Is the Oil Price Now in a BIG GAP for Investors?

By
Keith Schaefer
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Is This Oil Price “The Big Gap” for Investors?

I think investors are in the middle of a Big Gap in oil stocks.  The Leaders have already run so hard they’re pricing in $75-$80 oil–so there’s not much value or leverage there.  But the Laggards need even higher oil prices than that to really work–$90-$100.

Their assets don’t pay out quite as fast, or their debt levels are high enough they really can’t afford to grow at these oil prices–or even at $70 oil, without regular increases in debt or new dilutive equity.  Do I really want to own them–even for a trade in this volatile energy market?

It’s a conundrum.  Do I put my money into this Big Gap–buying the Tier 2 stocks and hope oil goes higher? (And let’s just forget that even the best US junior/intermediate producers are about 30% natural gas, which is slowly falling out of bed right now).

Earlier in 2015 I did buy a couple leading junior producers, and one service company but the charts say I didn’t buy enough.  Those stocks ran hard–in fact, so hard I see leading stocks on both sides of the 49th parallel at or even above their highs of a year ago–when oil was $100!  And most of these stocks have even diluted.  As a result, valuations have stretched from 9x cash flow to now 15-17x for a few companies, on really good days. Whoda thunk that only three months ago?

My original investment theory in 2015 was that US production would stay a little bit stronger for a little bit longer than the Street expected–despite the drop in rig counts.  That was certainly what happened in natural gas after the bottom in April 2012.  And the main way to play that thesis is to invest in refineries–stronger production creating oil prices weak enough to stimulate stronger gasoline demand and prices. Refiners earn the spread between oil and gasoline prices.

So I bought more refinery stocks than producers.  I’m flat to up on those trades, and I’ve taken some profits. But now it’s clear the Street is increasingly confident that US oil production is peaking right here, in March-April, and a definitive—even if shallow–production decline will start to happen 2-3 months sooner (mid-late Q2) than the Street thought it would in February (back then the thinking was mid-late Q3).

The two factors that surprised the Street in Q1 was the pace of rig drops (consensus was we would rarely see over 50 a week and we saw a month of 90 rigs drop per week) and that oil demand was inelastic to price.  Last fall there was lots of statistically-backed-up-stories saying oil demand did not increase as prices drop.  But by late January the demand stats were pretty clear—a BIG jump in US demand, much faster than the Street expected. (So that part of my refinery idea worked out…).  And now investors are seeing Asian demand numbers up as well.

All that data started to change psychology last week, and finally the Tier 2 oil stocks started showing some life. But I’m still feeling shy about deploying capital into the Tier 2 producers–because they need even higher oil prices to just survive.  And I’m just not confident the Market is going to see oil prices move that high.

I see the leaders like EOG saying that with reduced costs from the OFS–OilField Services–and other cost-cutting measures, $70/barrel is the new $90 (meaning their cash flow and profitability will be the same at $70 oil as it was a year ago when oil was at $90/barrel).

The problem is, even at $90 oil there wasn’t a lot of positive cash flow out of the shale plays (again–most have BIG gas weightings).  For most of them, that was because they were just growing too fast.   Now, EOG has the size and the team to make $70 oil work.  But most (almost all?) junior and intermediate producers don’t work at that prices. When I say a company “works”, I mean it can grow 10%-plus from its own cash flow.

For a junior producer–and even for most intermediate sized companies–they need wells to pay out in 1 year to even grow at 15% organically.  That wasn’t an issue before last fall because debt and equity were easy.  But for the Tier 2 players, that’s still not easy (though it’s not as hard as I would have thought!).

Most leading companies are now struggling to show in their powerpoints that they can get down to two year payouts with a new mix of lower pricing and lower costs, and sometimes as low as 1.5 years.  But even that means a very low organic growth rate–if not just keeping production flat.   I am seeing powerpoints talking about 4 year payouts.  That for sure doesn’t work.

The Leaders were able to finance in Q1 and all of those financings are up, as oil prices are up. So they have some breathing room.

But the stock prices of Tier 2 companies who were much more reliant on equity infusions to stay alive during the bull market—or are just too small in low margin environment—are still down a lot (though up to 50% off their January lows).  In Canada that’s companies like Long Run (LRE-TSX) or Crew Energy (CR-TSX) and in the US the baby-Bakkens like Emerald Oil (EOX-NYSE) and American Eagle (AMZG-NASD).  There are many others.

That’s what I call The Big Gap–oil prices have recovered enough that the Street is willing to back Tier 1 producers; those with proven teams and low break-even costs.  But with Tier 2 stocks so far behind–what all this is telling me is that the Street’s consensus is for higher oil prices, but not high enough that a rising tide will lift all boats.

Emotion could take the Tier 2 stocks higher but quarterly cash flow will be a big reality check for investors on most juniors and intermediates–even at $70 oil.

That fits into my $65-$70/barrel oil thesis—where the best producers and guys with size can make production profitable—but not the little guy or the inefficient guy.

If that theory gains credence through weekly Wednesday EIA numbers, it will be interesting to see how excited the Street gets and how much they start to move up the leading stocks—with all of them already pricing in $75-plus oil—or if the Tier 2 stocks get on a roll.

I would be biased towards Canadian (vs US) Tier 2 stocks now for a couple reasons.

I don’t see $65 oil improving the Canadian dollar much, so Canadian producers should enjoy some better pricing—if WTI does go to $65, that puts Canadian production very close to CAD$80/barrel–and makes decent cash flow for producers with big oil weightings.  I don’t see a larger drop for the Canadian dollar now that oil has, IMHO, put in a low.  That adds a currency bonus to the trades.

