It's a brave, new $10-a-barrel-of-oil world.
Investors were buzzing about how to play the collapse in oil prices that helped spur this week's announcement of a $75.3 billion merger of Exxon and Mobil. If oil at $10 a barrel is here to stay, or prices are headed even lower, as a growing group of Wall Streeters believe, what does it mean for investors?Whether the collapse in oil prices is bullish or bearish for the overall market is a matter of debate on Wall Street. Lots of investors are adopting the view that oil is headed to the $8 or $9 range, even as commodity prices in general tumble.
Conventional wisdom is that low oil prices are good for the stock market because of the anti-inflationary effect they create. But this time around, investors aren't so sure, especially because of the uncertainty about the degree to which weak demand in Asia is fueling the drop in prices.
"Low oil prices are stimulative. But the continuing decline of commodity prices is spooky. Commodity prices are back to the 1970s levels, and it just means that demand in the world must be much weaker than people realize," says Morgan Stanley market strategist Barton Biggs.
Nearly all the stock pundits agree that more mergers are bound to be announced in the energy sector. Normally that too would be great news for stocks. But this time may be different as well, analysts say, and it may be wise for investors to sit out this round of pick-the-next-merger candidate. That's because the Exxon-Mobil merger is viewed as one being struck out of weakness, rather than strength, as the two oil giants scramble to find a way to profit in an environment with oil prices at their lowest level in 26 years, in inflation-adjusted terms.
Charles Maxwell, the longtime dean of oil-industry analysts who built his reputation during the oil-price run-ups of the 1970s, doubts that oil prices will return to their 1997 levels in the low-to mid-20s "until between 2003 and 2005." Formerly with Deutsche Bank and now a part-time consultant, Mr. Maxwell predicts that in the meantime, oil prices will fall to $8 or $9 a barrel, the lowest inflation-adjusted levels since the Depression.
With that kind of scenario making the rounds, investors drove down stock prices of nearly all the major oil companies, not to mention the beleaguered oil-service stocks. Both Exxon and Mobil fell, with Exxon closing down $3.37 1/2 at $71.62 1/2, while Mobil fell $2.25 to $83.75. Chevron also fell $1.68 3/4 to $81.93 3/4, and Texaco dropped 87.5 cents to $56.81 1/4.
Some oil-service stocks fared even worse as investors concluded that further consolidation in the oil industry will continue to slow spending on oil services, such as drilling. Schlumberger fell $1.62 1/2 to $43.06 1/4, and Halliburton fell $1.75 to $27.62 1/2.
Under Mr. Maxwell's scenario, most of the small U.S. independent oil producers would hit the wall, being forced to liquidate or merge. He adds, "small and midsize service companies would have great difficulty surviving. The same consolidation trends would work to eliminate most of these names as they are pulled into the larger surviving companies."
The best thing for investors to do, Mr. Maxwell says, is to "stay out of the game. If you knew the winners and losers in the mergers, you could play it. In the early 1980s, however, buying merger candidates didn't work at all. They all came down anyway." The stocks didn't rebound, he says, until oil prices hit bottom and started to recover.
Mr. Maxwell is by no means the only analyst sounding such cautionary notes. "These stocks have yet to recognize the realities of the industry environment. We are in the early stages of a market-share war whose consequences at the very least are a price of oil noticeably lower than it is now," says Mark Gilman, an oil analyst at Furman Selz.
Mr. Gilman says he believes plunging oil prices sent Mobil, hoping to preserve its relatively strong share price before low oil prices caught up with it, into the arms of Exxon. The prospect of $10-a-barrel oil, he says, led to "a concern about stock-price implications that led" Mobil Chairman Lucio Noto "to do something for his shareholders. My belief is he said 'My goodness, my stock could be considerably lower, and I don't have anything in my own arsenal to keep it high.' "
All the gloomy talk didn't stop some investors from speculating about the next merger target. Two frequently mentioned candidates were Atlantic Richfield, which rose 62.5 cents Tuesday to $67.12 1/2, and Amerada Hess, which fell $2.18 3/4 to $53.31 1/4.