The oil price crash was inevitable.
To understand why we have to review a bit of history.
In 2013, I began warning of the risk to oil prices due to the ongoing imbalances between global supply and demand. Those warnings fell on deaf ears.
Nobody wanted to pay much attention to the fundamentals at a time when near-zero interest rates were pushing banks, hedge funds, and private equity firms, to chase the “yield” in the energy space. Naturally, with money flooding into the system, companies were forced to drill economically unproductive wells to meet investor demands, which drove supplies higher.
This week’s #MacroView is a broader commentary on the more general issues of the oil market. However, given this backdrop of what oil prices will likely remain suppressed far longer than most currently imagine, some opportunities exist in the energy space.
We recently added positions in Exxon (XOM), Chevron (CVX), and the SPDR Energy ETF (XLE) to our portfolios. We believed the companies offered significant value before the crisis, and offer even more due to the sell-off in oil.
Based on our discounted cash flow model for XOM and CVX, we think both companies are 25% undervalued. The model assumes very conservative earnings projections for the next three years and a low EPS growth rate after that. In addition to trading at a steep discount, we think their strong balance sheets put these companies in a prime position to purchase sharply discounted energy assets in the months ahead.
These stocks, and the sector, will be volatile for a while, but we intend to add to these positions in the future and potentially hold them for a long time.
Now, for the rest of the story.
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