Enbridge (TSX:ENB)(NYSE:ENB) stock was once a reliable port in any storm. Throughout several historical bear markets, the company’s shares actually grew in value.
The recent market crash has been different. Since the downturn began, Enbridge stock has fallen by nearly one-third. Its once-lauded position as a reliable stock is now in question.
But many of the basics haven’t changed. The company still owns some of the most valuable assets in the world. Its core business remains resilient against short-term economic shocks.
To be sure, there are growing risks, but the share price decline may be overdone, providing a buying opportunity for bargain shoppers.
Enbridge will survive COVID-19
You’re likely very familiar with the coronavirus market crash. That has dampened oil demand significantly, directly impacting Enbridge, which operates North America’s largest pipeline network. Enbridge is so large that it transports roughly 20% of the entire continent’s crude oil.
With planes grounded and automobile transit grinding to a halt, oil demand has been pressured. But the coronavirus crisis will end, and oil demand will normalize at some point. This is great news for long-term Enbridge investors. But it’s important to note that the pandemic was never really a concern. That’s due to pricing power.
As the largest pipeline operator in North America, Enbridge can play the game by its own rules. Pipelines are incredibly expensive to build, and there doesn’t need to be several competing projects. This creates a monopolistic environment for pipeline owners like Enbridge.
In response, pipeline operators usually charge on volumes. No matter where oil prices head, pipelines generate the same profit, just as long as volumes remain steady, which they almost always do. This dynamic is the biggest reason why Enbridge stock gained in value during 2014, even as oil prices were cut in half.
But the other crash could get ugly
The coronavirus isn’t the only market crash occurring right now. At the start of the year, oil prices were around US$60 per barrel. Dampened demand over the near term should have caused a pricing decline of 10-30%. Instead, oil prices have fallen all the way to US$20 per barrel. What happened?
For years, Canada and the U.S. have been ramping oil supply. Oil sands projects and massive shale oil plays have flooded the market with additional competition. That’s come at a cost to major energy-producing countries like Saudi Arabia.
To shore up pricing, Saudi Arabia suggested that global production should be cut. Russia, a member of OPEC, refused the proposal. To retaliate, Saudi Arabia increased production and slashed pricing. Oil markets plunged on the news. The moves made one thing clear: Saudi Arabia is still in charge of the global oil market.
One other thing should be clear: prices won’t normalize until Saudi Arabia curbs production and raises prices.
An investment in Enbridge stock today is a bet that conditions will normalize quickly. In that case, oil prices will re-balance towards US$50 per barrel, allowing the company’s customer base to remain profitable. This will ensure steady volumes, and thus, steady profits. In this scenario, Enbridge stock is a clear buy.
But what if conditions don’t normalize until next year? The results for Enbridge would be devastating.
The cost of maintaining a giant pipeline network is fixed. So, a small dip in volumes could have a disproportionate effect on profits, as the smaller revenue base would be spread across a static cost structure.
Could Enbridge experience a dip in volumes? Certainly. Canada has some of the highest cost production in the world. Many of Enbridge’s customers don’t break even unless oil prices exceed US$40 per barrel. That’s nearly 100% higher than today’s price.
If Saudi Arabia continues the price war, these money-losing businesses will eventually fold. New investors could be difficult to source amid worries that the pricing war will restart at any time. Many analysts think this is exactly what Saudi Arabia wants: to force high-cost producers to permanently exit the market.
What will the future hold? No one knows. But at today’s valuation, Enbridge stock is either vastly overpriced or severely underpriced. The outcome is up to Saudi Arabia.
