By Kirk Spano
Jim Rogers is one of the best-known commodity investors of our time. He correctly predicted the collapse of the stock-market bubble at the end of the 1990s and the rise of commodity prices in the 2000s. One of Roger's mantras was that oil prices would rise substantially due to a lack of new discoveries. That was also true — until a few years ago.
In the 2000s, the process of hydraulic fracturing became more viable, which led to greater investment in production and a new wave of oil and gas development that continues today. As I covered extensively on MarketWatch in 2012, fracking was driving a rebalance of oil-supply dynamics. Unconventional oil drilling, almost completely within the United States, was offsetting the decline in conventional oil supplies around the world.
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Today, the impact of shale oil is just beginning to take hold globally. Nations around the world are going through the de-risking process of shale formations. Ultimately, this could increase total global oil production by over 10%. With a very slowly increasing demand for oil and wet natural gas through 2040, according to the EIA, increasing unconventional oil, but declining economically viable conventional petroleum supplies, a peak oil plateau is developing that could last the better part of two or three decades.
The result will likely be a rangebound price of petroleum that can be impacted in any short-term window by the usual international-event concerns and economic growth cycles. This range will be from around $80 per barrel to around $120 per barrel — we were recently at about $103 on the July West Texas Crude (WTI) contract — as companies and countries alike need to maintain a balanced pricing structure. That's not to say there can't be out of the ordinary price plunges or spikes, however, should those occur, that opens the door for unique leverage opportunities by enterprising investors.
In the current short-term window, if there are no international threats to production and distribution, we could approach the lower end of the range by year end. Such a drop in oil prices could occur, largely due to increasing U.S. inventories, which reduces our need to import, thus putting downward pressure on prices. Throughout the major American oil plays, including the Bakken, Eagle-Ford and Permian, there are two-story storage tanks popping up and being filled which will prevent any shortages soon.
In addition, American refining capacity is running at approximately 86%, which is near full utilization when maintenance schedules are considered. Without increased refining capacity for the light-sweet crude that America is producing — most Gulf of Mexico refineries are set up for heavier crude from a different era — it will be some time before domestic prices face significant upward pressure. That scenario could change, of course, if oil-industry lobbyists can convince Congress to allow exports of oil or if significantly more refining capacity came on line. Either outcome is probably a long way off.
This week we also learned that Iran has exceeded its expected oil exports by about 300,000 barrels per day more than the million a day that was indicated as acceptable when sanctions were eased in December. Ongoing negotiations with Iran bear watching (there is a good article in Foreign Affairs this month by Javad Zarif that can shed some light on potential outcomes).
One thing is certain, if Iran can strike a deal over its nuclear program with the West, we would see an even greater flow of Iranian oil into international markets. That would result in action from OPEC, in particular, Saudi Arabia, that would be important to analyze. The likely outcome of an agreement between the West and Iran is more Middle Eastern oil in the markets soon.
Intermediate term, we are in the beginning of a trend in transportation toward alternative fuel, hybrid and electric vehicles. While just a ripple so far, there is little doubt that ripple will turn into a wave at some point. By the end of the decade, if battery technology allows — and it probably will — hybrid- and electric-passenger vehicles could hit a significant momentum point as the Millennial Generation starts spending in earnest. Since two-thirds of oil demand is due to transportation, the move toward vehicles that are not purely fueled by petroleum, while adding cars throughout the developing world, is a key factor to whether a supply and demand equilibrium in oil does develop and hold.
Impact on two recommended stocks
In January I recommended buying two oil stocks: Wh it ing Petroleum /zigman2/quotes/204602363/composite WLL +1.86% and Triangle Petroleum . Both are up well ahead of the markets so far this year, each gaining about 20%. Since I suggested buying these stocks, I wanted to follow up with my current thinking in light of what is starting to develop in oil markets.
Whiting has benefited from increased efficiency in its operations, record Williston Basin production, a small asset sale and the addition of gas production at its Redtail project in the Niobrara play which led to a record discretionary cash flow of $482 million. The company has significant capital expenditures planned for the Williston Basin and Niobrara for the coming year and expects in the short-term to experience increasing margins due to further improvement in drilling efficiency. The Redtail project is being deemed another transformative project — like the Bakken before it — due to its potential.
Triangle has risen on increased production and what appears to be a solid acquisition in the Williston Basin adding to its pure play in the region. The company also has solid midstream operations adding to its bottom line. The company will have significant capital expenditures in the coming year as it continues to transform into a operating company from the non-operating company it was a few years ago when it had others do its drilling.
Both companies hedge their oil positions, thus a short-term move to the low end of the oil-price range would not significantly impact them on a cash basis, however, it would impact their earnings as neither company uses hedge accounting. If a short-term drop in oil prices occurs, and I expect it will, the stock of both companies would likely fall, as most investors do not fully understand the earnings of the companies and will drive the share prices down. In that case, I would be a buyer of shares and possibly calls.
I believe there is a high probability that we do move to the low end of the oil-price range later this year, thus I have sold my profits in both Whiting and Triangle, though I am holding onto my core positions (4% of portfolio value to each). Should both or either company's shares rise higher on summer gas pricing, I will sell half of my core position into that strength.
Disclosure: Kirk and certain clients of Bluemound own shares of Whiting Petroleum and Triangle Petroleum. Neither Kirk nor Bluemound clients plan any transactions in the next three trading days. Opinions subject to change at any time without notice.