Can the price of oil fall to $15 a barrel? This may sound dubious to anyone who has watched the oil-producing countries operate for nearly a decade, but the oil stocks have now dropped to 1978-79 levels when the price of oil was $15 to $ 20 per barrel.
The oil stocks that were the darlings of the 1980 stock market have fallen 40 to 60 percent from their 1980 highs and 20 to 50 percent in the last seven months. Energy companies specializing in coal, oil services, and natural gas have been pulled down as well, dropping 50 percent in some cases from their 12 -month highs. The collapse of the energy sector has been blamed by many analysts for causing further weakness in the general market.
Now, one analyst, Bruce E. Lazier of Paine Webber, Mitchell Hutchins Inc., thinks oil stocks may have been oversold by the market even if the price of oil falls to $25 per barrel -- the current assumption on Wall Street. ''Twenty-five-dollar oil is not the end of the world,'' states Mr. Lazier. ''Stock prices are back to 1978 levels and in 1978 the price of oil was $15 per barrel. We're a long way from that.''
Earnings, he believes, will not go back to 1978 levels even if the price of oil dropped 36 percent to $25-a-barrel. He figures the companies would be shielded from a portion of this drop by the government. Since their marginal tax rate is 75 percent, the companies would absorb only 25 percent of the oil price cut. This would drop Getty's earnings 35 percent, Marathon's 34 percent, Sohio's 31 percent, Phillips's 28 percent, ARCO's 27 percent, Gulf's 26 percent, Exxon's 14 percent, Mobil's 13 percent, and Tenneco's, a gas company, by 8 percent. The stocks of these companies have already fallen more than that in the past seven months.
On a net present-value basis, the oil companies are likewise cheap. Wall Street is discounting the value of the companies' oil and gas reserves by a much greater amount than they would actually fall if the price of oil fell to $25 per barrel. From an asset point of view, says Mr. Lazier, the stocks have been discounted more than they have been historically. And, historically, he notes, they have been cheap. ''Now they are even cheaper.''
In spite of his belief the stocks are undervalued, Mr. Lazier says he is not recommending them to his firm's customers. ''If the price of oil falls to $25 per barrel, analysts will begin to discount them even further,'' he states, adding, ''the price of oil has to stabilize for a while.''
Then, how low can the oil stocks go?
Assuming the oil stocks fell to a price-to-earnings multiple of three times earnings, and they earned 25 percent less than many analysts' current estimates, they could still fall some. However, in most cases, the yields alone would make them attractive investments. Exxon, for example, earning $5 a share (25 percent below Mr. Lazier's 1982 estimate), and selling at three times earnings would be selling at $15 per share. At that level, the stock would yield 20 percent. The same is true of most of the other oil stocks. Their dividend yield - assuming they could continue to pay dividends - would cushion them from falling much further.
Although Mr. Lazier is not recommending oil stocks, he believes some natural gas stocks are bargains at these levels. ''I would pick up Transco, Texas Oil & Gas, and Texas Eastern, on any weakness,'' he says. ''They are the better bargains.''
If the price of oil did drop as low as $15 a barrel, the coal companies would be clobbered, he points out, since they have built up huge cost structures. However, again it would take the price of oil falling to $15 per barrel, and he concludes, ''I don't think that will happen.''
Trading on the New York Stock Exchange reached a frenzied pace last week as volume ran around 70 million shares for three consecutive days. According to stock-market analysts, the reason for heavy volume was massive portfolio switching by the big institutions. Richard McCabe, vice-president for market analysis for Merrill Lynch, Pierce, Fenner & Smith Inc., says trading of blocks of stock of 10,000 shares or more represented 39 percent of the market's volume last week. By way of comparision, a year ago it was 22 to 30 percent.
In the past, heavy volume has sometimes indicated market bottoms as institutional investors dumped their stocks. However, Mr. McCabe says the heavy institutional activity dosen't represent a switch by the pension funds and trust departments into cash. ''They aren't hoarding their cash yet,'' he says, adding, ''They still believe they can ride out the economic difficulties of 1982.'' He notes that the big traders are switching from energy stocks to more defensive groups such as utilities, food stocks, and health-care issues.
How much further can the slide go?
Mr. McCabe believes the market has yet to reach bottom. He says, ''It either stops at the 800 level and we get a moderate March rally, and then a deeper decline or we have a deeper decline now and then a couple of months of rising stock prices.'' Either way, the outlook isn't bright.
The stock market continued on its toboggan ride last week. The Dow Jones industrial average slipped 17.03 points last week, ending at 807.36, a two-year low. Short term interest rates fell last week but traders were worried about reports that the economic recovery would falter again later this year. RCA was extremely active and lower last week. The company announced it would cut its dividend in half and restructure is board of directors.
Oil companies faltering stock prices Company Current price Price 7/81 % change High 1980 % change Amerada Hess $16 $30 -47% $50 -68% Cities Svc. $26 $56 -54 $60 -57 Exxon $28 $35 -23 $47 -36 Gulf $28 $35 -20 $50 -44 Mobil $21 $31 -32 $45 -53 Shell $30 $45 -33 $60 -50 Std. Oil Ind. $35 $57 -39 $90 -61 Sohio $31 $48 -35 $90 -66