Over the past 24 hours I’ve done a lot of soul searching.
After reading Chris Mayer’s editorial on oil prices and the potential end to the oil bull market I’ve finally made some conclusions.
Today I want to share them all with you…
Allow me to come clean… I’m still addicted to oil investing!
Heh, you didn’t think I’d bail out on my favorite investment trend that quick, did you? After all, for the past few years I’ve stuffed my head so full of information about America’s shale boom that I actually know a thing or two about it!
But that doesn’t omit the fact that Chris made a lot of good points. So many in fact, that I needed to check my notes and make sure all of the opportunities I’ve been sharing with you lately still add up.
You’ll be amazed at some of the stuff I found…
Opportunity Abounds In America’s Tight Oil Patch…
Hopefully by now you know, the U.S. has unlocked a bounty of tight/shale oil. So much, in fact, that the needle for U.S. oil production is moving in the right direction — and more oil is starting to flow through American pipes than previously thought possible.
In a picture, here’s what we’re talking about…
Over the past few years tight oil production has really ramped up. [Why is oil production starting to ramp up? New technologies like horizontal drilling and “fracking,” click here to learn more.]
Crude oil from the Bakken formation in North Dakota (noted in tan) and the Eagle Ford in south Texas (noted in green) is leading the way — and set to make a real impact on U.S. production.
So with all of this new American oil hitting pipelines (along with increased oil production from Canada’s oil sands operations) will oil prices here in the U.S. hold up? Can domestic oil producers plan on profiting in the years to come? Let’s take a look…
Crude Oil Isn’t The Same As Nat Gas…
Don’t be fooled into thinking the oil industry is following the same road as natural gas.
Natural gas, as you surely know, has boomed. So much, in fact, that prices in the U.S. have hit rock bottom. Jeez, earlier this year wellhead prices dipped below $2 per MMBTU!
Although oil has pulled back in recent months, don’t expect prices to hit “crazy” low numbers like natural gas. We’re not going to see $30 oil again, unless something catastrophic happens and dries up demand. $30 oil won’t come from an oversupply of tight oil, that’s for sure.
Why am I so sure of this? Why won’t oil become the next natural gas?
I’ve got some pretty good reason to back up my case…
For starters natural gas is difficult to transport and, for the time being, is land-locked. Even if all of our LNG export dreams come true and Cheniere’s Sabine Pass facility begins exporting natural gas to a global market — it won’t be to a large enough scale to make a difference. Nor will it have any true effect on natural gas prices.
The same can’t be said for oil. The stuff is easy to transport. But, we don’t even need to get in to that discussion, because the U.S. won’t choose to export any large amounts of raw crude.
You see, the U.S. is proficient oil guzzler. Even though U.S. oil demand has slowed since 2008 there’s a lot of shadow demand waiting in the wings. So if the pipelines in America are flush with light sweet crude from North Dakota’s Bakken, the U.S. will find a use for it in quick order.
To prove my point with one recent example there’s already a lot of action in the mid-Atlantic refinery space. Knowing the light sweet Bakken crude isn’t the most efficient blend to be sent to Houston, refiners in the Philadelphia area are planning for the future.
According to Reuters, “Sunoco Inc and private equity firm Carlyle Group LP reached a deal on Monday to save and expand the largest U.S. East Coast refinery, capitalizing on the nation’s shale boom to reinvent the economics of refining in the region.”
These are the kinds of deals that will keep long-term oil prices afloat, and they’re happening as I type.
Not to beat a dead horse, but the MAIN reason U.S. oil isn’t set for the same fate as U.S. natural gas is simple. With history as our guide, this is the tale of two incredibly different markets.
Here’s an interesting tidbit: we produced more natural gas in 2011 than ANY YEAR in U.S. history. Simply put, the book is still being written on what to do with all of this stuff.
The previous high-water mark for U.S. production was in 1973 (at 22.6 TCF.) Last year we blew that number away — 2011 saw 24.1 TCF, and we’re already on pace to crush that record in 2012.
Sure, there are plans for using the gas — exports, power generation, chemical facilities, ethane crackers, etc. But most of these long-term plans are still in the works. This delay in demand is what lowered natural gas prices. And until that demand creation takes effect, prices will remain low.
The same isn’t true for oil. Take a look at the long-term chart…
The last year on record we produced this much oil was 2003 (and every year back to 1955.) And although we’re set for more tight/shale oil to hit the market it’s not enough to turn the market upside down.
Even if analyst expectations are correct, we’re talking about another 1 million barrels a day by 2015 or 2020 — that still puts us at 1990’s levels of production. But, trust me, we won’t be seeing 1990’s prices anytime soon. That’s because demand is much higher (more than 1 million barrels a day) than it was back then.
All said, comparing natural gas to oil in the U.S. is like comparing apples to armadillos.
