Basic Arithmetic Letting Oil Companies Down

Sesame Street is better at math than the oil companies are right now. Virtually every midsized oil exploration and production company has recently claimed not only to maintain production levels for 2015, but to increase production in the next year, all while slashing capital expenditure budgets to the bone. That math doesn't compute at all: Where is the Sesame Street "Count" when you need him?

It really is as simple as 1, 2, 3….

This week after capex slashes were reported from several US oil companies, including a stunning 75% drop in the budget of Abraxas energy (AXAS), Canadian oil companies started to report with their own version of austerity for 2015. Husky energy (HSE), the number four oil major in Canada, has dropped its capex a third for the year coming, to $2.9B dollars. Penn West Petroleum (PWT) has guided its capex down $215m Canadian Dollars or 25% to $625m. MEG Energy (MEG), Cenovus (CVE), Tormaline (TOU) and Canadian Oil Sands Energy (COS) have reported similar spending reductions. The only constant in today's cratering oil market are the dwindling drilling budgets of US and Canadian oil companies.

But production? Oh no, that's another story. So far, I've yet to see one oil company, US or Canadian, admit to static production numbers from 2014 repeating in 2015, much less a production drop. It sounds much like the old jokes of discount sellers of knives or salad bowls - ("we sell UNDER our own costs! How do we do it? VOLUME!).

If it were possible to slash spending budgets while increasing production so readily, as Conoco Phillips (COP) and Oasis Petroleum (OAS) have claimed this week, why did they wait for a major drop in oil prices to do it? Much better for the bottom line to increase production while spending less in ANY environment, isn't it?

Call in the Sesame Street Count - something doesn't jibe.

We know that admitting to a production collapse in 2015 is the quickest way to crater the common shares, although many of these companies are already down into single digits and, outside of going belly-up, can't trade any worse by admitting to a coming decline in production.

And indeed, that may be where the opportunity is starting to show itself.

Several of these distressed oil companies are down 50, 60, 70% or more from their highs this year and while I know that there are a few dozen who will either be bought at fire sale prices while seeing the common shares go to zero, I also know there are several of these who will make it through this relatively short "oil depression". The trick, of course, is in finding the ones who are more likely to make it.

When mentioning a few of these names, I hesitate to even use the word 'recommend', because they are trading in single digits precisely because there exists a real bankruptcy risk. Any dollars you put into these names you must be willing to see go to zero. But they also have the potential to increase 3 to 5 times in the next two years.

Two, I believe, that are capable of making it through the storm are Oasis Petroleum, who still have a reasonable amount of cash on hand, even if I don't at all buy their production numbers and Transocean (RIG), which absolutely needs to cut their dividend before bottoming but are already trading at around $17. These are both entirely speculative plays with a possibility of going to zero.

But with oil prices again sliding today, there's an opportunity to pick up some very speculative shares in both of these. It will be a long wait to see a healthy profit in either of these, if it comes at all.

But some shares are almost too cheap now to resist, despite the heavy risks.