Also important to note that Canadian differentials (discounts) for both heavy and light oil are very tight now, and are expected to stay tight—meaning the price difference for Canadian oil is now low; it’s very close to WTI (on a historical basis).

EDITORS NOTE–The cream of the Tier 2 crop sit just outside the Street’s comfort zone at $55 oil.  But they are welcomed into portfolios at $70 oil.  And right now, those are the stocks with the greatest leverage to a rising oil price.  Find out who they are and get positioned for Extra-Sized potential capital gains.  CLICK HERE.

Keith

 

The Next Group of Energy Stocks to Run

By
Keith Schaefer
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Psychology has changed in oil stocks.  Huge cash inflows are returning to the sector. And that means one very large group of oil stocks is poised to win significant gains.

It’s NOT the leaders—the very best companies. They didn’t dip as much in December-January, and they have already run.  The Early Bird Caught Those Worms.

I didn’t sell my leaders (in fact I added a little bit but not enough) so I’m making good paper profits watching them go up.  But if sentiment in this market is strong enough to allow the Tier 2 stocks to run….what to buy?

Let’s say WTI oil is going to $65—that’s $12/barrel or 25% from here.  With most companies having a roughly $40 breakeven op cost, that’s a doubling of cash flows.

Does that mean stock prices double?

For the leaders who are already up 70-100% from their December or January lows, almost certainly not (but never say never).

Forget the fact that at US$65 WTI, very few US shale plays work at all for the juniors.

But in Canada it’s different—because of the Low Loonie.  My guess is that US$65 WTI would only increase Canada’s dollar from 78 cents to 83-85 cents US.

A loonie worth 83 cents turns $65 oil into $78.31 oil up in Canada, and that price does work—and what I mean by that is that companies can grow production inside of cash flow (though a bit more slowly than they are used to).

Another positive factor for Canada—is condensate, or C5.  The prolific Montney formation on the BC-Alberta border is very rich in condensate—a 50 API oil—which is used next door in the oilsands to dilute heavy oil for oilsands.

Condensate is now trading at 15% premium to Canadian light oil prices—a huge cash cow.

Even the leading natural gas stocks in Canada—almost all of them in the Montney—are trending up because their gas has A LOT of associated condensate.

Condensate is now $70/barrel in Canada (Edmonton light = US$49.66 x 1.23 CAD/US = 61.08 x 1.15 = $70.24).  That produces great cash flow for these companies.

My list of the high-beta, Tier 2 companies that can really run if oil keeps moving gives investors a great opportunity to profit from oil in 2015—something nobody thought possible only one  month ago.

The first wave of buying is over and the leaders have moved.  The Next Wave will be focused here—find out these stories NOW.  Click here. 

PS—For free, I’ll add two other reports—The Top 3 Defensive Oil Stocks and The Three Junior Leaders—The Best Performers.

 

What the Stats Say About Oil Demand (Hint-Bullish)

By
Keith Schaefer
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0

Surprise!  Global Oil Demand Is Surging…..

While most of the oil market coverage has been focused on the glut of supply what has been missed is that an equally big story has emerged on the demand side of the equation.

Global oil demand is surging in response to the drop in oil prices and none of the major forecasting agencies have adjusted their projections to reflect it.

For investors, that is creating an opportunity.

The media has a job to do, that job is keep your attention.   These days they are doing their job by selling you on all of the negatives impacting the prices of oil.

Ignored has been the recent global demand response which could lead to a much swifter turn in oil prices than the market expects.
The information that I provide my subscribers is not focused on what the media is saying.   My service ignores the mainstream noise and focuses on what my vast contact network and hard data tell me.

Let’s look at what the mainstream media is ignoring:

United States – A Rapid Response By Drivers

The United States isn’t just the biggest consumer of oil on the planet.  It is the biggest consumer of oil by a country mile.
Just as U.S. oil supply was believed to be in a permanent decline prior to horizontal shale production emerging so too was U.S. oil demand.
Since the Great Recession of 2008/2009 American oil consumption had been in a steady downtrend.    The oil price collapse has reinvigorated the American desire to hit the road and purchase gas guzzlers.

Based on the statistics provided by the EIA we can see that American oil consumption is up 3.83% year on year since December 1st.

000s 000s
Actual Actual Total %
This Year Last Year Increase Increase
Dec Week 1 19,454 18,554 900 4.85%
Dec Week 2 20,465 20,996 -531 -2.53%
Dec Week 3 21,037 20,484 553 2.70%
Dec Week 4 19,939 19,004 935 4.92%
Jan Week 1 19,344 18,222 1,122 6.16%
Jan Week 2 19,224 18,858 366 1.94%
Jan Week 3 20,204 19,886 318 1.60%
Jan Week 4 20,508 20,047 461 2.30%
Jan Week 5 18,635 19,110 -475 -2.49%
Feb Week 1 19,655 18,541 1,114 6.01%
Feb Week 2 20,387 18,709 1,678 8.97%
Feb Week 3 19,776 18,283 1,493 8.17%
Feb Week 4 19,654 18,291 1,363 7.45%
Mar Week 1 18,609 19,027 -418 -2.20%
Mar Week 2 19,518 18,783 735 3.91%
Mar Week 3 18,700 18,257 443 2.43%
Mar Week 4 19,475 18,199 1,276 7.01%
Since Dec 1 19,681 19,015 667 3.51%
Since Jan 1 19,515 18,786 729 3.88%
Since Feb 1 19,472 18,833 696 3.70%
Since Mar 1 19,076 18,846 721 3.83%

Source of data: EIA U.S. weekly product supplied report

A 3.8% change in consumption may not sound like a lot, but when you are a country that consumes 19 million barrels of oil per day it has a big impact on global supply and demand fundamentals.

