Dealing With The New Oil Price Reality

Buckle in. It’s going to be a very long haul.

By Dan Dicker, Oil & Energy Insider:

You cannot go long on oil here. But I also think it’s impossible to be short. What that leaves us with, as we’re trying to trade and invest in the energy space, is more than a bit of a conundrum.

The OPEC meeting’s outcome was no surprise to anyone – all the ink being spilled on the ‘end of the cartel’ or other such nonsense is just that.

The Saudis have had a plan. They’re out to destroy non-OPEC production and regain control of the global marketplace. They’ve been following that plan for the last year, and gotten little in the way of help from other OPEC members, or destruction in production elsewhere – so far.

So they ratchet up the pressure. What, $45 a barrel isn’t low enough to force 20 large cap US and Canadian E+P’s into major restructuring? How does $35 strike you then? Are some of your ready to cry ‘Uncle’ yet?

That’s what’s been going on with oil stocks in the last week, since the meeting’s outcome last Friday.

Oil company shareholders are realizing this ‘ain’t no game’ and that prices are going to stay low for as long as it takes to shake out some of the weakies.

To use the parlance of the day – “Stuff” just got real.

A great parallel I got this week was from my friend Paul Siluch at Raymond James in Canada – where they dealing with their own serious stresses in the oil patch.

He draws a comparison from the tech bubble in 2000 and charts the movement of Cisco (one of the survivors of that crash) to EOG Resources (one of the likely survivors of this oil bust, which I own and have recommended).

One of the major similarities likely to play out in the oil patch is with corporate bankruptcies. During that disaster in tech more than a decade ago, a lot of very big names finally disappeared (remember Nortel and World-com?) before the sector began to recover.

If this parallel view holds even more value, two more takeaways emerge – oil prices and oil stocks are in for another year of depressed action (which I think is about right) and a significant short covering rally will happen in the meantime before ultimate lows are reached (which, considering the overwhelming number of shorts in oil futures is, I think, also quite likely).

Both of these takeaways tells us a bit more about how to approach our energy investments today.

First, investing in oil stocks, even the best ones, should come with a very long time horizon in mind.  Paul thinks as I do that valuations don’t go down much from here, provided you’re holding one of the survivors.

It also says that many energy companies that we thought of as staples in the patch won’t be around in the same form at this time next year. I don’t need to tell you what those names are, as the market may be telling us already – if they’re down more than 70% from their 2014 highs, you’re likely looking at a goner.

It also allows for a trade or two or three in the meantime – that short covering rally is likely to be a doozy.

It’s for all these reasons that certain oil stocks will get recommended by me at very specific prices. I’m again looking to buy EOG at $72, Hess (HES) at $50 and Cimarex (XEC) near $100. Some of these shares will be traded around, some will be held with a long-term goal in mind. Your situation will dictate what you do.

But the most important things is continuing to stay away from the doomed as I have advised countless times. Nothing good will come from either trading, or investing in those.

Buckle in. It’s going to be a very long haul. By Dan Dicker, Oil & Energy Insider

Oil is brutal. But for those prepared to survive this bust there are huge opportunities. Read… It’s Always Darkest Before The Dawn

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  26 comments for “Dealing With The New Oil Price Reality

  1. Alec says:

    Well, the US spent decades complaining that OPEC was an all but illegal cartel that was keeping prices artificially high. Now OPEC has decided to let the chips fall where they may, and they are complaining that they won’t support prices, and that that’s having a negative impact on the US’ own oil sector… yups, that’s about the definition of consistency.

    • Wolf Richter says:

      Alec, let me add some nuance. The US oil patch never once complained about OPEC trying to drive up the price. I lived in Oklahoma when OPEC threw its weight around in the early-mid-70s – and the place was BOOMING. Tulsa was still called “Oil Capital of the World.” The sky was the limit. When oil plunged, Tulsa went into a depression.

      It all depends whether you’re paying for oil or whether you’re trying to get rich off it. In the US, we have both in ample supply, hence the diverging complaints.

      • Pakilolo says:

        Not once in this article about the price of oil did I find the words “CLIMATE CHANGE”. Somehow our survival on planet earth has no relevance about the future of oil.

