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Use Oil’s Pullback to Your Advantage

by | Nov 18, 2022 | Market Outlook

On Friday, West Texas Intermediate (WTI) crude dropped under $80 per barrel for the first time since September. The U.S. benchmark is back under pressure thanks to growing recession concerns and questions about global demand.

Global benchmark Brent crude also pulled back as the markets moved into contango. This means futures prices are higher than current spot prices. It signals that demand on the ground is slowing significantly. Most traders are looking at efforts by China to implement a fresh round of lockdowns as COVID-19 cases pick up.

Keep in mind that the Federal Reserve’s interest rate hikes dramatically impact demand…

Today, I want to explain why this recent dip in crude prices creates a fantastic long-term opportunity. I’ll also provide some insight into the top picks for U.S. oil producers for the years ahead.

You Can’t Print Oil

The Fed primarily affects aggregate demand in the economy. When it raises interest rates, it increases the cost of capital for consumers and businesses. This will deter people from expanding their business or spending more today.

But that increasing cost of capital can impact supply in the markets, too. If the cost of capital continues to increase — borrowing costs — then companies may put off the expansion of their operations.

That’s especially true in the U.S. oil markets. From 2011-021, the cost of capital for new oil and gas projects increased from 8% to 20%, according to Goldman Sachs. With rates moving higher this year, naturally, the cost of expansion is also moving higher.

This is important because we already have a serious capital crunch hitting the global oil markets. According to JPMorgan, there is a $500-billion gap between the amount of money “we have” and the amount “we need” to produce enough oil to meet global demand through 2025.

And that’s just the supply side… Remember, oil is priced globally in U.S. dollars. About 80% of the global market trades in dollars. Another 16% is referenced in U.S. dollars. This means traders may settle their payments in another currency, like euros, but they will reference the exchange rate between euros and dollars before completing the transaction.

With the dollar surging this year, a retracement downward is likely for the greenback. With that pullback in the future, oil prices will increase to the relative movement in the dollar.

Oil also isn’t going away anytime soon. Despite all of the foolish efforts by politicians and environmentalists to shut down carbon-based fuel, oil and gas has only decreased from 82% of aggregate energy consumption in 2012… to 81% in 2022.

Despite spending $3.8 trillion on the global transition, that’s how little of a dent we’ve made. This matters because the world runs on oil — and the global economy was built around the commodity.

Fools will finally realize that throwing money at the problem isn’t going to solve it. Oil will remain a critical tool in the future, and emerging markets aren’t set to abandon it like the West desires.

Playing the Oil Market

I look at this pullback as an opportunity. Yes, there will be a recession and there will be impacts on the demand side.

But the Fed can’t just cut interest rates without driving demand higher again. In addition, China will eventually return to the markets and reopen. It’s just a matter of time.

In this environment, patience pays off. I know that people want to make lots of money in a short period of time.

However, we can see great long-term investors like Warren Buffett biding his time with companies like Occidental Petroleum Corp. (NYSE: OXY). This year, Buffett’s company, Berkshire Hathaway Inc. (NYSE: BRK.A), bought huge stakes in OXY every time the stock pulled back to the $56 to $58 range.

Meanwhile, Devon Energy Corp. (NYSE: DVN) is a major producer in the shale business. It currently pays a 7.5% dividend for an oil producer — that’s incredible.

Typically, you only see that level of dividend in storage and pipeline companies that act as limited partnerships. Devon continues to produce oil at a terrific profit, and it’s returning cash to investors at an incredible rate.

Finally, you should look at ConocoPhillips (NYSE: COP). The oil and gas producer is reportedly turning a profit on oil projects at a breakeven price of $45 per barrel. In addition, the company has two major natural gas projects that will benefit from the continued export revolution to help Europe keep its lights on.

You may only get one or two more pullbacks in oil in the coming years. Now is the time to put some money to work and take advantage of the unbalanced supply-demand situation. The economy will eventually recover, global demand will restore and patient investors will make an incredible windfall.

Enjoy your day,

Garrett

WRITTEN BY<br>Garrett Baldwin

WRITTEN BY
Garrett Baldwin

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