Following a steep decline, oil prices have typically bounced back reasonably quickly. With oil prices mainly derived from supply and demand rather than from investment, the coronavirus has smashed oil prices to historic lows. When adjusted for inflation, oil is at its cheapest since the end of the second world war.
Oil is considered an essential good and, as mentioned, prices have historically recovered after dropping. This is due to both demand from consumers and organisations such as OPEC limiting supply. Oil generally has relatively inelastic demand, which means that under normal conditions people use the around the same amount of oil, regardless of price fluctuations.
The WTI crude oil price is down from US$63.27 in January to just US$18.57 at the time of writing. That's a staggering drop of 70.65%. While the current price war between Russia and Saudi Arabia is driving prices lower, it's clear that subdued activity caused by worldwide coronavirus lockdowns is the primary cause of lower oil prices.
When lockdowns ease, as they have begun to in many countries, people will go back to their normal activity. This includes normal habits of driving and consuming oil-based fuel.
Below are 3 ways that individual ASX investors can gain exposure to a rebound in oil prices.
Betashares Crude Oil Index ETF (ASX: OOO)
This handy ETF aims to track the S&P Crude Oil Index and make this index available to ASX investors. It does this by investing in oil futures. This ETF is as close to a straight bet on oil prices as the ASX will allow. Currently it is down 84.40% in the last 12 months, and is set for a recovery, in my opinion.
There are some additional risks with this ETF that should be mentioned. For example, Betashares recently released an updated product disclosure statement stating that if the price of oil futures reduces dramatically, the net assets of the fund could be reduced to zero. However, if the oil price recovers quickly, this ETF will also see a sharp bounce. In my opinion it's a simple and effective way to gain exposure to the oil price.
Woodside Petroleum Limited (ASX: WPL)
Woodside Petroleum is a staple oil and gas explorer and producer. It's been around for over 65 years and is the largest producer of oil and gas in Australia.
Woodside Petroleum produced 24.2 million barrels of oil in Q1 2020, an increase of 12% since Q1 2019. In Q1 2020, despite lower oil and gas prices, Woodside Petroleum still made over $1 billion in revenue. Total revenue was $1.076 billion, down from $1.409 billion in the final quarter of 2019 when prices were at more normal levels.
Woodside Petroleum announced a 50% drop in spending during 2020 in response to the impacts of coronavirus. Prior to the pandemic, the company was prepared to undergo a rapid expansion phase. This means that Woodside's balance sheet remains conservative, with cash on hand of US$4.9 billion at the end of February. Gearing remains low at 13.8%. As a result, the company's ratio of debt to assets is modest, allowing Woodside to absorb low oil prices without running into issues with debt covenants.
The company expects costs of oil produced to be $4.50 per barrel, allowing it sufficient room to make a profit, even with oil prices depressed. It has hedged the sale of 13.5 million barrels of oil at $33.47 per barrel until December, so it's now receiving almost double the current oil price from a significant portion of its production. A smart move, given the current circumstances.
BHP Group Ltd (ASX: BHP)
BHP is a major producer of oil, producing 82 million barrels of oil in the last 12 months. This equates to 223,657 barrels of oil per day. At current prices this would fetch around US$1.4 billion per year and still generate profit at current costs.
The last time BHP reported costs, these were US$9.56 per barrel. If the oil price goes back to where it was in January, this level of production would generate US$5.189 billion or AU$7.98 billion in revenue. This is significant, given that BHP's net profit was US$9.185 billion or AU$14.13 billion in the 2019 financial year.
BHP is currently expanding its oil output. According to its latest quarterly report, the company is going ahead with its expansion plans: "[o]ur major projects under development in petroleum and iron ore are currently tracking to plan and are subject to potential impacts from COVID-19." The company forecasts that oil production for the 2020 financial year will be an estimated 110 million barrels and this will continue in the medium term.
For every $1 fluctuation in the oil price, BHP's earnings before interest, tax, depreciation and amortisation (EBITDA) changes by US$38 million. If the oil price recovers to where it was in January, BHP's EBITDA will increase by US$1.6 billion or AU$2.46 billion. BHP could see boosted profits from a recovery in the oil price, particularly as production is expanded.