On its own, the United States is consuming an additional 721,000 barrels of oil per day since the start of December 2014 relative to the prior year.  Keep in mind that when the price of oil collapsed it was believed that the supply and demand imbalance was roughly 1.5 million barrels per day.

Also keep in mind that all of the forecasting agencies are calling for virtually no growth in U.S. oil demand in 2015.

China – An Opportunistic Response By Leaders

China is the world’s second largest consumer of oil, but because it has a lower level of production it runs neck and neck with the U.S. for the title of biggest oil importer.

That is a vulnerable position to be in and China is well aware of it.  That is why we see them crank up their purchases of oil when the price is low so that they can fill their Strategic Petroleum Reserves.

In December in response to the oil price route Chinese oil imports hit an all-time high of 7.15 million barrels per day.   That was nearly a one million barrel per day increase over the 6.2 million barrel per day average for the prior 11 months.
That is a lot of additional oil being taken off the market.

The most recent data available from the General Administration of Chinese Customs from February 2015 still showed a 10.8% year on year increase in oil imports.

The American oil demand increase is driven by end consumers driving more as a result of low prices.  Chinese demand is bolstered by both consumers and the opportunistic filling of the Strategic Petroleum Reserve.

India – An Even Bigger Response On A Percentage Basis

The 3.8% increase in American oil demand is a big deal because it is on a big base of consumption.  The Indian demand response is on a smaller production base (just over 3 million barrels per day), but it is equally impressive because January gasoline demand skyrocketed by 18%.

February oil demand from India was also impressive hitting an all-time high of 3.91 million barrels per day which was a 9.4% increase from the prior year.  That means more than 400,000 barrels of incremental oil demand coming from India alone year on year.

That is what is happening in those three big countries.  There has also been a demand response in South Korea, Brazil, Indonesia and every other country where gasoline prices are down.

This is a global response.  Energy Aspects, a specialty oil market research firm reported December year on year oil demand had increased by 2.2 million barrels per day year on year.  And that was with considerably higher oil prices than we have had through the first three months of 2015.

Putting It All Together – The Market Isn’t Pricing This In

draft pic

Source of image: IEA March 2015 oil market report

The expectations of the market are set by the three major forecasting agencies (IEA, EIA and OPEC).   These agencies are seemingly blind to the surge in oil demand that has already happened.

The table above is what the IEA released mid-way through March 2015.

For 2015 the IEA is still forecasting global oil demand growth of just 1.0 million barrels per day.  In other words, the IEA is saying that demand growth this year will come in roughly in line with the prior two years when oil prices globally were over $100 per barrel most of the time.

That doesn’t make any sense.  How can it be business as usual for oil demand in 2015 with prices cut in half?
A 1.0 million barrel a day demand increase in 2015 seems highly unlikely when you consider that American oil demand alone has already increased by 700,000 barrels per day year on year.

And remember, the United States is a country where oil demand is expected to be flat if not declining.

After a few months of posted data, the market is going to start to realize that there are two sides to the oil price equation.  There is supply (which caused the collapse) and there is demand.  When the market’s attention finally locks on to the fact that demand is vastly outpacing expectations it will move both the price of oil and the stock price of oil producers.

The tricky part in this market is picking the timing of the move.  You don’t want to be caught owning oil producers that can’t outlast a long period of low oil prices.

That is why rather than trying to exactly time the move, the best strategy is to own the highest quality junior oil producers in the industry.  Low oil prices have actually been good for these low debt producers who are right now getting looks at once in a generation acquisition opportunities.

On the other side of an oil industry blow-out the strong companies emerge stronger.
I’ve identified the three best in class junior oil producers.  All of these companies exhibit the same characteristics:

  • Low debt
  • High quality proven management
  • Top quality, fast payback oil plays

I’m offering a free chance to take a look at this report.  I’ve studied this industry relentlessly for 6 years and I can tell you that these three companies are the cream of the crop.  Even their competitors say so.

 

Keith Schaefer

 

A Surprising Oil Hotspot Brewing in America

By
Keith Schaefer
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0

These Statistics Show A Surprising Oil Hotspot Brewing in America

Guess which American oil play will show the largest increase in production the next two years?  That’s right, I said increase.

The Bakken? Permian? Niobrara?

Well, defying all expectations of analysts and investors alike, it’s likely to be the Gulf of Mexico (GOM), with production forecast to rise 12% to 1.6 million barrels per day.

And that’s because Big Oil is back in the GOM.

percentage growth

Source: Energy Information Administration

Getting a play online in the GOM—in any offshore play—costs a lot of money.  Low oil prices don’t factor into offshore plays as much.

In fact, the numbers show that the Gulf of Mexico may actually be one of the bright spots for U.S. production growth over the next few years. In a recent analysis, the Energy Information Administration forecast that oil production from the GOM will surpass 1.6 million barrels per day by 2016—a nearly 12% rise from the 1.44 million barrels per day currently being produced from this region. The chart below shows the rise clearly.
monthly oil production

Source: Energy Information Administration

In fact, the Energy Information Administration says low oil prices will have “minimal direct impact on GOM crude oil production through 2016”. The reason being the long lead times involved with Gulf projects.

Unlike with onshore plays like the Bakken and Permian, offshore developers—especially in high-tech and high-cost ultra-deep water plays—can’t just shut things down when oil prices fall.

Simply put, after you’ve ordered hundreds of millions of dollars worth of custom equipment to develop on offshore field, you’re going to put the project online—whether crude is $50 or $100 per barrel.

