A Brief Note on Oil

$40 WTI Crude is not your savior.

The one thing I see paraded on CNBC nearly daily is that with oil sticking to the $40 level, it is a break-even or even sustainable level for the oil companies. This is simply not even close to the truth for the majority of the sector. Sure, Exxon Mobil may be the best balance sheet in the majors, but it’s just one company. Personally, I’m not sure how long they could keep up operations at $40 once their hedges roll off. On the subject of hedges, most of the smaller companies that have been taken out to the woodshed and mortally wounded by an axe murderer are actually hedged very well, some extremely well. I’m talking hedges in the $65–$85 range through 2018, which is clearly considered great prices after the massacre of crude in the past two years. One has to wonder, with hedges this good, why have the stocks been crushed? The truth is, even with extraordinarily high hedge rates, these companies are still losing money. Can you believe it? Load up some 10-Ks, pore through the hedge rates, and check out the losses over the past few years. So many of these companies will go out of business, more than we have seen, and they will put a strain on the entire complex.

How will the small companies affect the scale of the operation? Quite like the rising Atlantic Ocean will engulf Delaware someday, the damage will start at the bottom and work its way higher. In high volume production decline, the transportation and pipeline firms will be damaged as well by lack of revenues. Yep, they’re in debt trouble, too. If too many of these companies, and there’s really only a few comparatively, shut off parts of their operations to compensate, it’s bad news. They can’t afford to do that. On the subject of debt, let’s explore why even if U.S. production declines and WTI rises to, say, $80, it may be too late to recover the industry.

This could take a few years to play out, so let’s be clear on that. I believe prices could stay here through the 2018 period when hedges roll off. What financial institution, in their right mind, would lend money to any surviving companies (they would need it) or to any startups after witnessing the carnage of the past five years? I’m sure some people will call me stupid for believing they would be hesitant to do so, but I raise them this question: Would you lend your hard-earned money to your sketchy 3rd cousin begging to invest in an industry that will be on it’s way out by the time you’re dead? Yeah, renewables. I had to go there. Regardless of what its critics say, it does exist, it is getting cheaper to manufacture and construct every year, and it would be foolish of society to not embrace never-ending, ever-replenishing natural resources and strive to be commodity independent. I’d like to also say that in the next one-to-eight years we are likely to have a President who supports renewables, likely with subsidies and other incentives.

What would a good oil article be without mentioning the Middle East? In recent news, Saudi Aramco is looking to IPO here shortly. If the IPO is successful, it will show that our direct competitors are still able to access the capital markets. Who knows how long Middle Eastern producers will be able to raise capital, but as long as they do we are fighting an uphill battle. I’m familiar with the argument that they are destroying their wells by overproduction, but that’s still our problem in the near-term as they literally flood the market.

There is no “best bet” in the energy sector. If you had told me to pick one or you’d cut off my arms, I’d say Exxon Mobil, or maybe I’d be able to get some sick cyborg arms instead. Tough choice. This article doesn’t reflect my opinion on natural gas, but I will say I have found no company that generates revenue solely from natural gas that I consider to have a strong balance sheet.

This is what American oil producers see on the way to heaven
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