Royal Bank of Canada (TSX:RY)(NYSE:RY) is a blue-chip stock. It has a stellar reputation in Canada, with a long-term stock performance to back it up. In 1995, shares were priced at $6. A few weeks ago, they hit $110. The recent market crash, however, is adding some doubt.
Since mid-February, RBC stock has fallen by nearly 30%. The dividend, long regarded as a reliable payout, has spiked to 5.2%. That’s caught the eye of many value investors. When coronavirus fears subside, there’s a chance that today’s prices will be a steal.
But the market crash isn’t that simple. There’s another sinister factor at play: the oil war. Of course, we’re not talking about an actual war, but a pricing war.
The true market crash
For years, resource-rich nations like Saudi Arabia and Russia have ceded market share to new entrants, including low-cost U.S. shale projects and massive oil sands facilities in Canada. Saudi Arabia, it seems, had enough. The country proposed that OPEC, an influential oil cartel of which it’s a member, cut supply to boost prices. Russia wasn’t interested.
In response, Saudi Arabia slashed pricing and rapidly increased its own production. Global prices nosedived in response, plunging from US$60 per barrel to just US$20. Saudi Arabia’s motives are unclear, but there are two possible explanations.
The first is that it wanted to punish Russia for its dissent. As mentioned, Saudi Arabia has needed to compete with a growing number of global projects, particularly in the U.S. and Canada. Its latest actions, however, prove to everyone that it’s still in charge.
The second potential motive is that it wants to permanently drive out higher-cost production. As we will see, this could be devastating for RBC stock.
Buy with caution
As I wrote last week, the market crash may have just begun in Canada thanks to the oil bear market.
“Canada is the sixth-largest energy producer, the fifth-largest net exporter, and the eighth-largest consumer of energy in the world,” I explained. “Canada’s energy sector directly employs more than 260,000 people and indirectly supports over 550,000 jobs. Annual government revenues from the sector regularly bring in more than $10 billion, an unsurprising figure considering the sector represents 11% of GDP.”
If Saudi Arabia wants to keep prices low until foreign competition exits the market, Canada’s energy sector is in trouble. U.S. shale producers break even at roughly US$25 per barrel, sometimes less. Canada’s oil sands sector, for comparison, breaks even at roughly US$40 per barrel, often higher. If Saudi Arabia wants to push out U.S. competition, Canada’s entire energy sector will simply be another domino in the collapse.
These facts paint a dire picture for RBC’s loan book.
According to RBC’s website, the company is a “top lender to corporate clients in the North American energy sector.” It has “significant dealings with most senior and intermediate E&P products.” The bank currently has $8 billion in loans to the energy and gas sector, up from around $6 billion in 2014.
RBC’s energy loan book could face severe headwinds in the year to come. But if there’s an extended oil downturn, Canada’s economy will also be crushed, especially when considering second and third order effects. These forces in combination would force RBC stock much lower than the current price.
A bet on RBC stock today is a bet that the market crash won’t continue. But it’s also a bet that the oil crash won’t continue. The fate of that is entirely up to Saudi Arabia.
