Since the start of 2020, the FTSE 100 crash has knocked 20% off the value of top UK shares. A barrel of oil has crashed to around $35, and a whole bunch of explorers and producers are under threat yet again.
The industry is in a particularly pessimistic state right now, and I can certainly see why investors might stay away. But the FTSE 100 crash has brought back to me one of Warren Buffet’s best-known pieces of advice. We should, he urges, “be fearful when others are greedy and greedy when others are fearful“.
I’ve no idea how long oil will stay this cheap. It could be for quite some time. Industry will surely get back to normal eventually, but transport could be changed for the long term. And there’s a very good chance that some oil companies will go bust. That’s especially as, at current prices, there are some whose costs of production and debts mean they’re struggling to make ends meet.
Oil survivors Oil supply and demand must come to balance once again, at a price that’s profitable for whichever companies survive the FTSE 100 crash. So, how can we avoid Buffett’s famous first rule of investing, to “never lose money?“
I think one way is to find oil companies that are profitable at current oil prices. Another is to look for strong balance sheets, ones that are good enough to make it through the crisis. I would definitely avoid companies in the middle, without the needed balance sheet strength, and struggling at current prices.
So for me, Premier Oil (LON:PMO) and Tullow Oil (LON:TLW) are right out, falling far further than the FTSE 100 crash. Both are under the pressure of massive debt piles. And the extra cash flow from $60 oil that was helping chip away at that debt has vanished. So far this year, the Tullow share price is down 62%, and Premier oil is down a painful 70%.
If they survive, they could make very profitable recovery buys. But the risk is way too high for me.
FTSE 100 crash survivors At one end of the options scale, I’d place the big two, BP (LON:BP) and Royal Dutch Shell (LON:RDSa). Last month, shell cut its dividend for the first time since World War II. And that is a sign of how serious things are.
But I have little doubt that BP and Shell will survive the FTSE 100 crash and the oil price slump. Or, if things become so bad that they don’t, we’ll have far more important things to worry about than our investments. Their share prices are down, with BP losing 35% and Shell 45%.
I think that actually makes them better recovery candidates than Premier or Tullow. Not such big falls to potentially claw back, but a lot less risk.
Small and profitable At the other end, there’s tiny Gulf Keystone Petroleum. Now, Gulf’s shares are down a whopping 65%. And with full-year results in April, we heard the firm has suspended its expansion and is moving into defensive mode.
But, Gulf does not have the debt problems of some of its peers. The firm reported $164m in cash at 22 April, with no debt payments due until 2023. So maybe avoid the FTSE 100 crash altogether. I think Gulf Keystone could be offering the best risk-to-reward ratio of them all.
The post Why the FTSE 100 crash makes me want to buy oil shares today appeared first on The Motley Fool UK.
Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2020
First published on The Motley Fool