        • Wolf Richter says:

          Pakikolo, this wasn’t article about climate change or the presidential election or nude sunbathing. This was an article about the price of oil. Not every article in the universe is going to discuss climate change. Just get used to it.

  2. MC says:

    If Shell is to be believed, oil prices may not break over the $80/bbl mark before 2019/2020 and natural gas prices could remain at or below breakeven for far longer, given both the present glut in supply and much more production coming on to the market over the next few years, chiefly from Central Asia and the Persian Gulf.
    That’s an inordinate long time, a far cry from the “momentary weakness” predicted last year.

    So far energy stocks have fared the storm well. Perhaps suspiciously well. Apart from a few exceptions (Shell and Statoil above all), all majors are presently trading around their three year average.
    As soon as Exxon-Mobil hit the “buy now” $68 mark back in October, it instantly bounced back, oil and natural gas prices be damned.
    This is very curious behavior.
    If crashes are a thing of the past, slowly declining prices should at least be expected as investors gradually become more cautious and slowly decrease their exposure to energy markets to hedge their bets.
    Sure, colossi such as Exxon-Mobil and Shell won’t go under, and SOE such as Statoil and Rosfnet will stay around no matter what, but I find this behavior unnerving.

    The Saudi and the Russians are dead serious about fighting for market shares, and US oil producers just need the cash flow more than they need high prices. Given these three countries are the top oil producers worldwide, it will all be down to which of them blink first.
    So far these the Three Amigos have proven remarkably resilient: Russia is yet again giving proof she can endure the pain, the Saudi are happily burning through their immense cash reserves and somehow US producers are still able to service their debt and issue more.
    Other producers are moaning and groaning: Venezuela is in chaos (largely dictated by the overdependence of Chavismo on extreme oil prices), Iraq is effectively bankrupt, African producers such as Nigeria and Angola are nervously stroking their beards and Norway is sweating profusely, as it could face a serious budget crisis next year.
    To compound difficulties, Iran already has a fleet of oil tankers loaded up and ready to sail as soon as sanctions are lifted: the ayatollah are so starved for hard currency even oil at under $40/bbl would be a major boon for them.

    This situation is hardly conductive for energy stocks, but prices remain on the high side.
    But, as they say, high prices are their own cure so I expect to see some surprises in the next three months…

    • Colin says:

      Unless you have a recession the glut will vanish by 2017 as demand continues to increase while supply doesn’t go up very much. Prices will go back up, and oil companies won’t be able to do anything about it. Shell will be proven wrong.

      • MC says:

        We won’t have a recession.
        We are already in a stagnation, and will remain mired in it for quite long.

        You see: a recession is, effectively, a purge of malinvestment, which is something everybody has been desperately trying to avoid since 2008.
        But as free meals do not exist, avoiding a recession comes with a terrible price attached: no real world growth.
        The poster child for this is Spain: GDP is set to grow at a magnificent (by European standards) 3% in 2015 but unemployment inched forward this year, from a horrific 22% to a slightly more horrific 23%. And I am leaving out how real world wages are behaving.

        In a way it’s repetition of Japan’s Two Lost Decades, but worse: at least the Japanese people benefited from real-world deflation in housing and prices remained more or less stable in the real world until Abenomics started taking their toll.
        The Bank of Japan managed to avoid a full force recession but forced the country to pay a terrible price. And, in the end, it mattered little as even the huge keiretsu banks were decimated, with some demises made as quiet as possible in typical Japanese fashion by masking them as “mergers”.

        As a Jewish professor once remarked to me “Capitalism without the threat of bankruptcy works as well as Christianity without the threat of Hellfire”.

      • night-train says:

        I expect that prices will recover in the next 2 or 3 years to around $60 Bbl and hold near there for a few years. That is a price point that will render much of the American oil shale plays below profitability and much of the rest, barely profitable. That price also makes many of the deep water conventional plays uneconomical as well. When the Saudis pull back to increase prices, they may include more members and more discipline within the organization to set and hold production quotas.

        • Michael Gorback says:

          The breakeven for shale keeps dropping. Some wells can be profitable below $30. Part of the drop is due to improved technology and some due to downward price pressure on suppliers of materials and services.

