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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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U.S. Shale’s Breakeven Myth

Permian

Most oil analysts have one goal in mind, and it’s not to be right about predicting the future prices of oil. It’s about trying especially hard not to be wrong.

The difference is important. Most analysts, including the IEA and EIA, cannot make any forecast that can be recalled months later to make them look foolish. The safest prediction you can make is always to see not much change at all, whether you see oil at $25 a barrel or $125 a barrel.

If something dramatic changes, the worst you can be accused of is not seeing what virtually everyone else has missed too – and you keep your reputation and your job.

I don’t have those restrictions, which is why you’ll get what seems like wilder predictions from me, including my continued outlook for $100 a barrel oil in 2018.

This week, we have another indication that the ‘common wisdom’ in oil is not holding up and something entirely different from what the majority of analysts are predicting is going to happen.

This interesting piece in the Wall Street Journal outlines how most of the supermajors – Exxon, Shell, Chevron and BP – have been struggling to break even in a $50 oil environment and have been pulling free cash in order to continue to pay dividends.

This runs entirely counter to the ‘common wisdom’ on the street – that the ‘new normal’ of efficiencies and cost slashing in US E+P’s has made oil profitable at $50, $40, and even $35 a barrel, according to the happy talk from independent CEO’s.

It’s just not true. While there have been incredible strides in technology in shale drilling, cementing, fracking fluid formulas, and spacing, the claimed reductions for break-even prices have been far too optimistic to be believed. Oil companies, especially the independent ones, are very good at optimizing their presentations to keep analysts and shareholders happy – ignoring sunk costs in well development and highlighting the most efficient projects while minimizing the acreage that’s not as cost efficient.

I’m not saying that there have been no changes, but the claimed reduction of break-evens in shale, in some cases, claimed to be nearly 50%. Which, in my mind, is a bunch of hooey. In other words, $50 oil isn’t today nearly as profitable as $80 oil used to be; at best, perhaps $70 oil is.

That article in the WSJ proves it – and believe me, if the big boys are struggling, the smaller shale independents are hardly doing better. With their higher cost of money and deeper leverage, they’re likely doing far worse.

That suggests one very, very important conclusion for us as observers of the oil and gas space and investors in it: The oil bust is far from over.

While oil may have stopped going down, the difficulties for oil companies haven’t yet begun to lessen – and will get worse unless oil rallies much more significantly than it already has.

And, if that’s unlikely to happen, as most analysts seem to believe, then there’s yet to be a second, more violent disaster of defaults, reorganizations and bankruptcies that are just about to take place.

One way or the other, the common wisdom in oil right now has to be wrong.

Either oil prices are going to make a significant move higher, fixing the cash flow problems of almost all the oil companies working acreage right now or there is a lot more blood yet to be spilled in the oil and gas space.

Keep that in mind as you gauge which energy stocks to add to your portfolio.




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