It's open warfare on the oil stocks. They've all been painted with a black brush and the worst splotches have been sprayed by hedge fund kings David Einhorn and Jim Chanos. This, however, doesn't mean that the sector is toxic to us as investors – in fact, it is again creating opportunities that we haven't seen since oil dipped closer to $40 a barrel.
This is not because I am not in agreement with Einhorn and Chanos – the points they make are macro but smart and you know that both are brilliant in their arguments because they can be explained on the back of a napkin. Chanos is simple in his short argument, not just on shale oil producers but on oil majors as well; he simply points out the increasing costs of producing marginal oil and the shrinking profits from producing them. In short, Chanos points to the good old days when oil was bought for $3 a barrel by giving a buck and a half to the corrupt government somewhere in the Middle East or Africa – with that math, a $25 retail price makes for a helluva 6 time profit. Chanos is less impressed by a $55 barrel being produced in the Gulf of Mexico, even when the retail price of that barrel is above 100 bucks – although it's nowhere near that now.
Use that math and you'd hate the oil companies too.
Einhorn has literally called a massive short on the US shale players, and not the marginal ones, either – he's gone big with hate mail directed at Pioneer Natural Resources (PXD), EOG Resources (EOG) and Whiting (WLL). His back of the matchbook math is pretty compelling too – I've pointed out much of it in several articles comparing the pyramiding of well drilling and capital chase to a Ponzi scheme. Einhorn's calculations rely upon a very low oil price for a very long time, something I believe he is very wrong about – but the long-term outlook for all but the best capitalized and least debt-ridden shale players is still very shaky indeed. What's interesting about Einhorn is not his thesis, but the companies he's chosen to target – EOG and Pioneer are two of the shale players most likely to survive this shale bust, not succumb to it.
But although oil is hanging closer to $60 than $50, the shale players – in fact the whole oil sector – has caught one heckuva cold, courtesy of Einhorn and Chanos – EOG is well under $90 a share and Pioneer has drifted below $150.
This is not a column about finding value in the good shale players, however – it's a search for value in another, highly leveraged, debt-ridden sub sector of energy: the deepwater specialists.
Like the shale players, the deepwater operators are dependent upon high oil prices and poorly rated bond issues - and a lot of them. But unlike them, their prospects are not short-term, fast drill/fast depletion projects – and their long-term prospects, both in the Gulf of Mexico, off shore Africa and Brazil are better than shale – and more dependable. The oil world will have to circle back to off shore when oil prices recover. Shale might be sexy, but offshore is where the long-term money will continue to pay off.
And in that idea, some of the most unique offshore players are ridiculously cheap right now, taken down by the Chanos/Einhorn evil eye.
One of my favorites is Seadrill (SDRL), now under $12 a share, and one of the few offshore players who have the rigs even capable of going 5 miles down in the oceans to get oil, along with Transocean (RIG) and Ensco (ESV).
This is a simple column – recommending a long-term trade on offshore drill operators as the shale players get hammered. There's an opportunity here – not an easy one, and not a fast one – but an opportunity.
Buy Seadrill at $12 – it'll trade $45 sometime before 2017.