Avoid These ‘Shale Legends’ For Now

The Fed continues to dominate the markets and our trading in oil and oil stocks.

God knows there are hundreds of writers out there with opinions on the next move for rates, so mine would only be so much more noise. Instead, let's just acknowledge that the market is more likely than not to drag for the next several weeks, and thank our recent discipline in keeping our portfolios safe.

Let's also notice some recent news that convinces me that our investment discipline will be well served for a long time to come. Oil stocks have in many cases, run ahead of Oil, the commodity - as these examples will show:

First up, the EOG Resources (EOG) purchase of Yates Petroleum for $2.5b in mostly stock. This strikes me as a prime example where the current disconnect in oil prices compared to shale oil stocks has made me wary of increasing positions, even selling majority percentages of long-term positions in many of my most favored E+P's, including EOG. Add to this the even more exuberant froth that is persistently seen in those E+P's who have a majority interest in the Permian formation, and even more specifically in the most Western Delaware basin. We have benefited from this ourselves, as our holdings in Silver Run Acquisitions, now acquiring its interest in Permian player Centennial, has rocketed (prematurely) above $16 a share, although is tempering itself.

Don't call me bearish on oil, or bearish on the Permian - I was a buyer of Cimarex (XEC) as it was trading under $90 a share in the spring - but there are values to be found in energy at every level, and in this lone play, stocks like Cimarex and Pioneer Natural Resources (PXD) and Concho Resources (CXO) are priced as if oil were trading above $70 a barrel, not here at $45. The Yates deal was particularly heralded as EOG managed to buy acreage in this red-hot play for an average cost of less than half of other M+A deals. But Yates, a private oil company, was for sale on the cheap because of real challenges it faced, including a major negative cash flow that had virtually stopped fresh drilling. Yates family owners are banking on EOG expertise in longer well laterals, as well as much better access to capital, to reinvigorate production - but many challenges remain. I'm less enthusiastic about this deal than the market is, and happy to wait for an EOG pullback to add to this position.

I also retain more than a bit of skepticism towards the latest shale play of Apache Energy (APA) in the Delaware, the new 'Alpine high' discovery. This area of the Permian was previously thought to be difficult, if not impossible to frack, based upon its high level of clay composition that rejected liquid stimulation. Apache, through a new technology that it has understandably refused to talk about, has slowly acquired more than 350,000 acres in the Davis mountains, drilling 14 promising new wells. The technology of fracking certainly doesn't stand still, and I don't assume that Apache hasn't been able to solve a fracking into clay problem where others haven't previously. My skepticism comes in their claim of 3 billion barrels of oil equivalent in the play, and particularly 30% return at current oil and gas prices. I remember similar claims in the Monterey shale going bad. Infrastructure shortages in the Davis mountains will limit Apache growth in the area, at least for the next several years. In all cases, I'm not about to buy Apache closer to $60 a share, based solely on the enthusiasm for this finding.

Finally, both Sandridge and Halcon Resources (HK) are finding plans and gaining approval from courts to return out of bankruptcy.

The big takeaways from these recent events are an increasing but unwarranted (in my mind) premature enthusiasm about U.S. recovery in fracked oil, particularly in the Delaware area of the Permian basin. The destruction of production potential that we've needed to see to complete the bust cycle in oil and completely rebalance markets, allowing for a long-term constructive rise in the prices of oil and natural gas have yet to be seen. That, in turn, promises that the full recovery and big profits in oil stocks are still several quarters ahead of us. Patience remains the order of the day in our investment strategies, no matter what the final timing of the Federal Reserve plans turn out to be.