And there’s a big slate of such already-committed projects in the GOM. A total of eight new fields came online in 2014—and another eight are scheduled to begin pumping in 2015. Add on another five new projects to be commissioned in 2016, and there’s a lot of production coming down the pipe for this region.

All of which means the projected 12% increase in oil production is likely to come in as forecast. And as I mentioned, that’s got a number of the biggest players in the E&P sector excited.

Just look at the results from last month’s Gulf of Mexico licensing round.

When the US Bureau of Ocean Energy Management announced results for its 2015 GOM Central Lease Sale on March 18, critics were quick to jump on the numbers. Overall bids came in at just $539 million for 169 winning applications—down 37% from the $851 million for 326 winning bids seen in the 2014 round. And a number of players in the offshore sector—such as BP (NYSE: BP)—avoided the bid round altogether.

Most investors took this as a sign that interest in the U.S. offshore is waning. Not surprising, given the pullback in capital spending that’s been seen across most of the global oil industry since crude plunged below $50 in January.

But a closer look at the data on the recent GOM lease sale actually shows a more-subtle trend emerging here: Big Oil taking a renewed interest in this established and highly-productive play.

As Platts reported, even though overall bids for GOM acreage were down sharply, per-acre prices paid for leases actually rose. The chart below shows their analysis on going rates in 2015, as compared to a year ago.

percentage mexico

Source: Platts

On average, lease prices were actually up 16% to $583 per acre. And certain parts of the GOM such as the high-impact ultra-deepwater segment saw lease prices rise by an even-greater 18%, to $864 per acre.

That interest came from a number of major players including Chevron (NYSE: CVX), ExxonMobil (NYSE: XOM), Statoil (NYSE: STO) and Shell (NYSE: RDS.A). All of whom apparently still see lots to like in the Gulf—even as their brethren in the industry are pulling back.

That may be because “hot” shale plays are starting to cool off.

The fastest-growing oil play in America—the Bakken of North Dakota and Montana—saw output rise about 28% over the past year. The Permian Basin of Texas was close behind at 27% production growth. So the GOM is at least keeping pace in terms of double-digit production growth.
percentage us oil plays

Source: Energy Information Administration

Even more so when we look at numbers over the last three months. As the chart at the outset of this article shows, with oil prices tumbling and drilling budgets being slashed, production growth from big onshore plays has fallen off a cliff so far in 2015. The best of the bunch—the Permian—has eeked out a 5% improvement in output since January. Plays like Bakken and Eagle Ford have nearly crawled to a standstill.

Suddenly 12% growth looks pretty good. In fact, it could mean—against all expectations from investors and analysts alike—that the GOM will be the fastest-growing producing region in America over the next two years.

Judging from the latest lease sale results, GOM stalwarts like Chevron aren’t stopping with the current slate of new developments either. Instead, these regional experts are continuing to aggressively pursue new plays and new discoveries.

That makes the GOM a spot to watch—both for value-creating oil finds for major and junior firms alike, as well as incremental growth from larger E&P players, which may very well take the market by surprise.

Keith Schaefer

Editors Note:  I have bought very few oil stocks in 2015—but they’re all up.  In fact, some are up over what they were this time last year when oil was $100! That’s because in these times I only want to own THE LEADERS—the BEST stocks.  As oil prices continue to move up, the more leveraged stocks will run.  But I want to start my 2015 portfolio with the best stocks.  Get the names and symbols of these stocks RIGHT NOW.

 

5 Reasons Not To Invest In Energy

By
Keith Schaefer
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There are a lot of options for your hard earned capital and no shortage of folks wanting to tell you how to use it.

Recent trends have been very profitable in different sectors. On the other hand, energy has displayed a horrendous previous 52 weeks.

So here are 5 reasons not to invest in energy.

  1. Biotech is hot right now, having risen 30% in the past 6 months. The trend is your friend, right?

 1

  1. The S&P 500 has been hot since the autumn of 2011 producing gains of +82%. In the past 12 months it has risen 13%.

Are we edging on fear or greed almost 6 years to the day of this bull market?

2

  1. US Housing is on the rise, mortgage rates are still near all time lows.

Were you able to get in at rock bottom 30-year fixed interest rates and the most depressed real estate market in the last generation?

The trend could still be your friend.

Markets in Las Vegas, Phoenix and Miami are recovering from their extreme lows. Did you act when values plummeted after the mania?

  1. The Chinese Shanghai stock index is breaking to the upside and is up over 32% in the past 52 weeks.

Take a look at the ETF representing fifty large-cap Chinese companies, FXI:

3

  1. Technology is booming all around us and is more popular in the media than in 1999.

Facebook, Twitter, Tesla, Uber, AirBnB, Meerkat.

All of these hot companies have espresso machines in their lunchrooms that cost more than what I pay for annual office rent. They are all the talk of venture capitalists and retail traders from coast to coast.

You can’t go five minutes on social media or online without hearing about the next big find from TEDtalks, Fast Company or SXSW.

By the way, the broad based exchange traded fund – XLK – is up 19% over the past 52 weeks.

4

But there is one difficult way to make simpler money. Remember this key point and staple it to your wall because what’s simple is not always easy.

You buy fear and you sell greed.

That’s it.

Where do the charts show and where can we find greed?

Simple. And I think you would agree with this example…

5

A tweet by new age wunderkind Elon Musk can make him an instant $10 Million on paper.

He is quite a visionary, intellect and entrepreneur – but he is a human. How can someone make shares or a multi-billion dollar company jump with a tweet that doesn’t reveal anything but maniacal anticipation?

When greed comes to town, you can spot the mania in retweet and favourite numbers.

So how do we know when fear comes to town?

