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Michael McDonald

Michael McDonald

Michael is an assistant professor of finance and a frequent consultant to companies regarding capital structure decisions and investments. He holds a PhD in finance…

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Is This The Best Moment To Get Into Oil?

The billion dollar question for investors these days is what to do about oil stocks. Analysts and traders diverge on their views over the future of oil, with many analysts expecting a rebound before traders do.

Yet, it’s clear that even with the minor rebound that oil has seen of late, prices are still dirt cheap. It’s almost inconceivable that oil prices could stay below $20 a barrel for very long, and even prices below $25 for more than a few weeks would likely lead to a rapid curtailment of supply. All of this is a way of saying that if the market is not at a bottom for oil prices, it’s probably close.

Of course, even if the oil market has bottomed, there is no way to know how long it will take for prices to recover. The world could be looking at a V-shaped oil price recovery or a bathtub-shaped recovery. Either way, for investors with a long-term mindset, these are clearly interesting times full of opportunity. That point was recently made by Norwegian Bank DNB. The bank is forecasting a dramatic rise in M&A deals over the next year as stronger and better positioned companies look to swallow weaker and more poorly positioned firms. Related: OPEC Has Never Had As Much Power As People Think

DNB is certainly not the first firm to espouse the view that M&A deals are likely to rise in 2016, and the hiccups in the forecast rise in M&A have been discussed before. But DNB’s broader point is a good one.

The bank is really saying to investors that things cannot get much worse, so for those with a long enough time horizon, it’s better to start looking for investments now rather than wait. That’s axiomatically true whether you are an individual investor looking to buy into oil companies before stock prices rebound, or a firm looking to acquire a target before it is scooped up by a competitor. 2016 will be a momentous year, and more firms will go bankrupt, but it will also be a year of opportunity. Related: ExxonMobil’s New Reserves Fall Short For First Time In 22 Years

DNB is particularly excited about opportunities in the oil service sector, which has been absolutely decimated by oil’s slide. That’s an interesting approach on the part of the bank and perhaps a good one. While many oil companies continue selling their product at a price that is likely far below the long-run average price of oil over the next twenty years, oil service companies are selling a service which is non-rivalrous in consumption. This essentially means that for many of the big oil field service companies today, they can sell the same software, consulting, and drilling services at both the low oil prices of today and the (likely) higher oil prices of the future. Related: Texas Oil Production Remains Resilient In Light Of Low Oil Prices

The key of course is that these service companies have to survive the drought of work at present. And that survival is by no means guaranteed. A perfect example of this is offshore services company Paragon. PGN was spun off of Noble (NE) at perhaps the worst possible time, just as the downturn in the offshore drilling industry turned into a full blown collapse across all methods of oil production. Paragon had a low cost, though an old fleet of drilling rigs. In a normal environment, the firm probably would have been able to carve a nice niche for itself in low-cost low-risk offshore production. The current market environment proved too tough though, and Paragon declared bankruptcy earlier this year.

These are certainly risky times for oil investors and potential acquirers. The most distressed oil firms offer the biggest possible rebound if they can manage to come out the other side of the current Crisis. For those investors that choose badly, they may find their entire investment lost in a bankruptcy filing. With great risk comes great rewards and vice versa.

For more insights into energy investing from the author, visit www.MorningInvestmentsCT.com

By Michael McDonald Of Oilprice.com

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