.
In 2016, oil traded at US$35 per barrel. By the end of 2019, it had reached US$60 per barrel. Once the Saudi-Russia price war broke out, all bets were off. Today, oil hovers at just above US$20 per barrel.
Here’s what happened. Since 2009, Saudi Arabia had been ceding market share to cheap foreign production. The country wanted to cut production to shore up pricing, an action it proposed to the rest of OPEC, an oil cartel of oil-rich countries. Russia refused the proposal. Saudi Arabia slashed pricing in response, sending the market into free fall.
This is a complicated story with countless moving parts, but Russia is certainly hurting from Saudi Arabia’s retaliatory actions. That was likely the goal of the price cuts.
It’s unclear how long the market will remain flooded with cheap oil, but many analysts predict that Saudi Arabia will keep pumping until high-cost projects are permanently taken off-market. That could be devastating for Enbridge’s business.
Isn’t Enbridge stock protected?
As a pipeline company, Enbridge largely charges on volumes, not pricing. That’s why it was able to completely side-step the 2014 oil collapse. Oil prices fell, but volumes remained the same, meaning Enbridge was protected from the turmoil.
This time could be different.
If Saudi Arabia balances the market quickly, conditions will normalize, and Enbridge will have suffered very little throughout the drama.
But, if Saudi Arabia keeps global pricing low until high-cost projects go offline, that would directly impact Enbridge’s bottom line. That’s because Canada has some of the highest-cost projects in the world. Large oil sands operations, for example, don’t break even unless prices are above US$45 per barrel. Right now, they’re generating extraordinary losses.
As the largest pipeline operator in North America, Enbridge is fairly diversified, but its customer base can’t sustain losses forever. Even investment-grade producers will have trouble raising fresh cash into perpetuity.
A bet on Enbridge stock today is a bet on how long the pricing war will last. If it subsides within months, this is a clear buying opportunity. If it persists through the rest of the year, the results could be damaging.
Pipelines have high fixed costs. That’s great when capacity is filled. But when volumes drop, profitability can fall off a cliff.
There are plenty of other dirt-cheap stocks as a result of the coronavirus crash. If you take a bet on Enbridge, be sure to diversify with other low-priced options.
