Energy Prospectus

An EPG member e-mailed me today asking for my take on when it would be safe to get back into the energy sector. Here is my response. - Dan

I think the energy stocks may stay in the "dog house" for a few months. 4th quarter results will be OK, but many companies will be forced to take ceiling test write downs (for Full Cost companies) and impairment expense (Successful Efforts companies). Those with a lot of production hedged (all of the upstream MLPs) will report huge gains on their hedges in Q4. LINN Energy reported last week that their hedges have a cash value of $2Billion today. < Remember that these kind of adjustments required by GAAP accounting rules are non-cash items.

Trying to time the market is difficult.

I do believe the price of oil will be much higher by Q4 of 2015. $50/bbl is unsustainable. Drilling will drop sharply (already happening) and supply will drop a few months later. Global demand for oil continues to go up. Take a look at the big spike in demand forecast for Q3 2015 at the IEA website at https://www.iea.org/oilmarketreport/omrpublic/.

Keep in mind that the markets are forward looking.

It will soon become clear (based on analysis of E&P capital programs) that U.S. shale production will peak within six months and go on decline by Q3. Remember, North America (shale, GOM and Canada) is the only place in the world that has had net production increase since 2005.

Plus, other than Saudi Arabia, there is no excess production capacity. Every other country is producing as much as they can (exception is Iran because of sanctions.)

IMO we are planting the seed today of the next "Energy Crisis", which could happen as soon as 2016.

Keep an eye on the oil futures market: http://www.cmegroup.com/trading/energy/ ... crude.html

Note that the out months are already trading a higher prices.

Well managed upstream companies will be fine. Netbacks at $50/bbl are still very good (over $30/bbl). To survive, E&P companies will "hunker down" and reduce capital spending until commodity prices improve. All of our Sweet 16 have good cash flow from operations, even at today's low oil price.

For more read: http://oilprice.com/Energy/Energy-Gener ... -2015.html

Your earlier post indicate Russia had reached an all time high production month of 10.7 mmbpd in December. Does this not indicate rising production there? What level is consider normal production for Russia?

In 2012 Russia produced 10.4 million bbls per day > See: http://www.eia.gov/countries/

Here is what caused the price of oil to drop.
> $25/bbl can be blamed on the spike in the U.S. dollar. See: http://www.marketwatch.com/investing/index/dxy/charts
> Libyan production jumped up by 600,000 bbls per day in Q3 to over 900,000 BOPD. It is now back down.
> Asian demand was down
> U.S. shale production going up.
> Everyone expected OPEC to adjust production but they did not. Saudi Arabia was pissed because Russia and the other OPEC nations wanted them to do the entire cut.

Today supply exceeds demand by about 1.5 million bbls per day. The world consumes over 93 million bbls per day of hydrocarbon based fuels (some from biofuels) and demand is heading to 94.5 million bbls per day by end of 2015 (see https://www.iea.org/oilmarketreport/omrpublic/)

Actions being taken to balance Supply / Demand
> Libya is a mess and will stay that way.
> Demand growth is relentless and low fuel prices will increase demand
> Production will fall by Q3 as capex is being cut all over the world.

It should be clear to the market in less than six months that supply growth is falling faster than demand growth.

Of course Saudi Arabia and Russia can solve this much quicker by announcing they have both agreed to reduce production by 500,000 bbls per day each.

I think its a great time to wander down to the market and pick out a few bargains for payback later in 2015 or 2016. The current oil price scenario is unsustainable and somebody's going to blink before long. Algeria and Venezuela are already getting twitchy and the Saudis can only afford a few of those flying visits to deliver cash for suffering OPEC members.

Dan, in your above comments you stated "Plus, other than Saudi Arabia, there is no excess production capacity. Every other country is producing as much as they can (exception is Iran because of sanctions".
However I do not believe this is correct. I read that Canada is increasing their oil production from the tar sands on "long lived projects" that are ongoing, with projected increases in the hundreds of thousands
of barrels over the next few years. Russia has recently increased their production, and Iraq is known to have plans to increase their production significantly over the next few years. Also, despite the problems
in Libya, they too have the capacity to increase their production if they stop fighting with each other. And Venezuela as well could potentially increase their production in the future as their reserves are
quite large. Nobody can predict what will happen to oil prices, but I think it is wrong to assume that "every other country is producing as much as they can " since there is obviously tremendous potential in
all the countries named above to increase their production. ( I did not even mention Brazil offshore, Arctic potential, etc...). Also more energy efficient cars are taking a bite out of oil demand.

Saudi Arabia is the only country that has meaningful CURRENT production capacity above what they are producing today. I did not say that other countries do not have the ability to increase production capacity. No one else holds back production except Saudi Arabia (not counting Iran due to sanctions).

For example, Libya could produce a lot more oil if suddenly they all stopped fighting but the country is currently exporting all the oil they can under the current circumstances.

To increase current production anywhere requires MASSIVE capital expenditures. At today's oil price, that money will not be spent.