The S&P/ASX 200 Index (ASX: XJO) entered into a bear market earlier in March, before a very short bounce which ended a week ago. At this point in the coronavirus pandemic, it is hard not to think that we will have a recession at some stage this year.
The lower oil price and economic impacts of COVID-19 will be felt by the broader economy, but some industries will be affected positively while others will be hurt.
Here is one ASX industry I think it would be prudent to avoid, or at least be extra diligent with in 2020.
Oil and gas
The Organization of the Petroleum Exporting Countries (OPEC) is an intergovernmental organisation of 14 nations. The organisation effectively operates as a cartel, controlling the supply and thus price of oil. That is, until recently. Russia (which is not an OPEC member) and Saudi Arabia are locked in an ongoing battle over oil prices, after an agreement over supply cuts couldn’t be met.
As a result, oil prices have crashed by more than 30%. This is in addition to a previous 50% decline since the start of the year, due to weak demand.
As the world economy retreats or grows more slowly, demand for oil should continue to be weak. If Russia doesn’t agree to limit supply, we could see the oil price depressed for a while. This isn’t good news for oil companies like Oil Search Limited (ASX: OSH), Woodside Petroleum Limited (ASX: WPL) or Santos Ltd (ASX: STO), as they are price takers.
Drilling for oil, both on and offshore, is a capital intensive business which sees most oil companies carry some level of significant debt. If you do want to invest in this sector, keep an eye on a company’s debt levels and serviceability. A strong balance sheet will keep a company in business and could even provide industry consolidation opportunities via acquisitions.
Another key consideration is to look at the cost of production. The lowest cost producers should lose the least whilst oil prices are depressed.
A Foolish thought
If the valuations in the oil industry are too attractive for you to ignore, make sure you have a long time horizon, diversify and invest with cash you wont need for the next few years.
The quicker we beat COVID-19, the quicker our lives go back to normal. Following the government’s directives for social isolation and the like not only helps health outcomes, but will help the economy and your businesses get back on the path to growth.
Over the next couple of days, I’ll be detailing 2 additional industries I think you should either avoid or approach with caution.
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Motley Fool contributor Lloyd Prout has no position in any of the stocks mentioned and expresses his own opinion. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.