A nearly 50% pullback in the price of oil has done serious damage to revenue of oil producers. Companies whose production costs were already high, especially if they used leverage to fund themselves, might go bankrupt.
Is this it for the US ‘oil Renaissance’ whereby the US has surpassed Saudi Arabia in total production? Will the US shale industry survive?
Matt Badiali writes the Stansberry Resource Report, one of the largest resource newsletter services in the world for retail investors.
Matt says US shale production is more resilient than many people believe. Some of these companies might go out of business, he says, but other traditional oil stocks are more concerning right now.
Matt said he’s not bullish on oil just yet:
“Oil is cheap, but I don’t think it’s hated enough. People are still looking at it as a viable place to go to make money. I think that the first quarter of 2015 could bring more bad news for the industry, with reserves being revised in light of the new oil prices, and negative surprises brought on by bad decisions that were made at a higher oil price.”
He is interested in a related commodity, though – natural gas:
“People have sold it off, and no one is really thinking about it. They’re too focused on the oil sell-off. There’s already an uptrend in the price, and we’re heading into winter. It’s going to keep getting colder and consumption is going to go up. That should make natural gas stocks rally from here.”
The price of natural gas has held up better than oil. It’s only down around 30%, from $4.5 per mBtu (million British thermal unit) this summer to $3 per mBtu today.1 Matt says that natural gas stocks get dumped for the same reasons as oil, because it’s hard to disentangle oil producers and gas producers:
“It’s hard to unravel which stocks produce natural gas and which ones produce oil, because most of these companies produce a mix of both types of fuel.”
Still, you’d expect those that are more strongly weighted towards natural gas to hold up better. According to Matt, that’s not the case:
“You have companies like Southwestern, or Range Resources whose production is mostly natural gas. And yet, their shares are down with the rest of the index.”
This is a typical investor reaction, he says. Markets punish any stock related to a crashing asset without analyzing their specific level of exposure.
“There’s a funny analogy that occurred during the Mexican peso crisis. Every currency in the world with the name ‘peso’ also fell… For instance the Argentine peso, the Philippine peso. Investors weren’t discerning about which ‘peso’ to sell, even though they are unrelated.”
This is a good set-up for a short-term bet on natural gas, says Matt:
“The fear will come out of the natural gas market eventually. If we have a cold snap in the Northeast like we did last year, where we saw natural gas prices spike up to $7 per mBtu, we’ll certainly see people pile back into these stocks.”
He specified that he meant US producers of natural gas, and that he wasn’t interested in the Canadian stocks right now:
“The Canadian natural gas producers still have a lot of the logistical issues that they’ve always had. Producing natural gas in the hinterlands of Canada and getting it to a market that’s not oversupplied is really hard.”
I asked Matt which oil companies were the ‘sitting ducks’ if oil prices remained around $40 to $60 per barrel.
Matt says the shale industry is in the range where it could become uneconomic for many companies, but we’ll have to wait and see:
“I’ve heard from industry people that you could still make money at $65 per barrel in the US Eagle Ford shale, but not at $45 per barrel. Assuming those numbers are correct, then the tipping point is somewhere in that region.”
Still, too many people are only scrutinizing the US shale sector. Some of the big international producers could be hurt badly too:
“If you’re looking for the fragile companies, you have to look at the majors. Look at companies that have spent billions of dollars on projects that are dependent on higher oil prices. For instance, look at the Kashagan oil field debacle (a proposed oil field in off-shore Kazakhstan that has cost over $50 billion and failed to produce oil).2 Eni, Shell, ExxonMobil, and Chevron all have exposure to that project. Now you knock $30 or $40 off of the price of oil and they’ve still got the exposure to an expensive, unproductive project but without the same revenues as before.”
Some of the European producers could be in for a tough period because their production is largely off-shore:
“I think that the North Sea oil producers are going to get hurt. Off-shore drilling is much more expensive than on-shore drilling. I would be concerned about Statoil, or Lundin Petroleum.”
The coming months could bring bad news from one of the largest off-shore oil producers in South America:
“I think Petrobras is toast. It’s hemorrhaging money. They’re going to be propped up by the Brazilian government, but even so there’s just no way to get ‘sub-salt’ oil (a type of deep underwater deposit) out at $65 per barrel. And those guys have spent billions of dollars already.”
Some of the Canadian producers might be on the chopping block too:
“I would be wary of some of the peripheral heavy players or tar-sands stocks in Canada. It’s very hard to reduce your costs when you’re taking asphalt from sand and then extracting the oil to sell.
“And you’re still in the hinterlands of Canada. You’ve got to get it to a railcar or a pipeline in order to sell it.”
On the positive side, a lower oil price is a boon to the economies of countries that import oil, says Matt:
“Low oil prices are really good for the global economy. There has been an astonishing transfer of wealth from developed importing countries to the countries in the Organization of Petroleum-Exporting Countries (OPEC) – the less developed oil exporters – on the order of hundreds of billions of dollars per year. China, Japan, the US, and Europe were all buying oil at over $100 per barrel, which can just cripple an economy. You do less, you spend less, and you feel less wealthy.”
At a cheaper oil price, that dynamic is shifted around:
“There’s more money going into the economy and less money going overseas to Saudi Arabia, or to our neighbors like Canada.”
Shale oil is still a relatively new technology. Shale companies have fast depletion rates and high debt levels, which makes them vulnerable. Investors naturally believe they could suffer a big setback if the price of oil stays low.
As Matt points out, however, the larger oil companies that have sunk hundreds of millions to billions of dollars into projects might be more exposed than US shale producers.
P.S.: Last week in Sprott’s Thoughts, Mishka vom Dorp explained why he thought Saudi Arabia was unlikely to cut oil production for another 30 months. He was invited to discuss the topic later that week on Fox Business News. Click here to watch the clip.
P.P.S.: Not yet subscribed to Sprott’s Thoughts? Click here to subscribe, free.
1 Bloomberg
2 http://graphics.wsj.com/the-kashagan-debacle/#the-players
By Henry Bonner ([email protected])
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