That too is simple. But it’s not easy to deploy your capital.

Simple and easy are two very different things. Especially in the opportune times to position your capital that fearful markets provide.

Take a look at headlines like this…

“Energy stocks punish TSX amid worries oil prices are in for further losses”
– Financial Post, March 13, 2015.

Or take some time to spot charts like this…

 6

It doesn’t take a doctorate degree to figure out which side of greed and fear the pendulum is on.

Take a look at how the various sectors are doing on the S&P 500. There is only one major outlier swinging its lines well into the fear spectrum.

7

At the risk of over-repetition, there are a lot of potential suitors and sectors looking for your capital.

Many times, it’s for the service a business is trying to sell you. If that’s what you’re looking for, that’s not the way that I operate.

I operate on the philosophy that my portfolio is open for all to see.

Instead of making recommendations, I show you exactly what I am doing with my own money. And you have 24/7 access to my whole vault of trades.

I’ve shown you just 5 other sectors and investment opportunities that have delivered great returns. Indeed, there are many more loved investments out there.

Call it a combination of luck, preparation, tact and strategy, but last year was my best year of investing to date.

While oil was down over 40% in 2014, I made six-figures investing through my rigid methodology. You can find out exactly the moves and profits I made by accessing the archives as a member.

To see how to start taking small, calculated bites into energy positions that offer profitable odds…

Click here.

With a risk-free trial that provides complete access to my alerts and bulletins, your only real risk is not trying it to see if it works for you.

Sincerely,

Keith

The Marcellus is close to Peak Production and why this is so Important

By
Keith Schaefer
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0
By Bill PowersOne of the little spoken truths of the shale gas industry over the past three years has been that most of America’s gas fields are now experiencing production declines with one large exception: the Marcellus Shale in Pennsylvania.And that narrow reliance on one play gets even more concentrated—the North American natural gas market has morphed from relying on the entire Marcellus to provide all of the continent’s production growth a year ago—to now hoping that growth in select Pennsylvania counties will sustain current trends.

Unfortunately, in addition to production declines in West Virginia, Pennsylvania Marcellus production is now in decline in two of its three most prolific counties.

According to 2H 2014 production data from the PA DNR, Bradford and Lycoming Counties, which produced a combined 3.6 bcf/d in 2H 2014, experienced production declines of 3 and 5 percent respectively.

A flattening of Marcellus production will send shockwaves throughout the North American natural gas market.   With US production at approximately 70 bcf/d of which ~58 bcf/d is production from outside of the Marcellus, US production could experience a net decline of 6 bcf/d over the next 12 to 18 months should growth in the Marcellus not pick up and natural declines continue.

Based on state production data in recent months it is easy to see Texas decline 2 bcf/d, Louisiana drop 1 bcf/d with Wyoming, Colorado and New Mexico each experiencing declines of .5 bcf/d over the next 12 to 18 months.  Another 1.5 bcf/d of aggregate declines can be expected from states such Oklahoma, Kansas, Utah, North Dakota, Montana, California and the Gulf of Mexico where drilling activity  is down approximately 40 percent compared to year ago levels.

Sound far-fetched?  A look at the data from both Pennsylvania Department of Natural Resources (DNR) and other important producing states supports the thesis that US natural gas production is headed for a material fall this year.

In this article I will take a closer look at production trends in the Pennsylvania Marcellus as well as developments in other gas producing states to show that US natural gas production is rolling over and there is little that can be done to stop it.

The Monster Marcellus –And EIA Extrapolations

The Marcellus, which has added roughly 3 bcf/d (billion cubic feet per day) of net production in each of the last four years and recently established a new all-time high level of ~12.5 bcf/d, has nearly single-handedly offset production declines in other shale plays and conventional production over this time period.

Some analysts as well as the US EIA (Energy Information Administration) have reported that Marcellus production is already 18 to 19 bcf/d.  But recent data from the State of Pennsylvania resoundingly contradicts claims of such lofty production levels.  Pennsylvania, according to the state’s Department of Natural Resources, produced an average of less than 12 bcf/d during the second half of 2014.

Why the discrepancy?

It likely has to do with analyst models being unable to detect rapid changes in drilling activity and well productivity.  The EIA has cited rapid changes in the drilling activity for inaccuracies in its monthly 914 natural gas production reports.

(It should be noted that the Pennsylvania Marcellus accounts for nearly 95 percent of production from the play while West Virginia supplies the remainder.)

So where will the US declines come from?

The state should account for the biggest drop in US natural gas production this year is Texas.  Contrary to recent reports from the EIA that natural gas production in the Lone Star state grew approximately 10 percent in 2014 (Source: http://www.eia.gov/oil_gas/natural_gas/data_publications/eia914/eia914.html ), early indications from the Texas Railroad Commission show a small decline in  production during the year.  The below table shows total production in the state over the last seven years:

texas commission drop
Source: http://www.rrc.state.tx.us/oil-gas/research-and-statistics/production-data/texas-monthly-oil-gas-production/

There are a couple of important takeaways from the above table. First, despite one of the biggest drilling booms in Texas history over the past seven years—which included the emergence of the Eagle Ford Shale as one of America’s top unconventional plays—2014 gas production was only 6 percent higher than in 2008.

During this period the Barnett Shale peaked and entered terminal decline while the Eagle Ford grew from a standing start to nearly 5 bcf/d and the Permian saw modest gains.  Now that:

  1.  activity is in freefall in all of these plays and
  2. many wells are still in the high decline portion of their productive lives,

investors should see material production declines in 2015.