Unconventional Oil Production Creates A Floor Under Prices…
To be clear, what we’re seeing in North America isn’t the 1950’s In Saudi Arabia. Although oil is gushing through the pipes it’s not just freely flowing and gushing from the wellhead. Indeed, there’s a lot of work, and cost that goes into producing an “unconventional” (see: tight oil or oil sands) barrel of oil.
New technologies, like horizontal drilling and fracking, come at a cost. And although costs are coming down there’s still a floor for prices.
“Our Bakken shale portfolio” a representative for Statoil says, “competes very well with the average of projects across the [onshore North America] group, which would have a breakeven price of about $50-$60 per barrel.”
So some companies can produce Bakken oil at $50-60 a barrel, but right now those are the efficient scalable companies. It’s by no means an across the board break even.
Combine that with high prices coming out of Canada’s oil sands operations and you’ll see that prices are set to stay relatively high.
This according to Canada’s Globe and Mail:
“New oil sands mines, for example, require prices of around $80 (U.S.) a barrel to break even, Wood Mackenzie found. Add an upgrader, the “pre-refinery” that transforms heavy oil into a lighter crude that can be further refined into diesel and gasoline, and the needed break-even rises to above $100. So-called “in situ” projects, which use wells and underground steam injection to extract oil sands crude, are less vulnerable, with a break even of about $60.”
You see, once the price of oil drops below certain break even prices, marginal producers drop out of the market. Think of it this way, if you’re operating a large-scale oil sands operation and have the ability to shut down operations while prices fall below your breakeven you certainly would. When these producers drop out of the market, supply drops and prices find support. It’s simple supply and demand.
Looking at this North American price floor, $60/barrel oil is possible. But I wouldn’t count on prices staying that low for long, if they ever get there. And even at that price, some low-cost Bakken producers can make a buck and continue to pay a sizable dividend.
Canadian Producers — Sell To The Highest Bidder!
Other than Canadian break evens, there’s more reason to believe the U.S. won’t be too packed with oil sand production.
Oil is a global market — that’s especially true with Canadian oil sands production.
As Byron King recently stated, “Let’s get something clear. Canada’s oil is Canada’s oil. It’s not America’s oil. We in the U.S. can’t boss Canada around. That’s not how this world works.”
Although Bakken oil production will remain here in the U.S. some oil sands operators are already searching for new, global markets to sell their crude.
Just this week Bloomberg reported on this budding trend:
“Cenovus Energy says it’s selling Canadian oil sands crude near world prices by exporting through Vancouver’s port as Canada’s fourth-largest oil producer by market value lines up buyers ahead of a surge in production.”
“[...]Prices for the Canadian crude sold through Vancouver are closer to those paid for oil from Dubai and for Brent, the benchmark used in Europe, and at a premium to West Texas Intermediate, he said, without providing specific figures. WCS has been selling at a steep discount to WTI in the U.S. market.”
So you see, while the U.S. bumbles around on the Keystone XL Pipeline deal, a pipeline project that would increase the flow of Canadian oil to the U.S., oil sand producers like Cenovus are looking to global markets.
With the way things are shaping up in the global market it would be foolish to think all of the Canadian oil will flow south to the U.S. (especially the way the current administration is handling energy policy.)
This is all very supportive of U.S. oil prices. But nothing may be more supportive than this next nugget…
A Countdown To Oil’s Next Big Move…
It’s not called black gold for nothing.
Investing in oil, much like investing in gold, is a good way to protect yourself from a depreciating U.S. dollar. According to the U.S. Inflation Calculator, since 1980 the dollar has lost 64% of its purchasing power.
Fast forward to today and the U.S. dollar index is at its highest point since mid-2010.
To me, this isn’t the time to be shorting oil. When the markets straighten themselves out, which they have a tendency to do, the U.S. dollar will continue its march lower. And when that happens the price of oil will have direct fundamental support.
Unless you’re looking for short-term trades, I’d make sure you’re on the right side of this trend.
The U.S. dollar was at the heart of creating $147/barrel oil in 2008, and it’ll surely push oil to the $100 mark again. It’s only a matter of time.
Opportunity Still Abounds In America’s Tight Oil Patch…
So you see, although the Bakken, Eagle Ford and other tight oil plays are creating an amazing boost for U.S. energy it’s not enough production to drive oil prices down a significant amount. And going forward domestic producers will still have solid opportunity to profit.
When you get down to brass tacks I understand the argument that oil prices could head lower. If anything, that’s only a short-term phenomenon. But it’s not the longer-term, big-picture profit plays we look for here.
Right now I’m comfortable to sit back, watch the show and collect a dividend with U.S. oil producers. The best of the bunch match perfectly with our long-term investment goals. And when oil heads higher, it’ll just be icing on the cake.
Keep your boots muddy,
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