          Meanwhile, although the GCC countries can be profitable at low prices they can’t fund their government programs at those levels. They have already had to institute a VAT to make up for lost revenues. That will exacerbate social unrest.

  3. MAS says:

    Again I’ve said this before. Oil is headed down to 20 Bucks a barrel like it used to be.
    One thing I won’t shed a tear about is when the Saudi’s go bankrupt over it and Dubai becomes a waist land in the desert.
    You gotta remember Globalization and the Global Warming Scam has put every nation in the same boat of bankruptcy.

  4. Mark says:

    Agree, oil is doomed for long time and hardly it will recover to earlier price levels because shift to new energy source will happen in coming decade and this is going to create new boom in energy sector and manufacturing which will again create thirst for all other commodities.
    Until then be careful where you going to park your money.

  5. che says:

    Ridiculous. EOG, HES and XEC are 50% too high, and that Cisco chart says as much.

  6. Paulo says:

    Didn’t Michelle Bachman run for the Republican leadership guaranteeing $2.00 gasoline? Guess what, this is what it looks like. The economy has one foot in the grave and one on a bannana peel loudly and proudly proclaiming, “Don’t worry, I’m fine…it’s all good…we’ve got this whipped”.

    Good article.

    Boy, the mention of Nortel brought back memories. I was doing my usual investment run, slow and steady, and the husband of my wife’s long-time friend was touting Nortel.

    “You can’t miss”, he said.

    I replied, “Man, I don’t know about that, the stock’s dropping”.

    “It’s a great company”, he shot back. “This is just temporary. I bought more and I might double down”.

    On the way home I said to my wife, “________is nuts. He is caught up in the hype and mistakes the ride for inside information everyone else doesn’t have”.

    Well, he lost it all, his Nortel investment. His wife brought it up once in awhile to bring him down to earth when it needed to be done, but I haven’t seen him for years. He ended up being one of those kind of guys who would invite us out to dinner, and then ask for two cheques. At the till he would pull out a coupon. The first time he did this I simply couldn’t believe it?!!#! The second time was the last time, and I haven’t seen him since. (Greed and cheapskate must have the same root).

    • Nick Kelly says:

      Here is a Nortel story I think is telling. A young lady was persuaded to put her 5000 into Nortel, by her GRANDPARENTS.
      The reason I mention it is that there is an axiom or cliche that kids can avoid the mistakes of their parents, but repeat those of their grandparents.
      Maybe the point is that it takes 60 years for a wave to repeat.
      But then recently we are seeing a wave of irrational exuberance at more frequent intervals.
      So who knows.
      But am more and more fascinated by the parallels with 1928.

  7. Michael Gorback says:

    “Deja vu all over again”. We’ve seen this movie before.

    In the 80s the world experienced an oil glut. In 1986 the Saudis went full throttle on production in response to other OPEC countries cheating on quotas. They pushed prices down to punish the misbehaving producers. The strategy failed. When they tried to cut back production to raise prices no one cooperated so they raised production. Oil prices trended down for almost 15 years.

    In today’s dollars, it was the equivalent of going from $100+ to $20.

    Since that time the influence of Saudi/OPEC on markets has weakened further. Six of the top ten oil producers are non-OPEC. They have increased military spending because of the spread of ISIS. Their social programs are budgeted on $100+ oil. The GCC countries have been forced to abandon their near-zero tax policies and are instituting a VAT.

    Meanwhile oil consuming countries have decreased their dependence by developing natural gas, nuclear, wind and solar energy. Russia, the US and Canada have increased oil production. Iran is about to come back to world markets. The world is slipping back into recession.

    The minute oil prices turn up significantly shale production will start back up.

    The Saudis and OPEC are hosed.

    I don’t think they have a choice. Deliberately increasing production is as unlikely to work as the last time. Decreasing production when no one else is just diminishes their income. So they just sit on their hands and everyone calls it a “strategy”. Paralysis is not a strategy.

    • night-train says:

      One old oilman’s view – Oil shale was, is, and will be a ponzi scheme. It has to have an unsupportable price to support an unsustainable resource. If oil shale is our energy future, we are screwed three ways from Sunday.

      • Michael Gorback says:

        The fact that it’s a business that costs more and more to produce less and less does not make it a Ponzi scheme. It makes it an industry with a short life span.

