Citi says oil could fall to $65 in a recession. Here's what that would mean for our stocks

Published Tue, Jul 5 20225:01 PM EDTUpdated Tue, Jul 5 20226:14 PM EDT

Kevin Stankiewicz @in/kevin-stankiewicz-b5593466 @kevin_stank

The price of oil has pulled back considerably in recent weeks after such a strong start to the year, driven largely by concerns of a looming recession. Economic slowdowns, after all, have historically led to lower oil demand. A new note Tuesday from Citigroup analysts examines that historical link and suggests "in a recessionary scenario" this time around, the price of Brent crude could end the year around $65 per barrel; it could potentially fall even lower to $45 by the end of 2023, they say. The five oil and gas stocks owned by the Charitable Trust, which is the portfolio we use for the CNBC Investing Club, would certainly take a hit if Citi's oil outlook comes to pass. Big picture Recession fears hit energy markets again Tuesday, as the price of crude slid more than 8% in the session. Over the past month, U.S. oil benchmark West Texas Intermediate (WTI) crude is down around 15% and fell below $100 per barrel Tuesday for the first time since May. International benchmark Brent crude traded just above $103 per barrel, a decline of more than 13% since June 6. Energy stocks have been slammed, too. As of this writing, all but one member of the S & P 500 energy sector is in correction territory, defined as more than 20% off the most recent high. But even with the recent pullback, energy remains the only one of the S & P 500's 11 sectors to be in positive territory for the year. It's up roughly 24% year to date. What Citi sees The analysts note that Citi's U.S. economists do not expect the American economy to enter a recession, as the Federal Reserve raises interest rates to try taming high inflation. Even so, Citi's economists still are "skeptical about the Fed's ability to engineer a modest slowdown, as the historical experience has been of hard rather than soft landings." "For oil in particular, the historical evidence suggests that global oil demand only turns negative in the worst global recessions. Yet lower demand growth and persistent supply availability results in commodities prices falling in most recessions and in some cases to roughly the marginal cost," they write. To be clear, Citi is making a forecast about the price movements of a commodity that's shrouded in uncertainty and unpredictably. Nobody can say with 100% accuracy what's going to happen to the economy and oil — especially given the overhang of Russia's war with Ukraine. Citi analysts offer a word of caution themselves, writing: "It is difficult to quantify the final impact on global oil demand and prices as we are not sure how severe a recession would be, if it occurs." Citi's note Tuesday also comes just days after JPMorgan warned that Brent c ould reach $380 per barrel in "the most extreme scenario" in which Russia retaliates against potential price caps by slashing its own production by 5 million barrels per day. Those are two very different warnings, underscoring the uncertainty. That said, it's important for investors to understand what could take place based on past cycles, and how different hypotheticals could impact their portfolio companies. We'll do that here with our oil names: Chevron (CVX), Pioneer Natural Resources (PXD), Devon Energy (DVN), Halliburton (HAL) and Coterra Energy (CTRA). What it could mean for our stocks We expect oil prices to remain higher for longer, given the energy-market disruptions stemming from the Russia-Ukraine war and the general supply-demand imbalance for oil, especially if China takes steps to further reopen its economy and welcomes more inbound flights. In our outlook, the higher price for oil would allow the companies to continue generating significant excess cash flow that is returned to shareholders via buybacks and dividends. Of course, we cannot say for sure that's what is going to happen, and Citi's forecast could come to pass. In short, our base-case assumption is that if Brent crude falls to $65 per barrel, the five energy stocks we currently own are likely to come under additional pressure. One thing to keep in mind when thinking about further potential declines in crude, however, is an oil producer's breakeven price — basically the level at which the company could cover its capital budget and its dividend payment. The oil producers we own have a breakeven price that's much lower than $65 per share, offering them plenty of cushion for operations to be profitable even if oil keeps sliding. For example, at a conference June 1, Chevron CEO Mike Wirth said that even if Brent crude traded at $50 per barrel, "we continue to have the capacity to increase the dividend and buy back shares for five years at a $50 price," according to a FactSet transcript. Meanwhile, Devon CFO Jeffrey Ritenour said on a February earnings call the company's breakeven price is around $30 per barrel. Pioneer Natural Resources's breakeven oil price also is around $30 per barrel, CEO Scott Sheffield said on a February earnings call. And Coterra's WTI breakeven price is roughly $40, according to a May 2 presentation for the company's first-quarter results. As for Halliburton, in particular, it is an oilfield services company, so we're less concerned about what it's potential breakeven price is and more on the overall level of drilling activity. That said, the price of oil does have a relationship with the level of drilling activity — namely, higher oil prices can incentivize more drilling activity. At the same time, it's important to remember that surging commodity prices contributed to the hot inflation readings we've been getting since last year. For that reason, the decline in commodities including oil could signal an easing to price pressures in the coming months, a development the Fed is watching closely for as it embarks on a policy-tightening strategy that some fear could induce a U.S. recession. In other words, falling crude prices isn't great news for the near-term direction of oil stocks, but it could ease inflation and help the economy overall because consumers get relief at the pump and companies that use petroleum-based products get help on the input side of things, too. It could translate into a less-hawkish Fed if central bankers see price stability being restored without them raising the federal funds rate dramatically above its current target range between 1.5% to 1.75%. Consequentially, that would benefit a number of other stocks in our portfolio, demonstrating why we preach the importance of a diversified portfolio for long-only investors. In recent months, owning oil stocks has been our hedge against inflation, a way to own some of the companies that actually benefit from higher energy prices. Jim Cramer's Charitable Trust is long CVX, PXD, DVN, HAL and CTRA . See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.

Oil prices will hold steady for the rest of the year with marginal declines in 2023, analysts estimated, with the exception of one who foresees "more bullish than bearish factors" for the market going forward.

Ian Tuttle | Bloomberg | Getty Images