Everyone is scrambling for a new plan now --- now that oil is in its third mini-bust since the major bust cycle that began in 2014.
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Since the lows in early 2106, oil has made three retreats; in July/August of 2016, in November of 2016 and right now, in June of 2017. But this retreat is different, in that it comes after the extension of OPEC production cuts that are scheduled to last until mid-2018. Those cuts have not helped oil to maintain prices above $50, they have in fact heralded this latest drop.
And that’s bad news for everyone – OPEC, U.S. producers and for us as oil investors.
Previous plans based on an inevitable rally in prices have been made by all three of these groups, and all of them now have to revisit how they’re going to go forward from here.
OPEC has staked much in their ability to still control oil prices using these production cuts. Now that their efforts haven’t helped to support prices, they’re likely going to have to consider a new strategy. Will they extend cuts further? Will they try to get even deeper production quota cuts from members? Or, will they abandon the effort to limit production and return to the ‘free-for-all’ battle for market share that they used in through 2015 and into late 2016? That effort mostly failed to bankrupt US producers and trim US production, which has rebounded to its highest levels today, above 9.2m barrels a day.
What will they do? Perhaps the ascension of Prince bin Salman in Saudi Arabia as next in line to the throne gives us a bit of a clue – he is the force that ousted oil minister al-Naimi, who spearheaded the flooding of oil markets in 2014. Al-Falih, his replacement, has been behind the negotiated efforts to curb the Cartel’s supplies.
US oil companies are also faced with finding a new strategy. They did well in surviving the first Saudi market share strategy, but the end result hasn’t been exactly worth celebrating. While managing to mostly survive, they have also not found steady profitability at $50 oil. And while many of the larger E+P players crow about their cuts in break-even costs and claim survivability at $45 oil, the facts are less optimistic. Check this out from RBN energy, crowing about $4.6b 1st quarter pretax profits for 13 of the largest consolidated E+P’s they’re tracking. To put that in less glowing perspective, these are thirteen companies with both up and downstream assets, oil, natural gas and chemicals, managing only a third of the profits that Exxon-Mobil did ITSELF in 2013.
Obviously, one-trick shale oil ponies are not even doing close to this well.
So, what do the oil companies do? Outlines for production for the rest of 2017 and 2018 have been announced and guidance given, and you don’t turn around drilling on a dime – even shale drilling. Most of them will have to try and soldier on, despite even deeper negative cash flows. They’ll try to make do with a further cut in capex and further cannibalization of assets – as Devon is doing here in selling off their previously premier Barnett shale assets.
Finally, what do we do as oil investors? Like OPEC and US oil interests, we also expected OPEC cuts and still very healthy global demand to translate into constructive oil prices and increasing oil stocks. Instead, signs are now mounting that oil prices will be, if not dropping even more below $40 a barrel, difficult to see rise much above $55 for several months to come. First, there is the continued inventory of scheduled production yet to be hedged, promising selling from commercials if oil stages even a moderate rally near to $50.
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Second, there is a continued increase in drilled but uncompleted wells (DUC) that also promises an inventory of new supply if and when oil finds its way above $55 – also keeping a lid on prices.
All of this requires a change of strategy from us, even though we have been careful to position ourselves almost exclusively in well-capitalized Permian producers and have stayed away from the over-leveraged, and those dependent upon natural gas.
And on this, I will be writing exclusively for the next several columns, using specific stocks that I have concentrated on in the past and are likely to be a part of your portfolio. In essence, however, it will benefit your outlook if we push our expectations, and therefore how we are positioning these stocks, further into the future. We’ll be using options and targeted buying and selling to focus a new strategy for this latest move in oil prices.
Because we also have to be flexible and not stand still in the face of changing conditions. Whether or not OPEC and US oil producers follow suit and change theirs or not.