Second, the rebound in Texas gas production in 2011 after declines in 2009 and 2010, is largely attributable to huge growth in associated gas production (gas production from oil wells).  Since 2008 production from gas wells has declined 12 percent while gas from oil has increased an incredible 193 percent.

Put differently, gas production from oil wells accounted for 24 percent of total statewide production in 2014.  With Texas now relying on oil wells to generate a higher percentage of its gas than it has in decades, the ~45 percent drop in drilling activity over the past year will have a significant impact on both gas and oil production in the state.

Barring a rapid return of triple-digit oil and a corresponding bounce in the price of natural gas, it is reasonable to expect Texas production to drop 10 percent or 2 bcf/d to approximately 20.5 bcf/d over the next 12 to 18 months.

Louisiana production has been falling at a precipitous rate since early 2012 when the Haynesville reached its production pinnacle.  As you can see from the below chart taken from the Louisiana DNR, production was down 18 percent in 2014 compared to 2013 and further declines are in store for 2015 now that the state’s rig count is approximately 35 percent lower:

lousiana
lousianachart

Source: http://dnr.louisiana.gov/assets/TAD/data/facts_and_figures/table09.htm

While the drop of 1.13 bcf/d in Louisiana production during 2014 may surprise some industry observers, it was very predictable.  Natural gas production in the Bayou State hit a multi-decade peak in 2011 at nearly 8 bcf/d and has been declining in nearly a straight line since.  As you can see from the above table, current production in the state is approximately 4.5 bcf/d and dropping.

Without a material rebound in drilling activity in state, it is easy to see that annual production could fall an average of 1 bcf/d in the state during calendar year 2015.

If Texas and Louisiana decline by a combined 3 bcf/d, what states will make up the balance of America’s total decline of 6 bcf/d over the next 12 to 18 months?   As mentioned previously, based on well productivity trends and recent state production data, Colorado, New Mexico and Wyoming should each experience a production decline of .5 bcf/d over the year and a half.  Other major gas producing states and the Gulf of Mexico will easily account for the remainder of the expected 6 bcf/d production drop.

Wyoming, where production has been declining since 2009 due to the advancing maturity of the CBM in the Powder River Basin and the Jonah Field, is certain to see an acceleration of declines.

Natural gas production in Colorado peaked in 2012 due to a downturn in activity in the Piceance Basin, the state’s largest producing area, and there is no sign of this trend reversing.  The Piceance, once lauded as an area with “gas manufacturing”, has been left for dead by both EnCana and Exxon while WPX Energy has reduced its rig count in the basin from eight to three in recent months.

New Mexico, which saw it gas production remain flat on a year-over-year basis in 2014 after falling every year since 2004, will likely see a decline in production in 2015.  Similar to Texas, New Mexico’s gas production was only able to stay flat last year due to an increase in associated gas production.   A more than 40 percent decline in active rigs in the Land of Enchantment will likely result in at least 10 percent decline–or 0.5 bcf/d–in gas production in the next year to 18 months.

What is going on Beneath the Headlines in the Marcellus?

Similar to a teenager who grows six inches during the summer between eighth and ninth grades, the rapid growth phase of the prolific Marcellus Shale has likely ended.  Does this mean that America’s largest gas field will experience immediate and severe production declines? Absolutely not.

However, given today’s current natural gas price environment and the advancing maturity of its highly productive areas, the mighty Marcellus has likely entered a period flat production for at least the next year or so..   Let’s examine the facts behind this prognostication:

  1. Most recent data from PA DNR shows the slowest growth since 2009.  According the DNR, production growth in the Pennsylvania Marcellus, which accounts for approximately 95 percent of total Marcellus production, grew only 859 mmcf/d in the second half of 2014 compared to H1 2014 to 11.65 bcf/d.  Growth of less than .5 bcf/d per quarter (1 bcf/d for 6 months) will be nowhere close to enough to offset declines in the rest of the US.  Also, production in the West Virginia portion of the Marcellus is already declining.
  2. Current prices in the Marcellus are incredibly uneconomic.   With the price gas for delivery on March 30th at $1.69 per mcf, production in the Marcellus at today’s prices equates to epic capital destruction.   With half-cycle costs in the Marcellus for Talisman Energy, a top ten producer with operations in one of the most prolific parts of the play, at $3.25 per mcf and full-cycle likely over $4.00 per mcf, the company is losing approximately $2.00 for every thousand cubic of gas it producers.
  3. Producer debt levels indicate slowdown in Marcellus activity.  With operators experiencing significant losses on their Marcellus production, activity levels will continue to slow, barring a big rise in basin gas prices.  For example, debt-soaked Chesapeake Energy, the largest Marcellus producer, recently sold off part of its southeastern Pennsylvania core acreage and is shutting in producing wells northeastern PA due to extremely poor economic returns.
  4. Law of Large Numbers.  Now that there are approximately 7,000 producing wells in the Marcellus, of which more than 6,000 have been completed since mid-2009, the play’s natural annual decline rate remains over 30 percent.  In other words, 1,100 need to be placed onto production every year for the Marcellus to maintain its current level.  This scenario is likely to be achievable given the significant inventory of wells and the 70 rigs currently active in the basin.  However, unless new wells can become more productive to offset continuous declines, a pick-up in activity levels will be necessary for Marcellus growth.
  5. Recent data shows that major portions of Marcellus already in decline.

Conclusions

Extrapolating recent production growth in US natural gas production into the future is clearly the consensus view and has been for some time.

What most investors forget is that the EIA monthly production model uses data that is 2 years old and even publishes the caveat along with its monthly report that modeling errors occur at time of rapid changes in drilling activity.

The EIA even cites the ramp up in production in the Haynesville as an example of where its model was unable to produce accurate estimates due to its inability to incorporate recent production data.

