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Dan Dicker

Dan Dicker

Dan Dicker is a 25 year veteran of the New York Mercantile Exchange where he traded crude oil, natural gas, unleaded gasoline and heating oil…

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What You Missed In The Wood Mackenzie Report

Baker Hughes Employee

The latest report from Wood Mackenzie on U.S. and other non-OPEC oil exploration and production into 2025 is worthy of a very deep dive, because it gives terrific information, not just on where U.S. oil will be coming from in the next 10 years, but where the best likely places to invest will be.

I truly rely upon Wood Mackenzie as one of the finest, if not the finest energy analytics service out there – and their latest report serves as a tremendous template for our investment purposes. While the report is fairly long and wonky, the major takeaways can be culled from this one very important slide:

(Click to enlarge)

There’s so much information here, it’s hard to know where to start. But let’s start where Wood Mackenzie did, pointing out the tremendous gains in efficiencies, spacing and techniques for shale drilling, and discussing at length the terrific gains (drops) in breakeven production prices for various shale plays here in the U.S.

This note of dropping breakeven prices was heralded by most of the energy world as the important point of the report, showing that oil was much more likely to remain under $100 a barrel for a very long time, considering the profits that several core plays could achieve even at $40 a barrel.

But this, I submit, is an ultimately incorrect conclusion. Let’s look deeper.

First, it can be seen in the chart that the breakeven prices that are represented are weighted averages, meaning that while much of the oil that might be produced in a certain area will be at or below that average number, a healthy portion will be above it and sometimes far above it. Indeed, the Woodmac chart goes a good way to showing just how healthy each area is, how much oil is likely to be produced and how much of it is at or below their average breakeven price and also, importantly, how much will be above it.

Look, for example, at the Wolfcamp bar on the slide, a prime Permian area. The breakeven for that play lies low in the bar, implying that a large portion of those wells will deliver breakevens below $40, but it also implies a sharp cutoff once those core wells are counted, with other portions of the play requiring upwards of $75 to be profitable. The Eagle Ford bar shows a similar profile.

It is essential that we take the slide in its entirety, because Woodmac points out that 9 million barrels a day of new production will likely come online at a breakeven price of $60 a barrel or less - HOWEVER, it notes that 20 Million barrels a day of new production will be required of U.S. and non-OPEC producers to meet total demand by 2025.

If, at this point, you don’t have a reference about the marginal barrel price of oil and why that’s what drives the fundamental market price of oil, I invite you to immediately pay $5 and read my book explaining the concept. It is the most critical point in understanding how fundamental prices are reached. To put it simply for those uninterested in reading my book, it is not the cheapest barrel of oil that satisfies demand that sets the overall price. It is the LAST AND MOST EXPENSIVE barrel’s price that does so.

Now, understanding that and looking at this slide, instead of a stable and bearish view of oil, you come away with a far different, much more volatile and bullish view on oil.

All of a sudden the most expensive breakeven areas become as necessary as the cheap ones in order to fully satisfy future demand; For example in Ultra-deepwater areas in the U.S. and elsewhere, where breakeven prices are well above $100 a barrel.

Further, the slide only accounts for what are recognizable non-OPEC reserves currently earmarked for development – or about 13 and a half million barrels a day. Even in a best case scenario, Woodmac cannot account for where the other 6 and a half million barrels to satisfy 2025 demand will ultimately come from. While plenty of other reserves exist that could be tapped, all of them have even higher breakeven prices than those listed here.

Suddenly, this slide looks very bullish indeed.

From an investment perspective, there’s a lot to be learned too. Small compact bars in the slide that have extremely low breakeven prices stand out as superb investment areas, as that oil will in all markets be profitable and likely hugely so. Look at Bone Spring, a Permian area in New Mexico and Western Texas where Cimarex (XEC), Devon (DVN) and Apache (APA) have strong acreage. Look also at Mid Con Scoop/Stack areas of Oklahoma, where Anadarko (APC) has been deeply invested. Eagle Ford looks challenged, unless you’ve got a huge backlog of decades of core acreage to develop – think EOG Resources (EOG) and Conoco-Philips (COP).

There’s a lot of great material to digest from the Wood-Mackenzie report, not just about the future trajectory of oil, but who is most likely to benefit the most from it. They are a group worth following and reading every piece of info they release, if you are interested in profiting from oil and gas stocks.

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