        The same argument applies to conventional oil extraction. Otherwise nobody would be talking about ulta-deep offshore wells that cost $100 million.

        Maybe new technology and lower input costs will make it viable. I doubt anyone really knows. On-water drilling went from barges in 20 feet of water to MODUs in 10,000 feet in 75 years.

        • night-train says:

          MG – Perhaps your argument supports our need to aggressively pursue renewables and alternative sources of energy. Technology helps with costs in O&G exploration, but usually fails to be a true game changer. The technology that made the Bakken play was the misallocation of loads of capital. The engineering was financial, not technical.

          Perhaps scam better describes the oil shale industry, than Ponzi scheme. But whatever you choose to call it, it is expensive to produce and the wells draw down quickly. And the same people who told us it was a miracle in the first place are now telling us that, what was unprofitable at $80/bbl is now profitable below $30. Sorry, I can’t make that dog hunt.

  8. Cae says:

    I’ve read that most of opec countries are net borrowers now and need to keep their revenue streaming in to meet obligations. Price goes down, sell more. Same for fracking, debt loads keep the wells that are producing, flowing. If true, supplies should be ample for a while.

  9. William B. Duddleston says:

    The Excess Demand Equation that confronted OPEC in the 1970s through the 1990’s was equal to the growth of world oil demand minus the growth of Non-OPEC oil supply. In the 1970’s that Excess Demand Equation was shifting to the right ( thanks in part to oil price controls in the USA that were finally removed by Carter and Reagan), and OPEC was in a position to hold the line on the quantity of oil supplied and the price took off especially during the Iranian Hostage Crisis in 1979. However, when oil price controls in the USA were eliminated and Paul Volcker’s tough monetary policy was introduced, then the growth of world oil demand turned negative at the same time that Non-OPEC oil supplies were beginning to increase. These tow forces combined to shift the Excess Demand Equation to the left, and the Saudi’s tried to maintain the discipline of OPEC by cutting daily oil output dramatically. Cheating within the ranks of the OPEC producers rankled the Saudis and eventually they increased production to maintain market share. The price of oil in $ declined to roughly $10 by 1986.

    The same scenario is playing out now. Oil production among OPEC producers has not been cut, the Excess Demand Equation is shifting to the left, and oil prices fall until marginal producers begin to drop out. Last December. a fellow economist calmly said that $45 per barrel was the critical support base. I said that I wasn’t sure that the Saudi’s had the same power as they did in the 1980’s, and the magic of the OPEC cartel was disappearing. $20 per barrel would be a rough approximation in today’s dollars. Will oil prices drop to $20 briefly in 2016? Oil prices dropped to $.10 per barrel for a short period of time in Texas back in 1931 when world oil demand was collapsing in the midst of the Great Depression. Who really knows what will happen in 2016 to world oil demand? It is going to be a wild ride, but in the long run( an economist’s ultimate escape route) Non-OPEC supply will decline at sub $30 per barrel.

  10. kato says:

    This business of driving down prices by increasing production will sideline some producers. But oil does not ‘spoil’ while it is sitting in the ground. When prices return, the sidelined producers will go back into action. Saudi Arabia is risking it’s own economy for an advantage that will probably benefit them less than 18 months in the end.

  11. ERG says:

    Much better article than the last on the same topic. That one just plain baffled me. If shale has accomplished anything it is that it has limited the price of oil at the top end, while the inherent nuttiness of the countries located on top of most of it limits the bottom end. That limts the duration of wild price swings and leaves OPEC with even less flexibility and influence on price than they pretend to have. And it couldn’t happen to a ‘nicer bunch’, AFAIC. American technology and US oil exploration companies helped out them in business, and now its back to limit their ability to manipulate prices. As Dr. Evil would say ‘ Boo frikin Hoo,’.

  12. Pakilolo says:

    I will never invest in fossil fuels because of climate change. Profits over the future of your children and grandchildren seems immoral. Unless you don’t believe in science or the laws of physics. The world is burning and you are trying to profit from it.Shame!

  13. ERG says:

    Really, Pakilolo? Are you ready to put your actions where your mouth is by walking or cycling everywhere and shutting off the electric power to your home if it comes from oil, coal or natural gas fired power plants?

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