Problems with the EIA’s production estimates have been around for more than a decade though they are not widely recognized.  I even dedicated an entire chapter of my 2013 book discussing the many problems with EIA production estimates since it is one of the biggest sources of misunderstanding today’s gas market.

Like all things that must end, so too will US shale gas production growth.

Times have changed:

  1. The balance sheets of shale gas producers have no more capacity
  2. oil prices no longer supportive of continued growth in associated gas production,
  3. high decline rates and
  4. shale operator management teams who are now being rewarded in the marketplace for capital discipline (i.e. dropping rigs) rather than production growth

No longer will booming production from a small sliver of northern Pennsylvania be able to single-handedly offset production declines in US conventional production and older shale gas plays as well as perpetrate the myth that rig counts don’t matter.

Unless it is different this time (and it never is), the greatly reduced gas and oil rig counts will result in lower production and higher prices in both the short and long term. 

Lastly, it is not just declining production that will be the source of extreme volatility in coming months–rising demand will help push the US natural gas market to extremes.  With the retirement of between 25 and 50 GW of coal fired power plants that will largely be replaced by gas-fired plants, and the opening of dozens of chemical and fertilizer plants–sharply rising for natural gas prices over the next two years is virtually guaranteed.

Increasing demand at a time of falling production will radically change the landscape of gas market despite the widely held belief that today’s status quo of low prices will continue.

EDITORS NOTE—wouldn’t it be ironic if the energy producers end up being The Big Trade for 2015? The EIA just reported that US oil production FELL in February.  Be prepared for the turnaround NOW—read my report that cover The Top 6 Oil Stocks—3 Conservative Seniors and 3 High-Torque Juniors.  They all have strong balance sheets.  Get all the relevant details HERE.

Why It’s The 2009 Bull Market All Over Again

By
Keith Schaefer
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0

Corporate profits for US companies—especially small caps—could be set to soar 20% in the first half of 2015.

That’s what happens when the CPI—the Consumer Price Index—breaks up and away from the PPI—the Producer Price Index.

The chart below (courtesy of  Unit Economics in Boston) shows that the Consumer Price Index has only moved slightly negative (only 0.1%) in its most recent measurement:

chart 1

But the move down in the Producer Price Index has been much larger at 3.1%:

chart 2

Corporate profits are the difference between the revenue a company generates (related to CPI) and how much it has to spend to generate that revenue (related to PPI).  Watching the relationship between the CPI and PPI can provide direct insight into how corporate profits are tracking.

The CPI measures the retail prices of goods and services purchased by U.S. consumers.  These are the prices that consumers are paying—and therefore the prices that corporations are receiving.

The CPI tells us what is happening to the top lines (revenue) of corporations.  If it drops, revenue drops.

The PPI meanwhile measures the prices that producers of domestic goods and services are receiving.  These are the wholesale prices that corporations are paying and are therefore a good indication of how their input costs are trending.

The PPI tells us what is happening to the expense lines of corporations.  If it drops, expenses drop.

If the CPI stays flat and the PPI rises, corporate margins are going to be squeezed.  On the other hand if the CPI stays flat and the PPI drops corporate margins are going to expand. While the CPI has trended down marginally on the back of lower energy costs, the PPI has plunged.

The above two charts indicate the US should experience a rapid expansion in US corporate profits as companies SELL their products at CPI-linked prices, but have production costs linked to the Producer Price Index (PPI) – which is absolutely plunging.

With the market sour on corporate profitability–because of the high and rising US dollar–this creates the recipe for positive earnings surprises that will drive stock prices higher.

The chart below tracks how US corporate profits move with the CPI-PPI relationship.  The white line is the CPI minus the PPI (-.01 minus -3.1 = 3). Whenever the white line spikes up–like it is now and like it did in 2009–corporate profits (the yellow line) are quick to follow.

chart 3

Source: Unit Economics, Boston MA

Unit Economics estimates that this 3% expansion in margins will translate to nearly a 20% increase in overall profit growth.  They believe that there will be roughly a two month lag between the numbers that show up in the CPI/PPI and the timing of U.S. corporate profit growth.   That should make for a good Q1 for US small caps (which will benefit in March) and a blow-out Q2.

This idea of a surge in corporate profits is against market consensus now, which is focused on weak international GDP growth and also the stronger US dollar.

That’s potentially true, but it misses the fact that not all companies face those challenges equally.  Large caps doing a lot of business internationally will face big headwinds in 2015 even with the CPI/PPI margin expansion.

On the other hand small caps that are focused only on US consumers avoid those headwinds AND have a strong tailwind from the margin expansion that the CPI/PPI trends have identified.

That should set the stage for significant outperformance for small cap US focused companies in 2015.

EDITORS NOTE: The two editors at our sister newsletter at www.SmallcapDiscoveries.com spend all their time doing bottom-up research on individual small and micro-cap companies with a US focus.  Paul Andreola and Brandon Mackie go through quarterly financials of publicly traded small caps every night as they are posted to SEDAR and EDGAR, the regulatory websites for pubco financials in Canada and the US.

They look for orphaned stocks with positive cash flow, partway into a big growth curve.  They search for the stocks that are going to go up 2, 3 or even 10 times over a period of 2-5 years.

They look in the corners of the market that are ignored by the big institutional investors.  When you combine their stock picking with the tailwind of the surging corporate profits that are coming in 2015 the results can become truly exceptional.

Paul and Brandon are issuing a new stock pick on Monday March 30 after market close at 4 pm Eastern Daylight Time.  The subscription page will re-open for only the next 7 days–until they release the 12 page report on this fast growing American micro-cap.  To join our exclusive small community–and our new Subscriber Chat Forum–CLICK HERE.

The Best Portfolio Hedge for Low Oil Prices

By
1940bkg
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0

Everyone in the oilpatch is now nervous that the United States could run out of oil storage capacity.  This “storage issue” is now Big News, and is driving light oil prices in the US—WTI—to fresh six year lows of $42-ish a barrel.

I see a lot of copy on the Internet dedicated to this debate.  Is there enough storage capacity?  Is there really just eight weeks left before the industry fills all the tanks? Or will it happen later in the year?

In a fundamental sense, that’s an important question.  As I outline below, there are some pretty smart people calling for as low as $10/barrel for oil because of this issue.

But in a Market sense, it’s not that important.  That’s because just the FEAR of storage congestion is enough to drive and keep oil prices low.

A less well known story is what is happening to demand for gasoline in the United States.   Over the past three months demand for gasoline has skyrocketed.

I’ve identified a company that generates HUGE Free Cash Flow (FCF) from these two trends.

More on that in a minute.

A Very Real Possibility That Oil Is Headed To Shockingly Low Levels

North American oil producers are terrified right now and the graph below explains why.  Oil inventory levels in the United States have hit disturbingly high levels. Worse still, they are headed higher at a record pace.

crude oil inventory

At the current pace of inventory builds, there’s a chance that U.S. inventories will fill later this year.  If storage becomes full, oil prices will plummet.  That is not a debatable point.

How low could WTI oil prices go?

It is of course impossible to predict with any degree of certainty, but there are some shockingly low predictions being made by some very credible oil market observers.

Former Royal Dutch Shell President and current President of Citizens For Affordable Energy said this week in an interview with Bloomberg that $20 per barrel oil is a real possibility.

Hofmeister is well known as an oil “perma-bull”–which provides some color on how severe this inventory situation is.

Ed Morse–head of commodity research at Citigroup–recently said $20 per barrel oil becomes very possible in the coming months if oil storage fills up.

Morse, BTW, was calling for a collapse in oil prices last spring and he was proven to be exactly correct.

And then there is Wall Street veteran Gary Shilling who thinks oil could fall even further than that.  His target?  $10 per barrel.  Like Morse and Hofmeister, Shilling’s words carry some weight.

In 1981 Shilling said that bonds were headed for the “rally of a lifetime”.  Since then a strategy of rolling a 30-year zero-coupon bond has beaten the S&P 500 by 630%.

These pessimistic views guarantee nothing, but it does indicate there is very real potential for something extraordinary happening.  And that potential is all that’s needed to make my Big Position a Winner.

It Hasn’t Been Well Covered, But Gasoline Consumption Has Surged

While the media focuses on the looming oil storage crisis, you rarely read about how gasoline (and other refined product) consumption in the United States is surging right now.

Here is the year-on-year data from the EIA website:

Last This Demand
Year Year Change
Dec 06, 2013 18,554 Dec 05, 2014 19,454 900
Dec 13, 2013 20,996 Dec 12, 2014 20,465 -531
Dec 20, 2013 20,484 Dec 19, 2014 21,037 553
Dec 27, 2013 19,004 Dec 26, 2014 19,939 935
Jan 03, 2014 18,222 Jan 02, 2015 19,344 1,122
Jan 10, 2014 18,858 Jan 09, 2015 19,224 366
Jan 17, 2014 18,959 Jan 16, 2015 20,204 1,245
Jan 24, 2014 20,047 Jan 23, 2015 20,508 461
Jan 31, 2014 19,110 Jan 30, 2015 18,635 -475
Feb 07, 2014 18,541 Feb 06, 2015 19,655 1,114
Feb 14, 2014 18,709 Feb 13, 2015 20,387 1,678
Feb 21, 2014 18,283 Feb 20, 2015 19,776 1,493
Feb 28, 2014 18,291 Feb 27, 2015 19,654 1,363
Mar 07, 2014 19,027 Mar 06, 2015 18,609 -418
Dec Avg 19,760 20,224 464
Jan Avg 19,039 19,583 544
Feb/Mar Avg 18,570 19,616 1,046

In December 2014 daily U.S. consumption/demand for oil increased by 464,000 barrels per day over the prior year.  In January 2015 the year on year increase was 544,000 barrels per day.

Since the beginning of February the year on year increase is surprisingly large–at more than 1 million barrels per day.

Americans love their driving, and with $50 oil they can afford to do a lot more of it.

The increase in demand is helping to make the inventory glut better than it would otherwise be, but it isn’t going to solve the problem because year on year oil production is also up by a million barrels per day.

Who Benefits From The Combination of Low Oil Prices And Surging Gasoline Demand?

At the start of last July I sent an e-mail to my subscribers telling them that it was time for me to start selling my oil producers.  I then spent the rest of 2014 figuring out how I could profit from low oil prices.

My work lead me to my latest subscriber pick which I knew would be a huge beneficiary of low WTI oil prices.

However, I greatly underestimated how good things would actually become for this company in the first half of 2015.

Oil has already gone lower than I expected (which is good for this trade) and another leg down is happening now.

On top of that, my latest subscriber pick also benefits from surging gasoline and finished product consumption.

That means the company is posting blow out numbers on both the top and bottom lines which creates huge margin expansion.

Sometimes you are good, and sometimes you are lucky.  In this case for me I think it is a bit of both.

The market is just starting to realize how huge profits are going to be for this company this year.  Before the stock really takes off I’m offering you a risk-free opportunity to read my full subscriber report by clicking here.

I’ve put more than half a year into identifying this opportunity and you can get up to speed in an afternoon. 

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