Energy Prospectus

I have FINALLY finished updating all of the Sweet 16 individual forecast models and my valuations for each company. All 16 companies reported solid results for the quarter. BTE and BCEI are the only two that are going into "maintenance mode". EOG has also pulled in their horns a bit. I do see that several companies will be drilling wells, then delaying completions until oil prices improve. We will be sending out updated profiles next week. Updated reports for RRC and SM are already on the website.

For the week ending August 7, the Sweet 16 was down 2.22% and is now down 16.54% for the year. All of last week's loss (and then some) came on Friday. Wall Street is in "FEAR" mode and unless everything is supportive, the price of oil keeps going down. On Friday it was a small increase in the active rig count. I do think this 3rd test of the low will end in August. There is now almost no excess production capacity in the world and demand growth is rapidly reducing "the glut". Do you hate the word "glut" as much as I do?

Earlier in the week, the good 2nd quarter earnings reports and a larger than expected drop in U.S. crude oil inventories cause a brief rally. I continue to believe there is a lot of cash sitting on the sidelines that wants to get into this sector. Many Wall Street analyst are telling their clients that this sector is oversold. Just look at the First Call Price Targets, five of them are over my valuations.

As a group the Sweet 16 is now trading 79% below my valuations. My valuations are very close to the First Call price targets. UNLESS YOU BELIEVE OIL PRICES ARE GOING TO STAY DOWN FOREVER, THESE STOCKS ARE GROSSLY OVERSOLD. You may have noticed that the "Elite Eight" (the larger companies) have held up better. This is because they have big institutional ownership that has a long-term outlook. Plus, small-caps always get hammered in this phase of the cycle.

That said, it does not mean the stock prices will go up. I can be "right" a long time before Wall Street figures out. We need a few things to happen.

1. We need the price of oil to stabilize (fairly obvious). Low prices do reduce supply and increase demand, but it takes awhile in this business. "A while" is just ahead. The fundamentals have caused every previous drop in the price of oil to reverse, and this cycle is not an exception. Especially, because there is almost zero excess production capacity today.

Watch this video: http://www.bloomberg.com/news/articles/ ... oil-market

2. We need EIA and IEA to confirm that U.S. oil production is on decline. EIA reported a 130,000 barrel per day decline in U.S. production in July, but the market barely noticed. I believe we are going to see the U.S. oil production decline accelerate. I am expecting a decline of ~500,000 barrels per day in the 4th quarter. With today's active rig count, I don't see how the wells completed in Q4 2015 can come close to offsetting the decline of just the wells completed last year. There are over 50,000 horizontal shale wells and they are all on rapid decline.

3. I got several reports last week indicating a big increase in global demand for refined products. Low prices for fuels has a lot to do with this. It will be nice if IEA's monthly Oil Market Report confirms this. You can check the new report next week at https://www.iea.org/oilmarketreport/omrpublic/ < This is not an active link.

4. We need to see several weeks in a row of declining U.S. crude oil inventories. With refineries running near capacity and production on decline this should happen. Historically, U.S. oil inventories decline through mid-September.

5. We need Wall Street to understand the Iranian Nuke Deal. Other than what the Iranians are already smuggling out, the sanctions will not be lifted until we are several months into 2016. In my opinion, the hype and misunderstanding of this deal is the thing that took WTI down from $60/bbl AND I believe the impact on global supply is GROSSLY over-estimated. There may be a bit of "surge" right after the sanctions are lifted, but it will take year's for Iran to meaningfully increase their oil production.

6. In previous cycles, an indication that things were improving was a bunch of takeovers. I got two calls from fund managers last week who told me that $billions is sitting in hedge funds ready to finance deals. These are smart guys that know that buying when "blood is in the streets" is a great way to pick up some valuable assets on the cheap.

The "Dog Days of Summer" will be over soon. It is going to be an interesting football season.

From a newsletter I received from a very smart fund manager: "At the start of 2015 the principle forecasting agencies were predicting global oil consumption to grow by around 1 million bpd in 2015. They are finally beginning to revise their projections higher. It would not surprise us if growth this year climbed to close to 2 million bpd when all is said and done."

In 2009, EIA started the year with a forecast that demand for oil would increase by 1.0 million barrels per day. By early 2010, EIA confirmed that demand went up 3.3 million barrels per day in 2009.

Raymond James reported last week that Non-OPEC + Non-Shale projects which were expected to add 4.8 million barrels per day of global supply in the next three years have been cancelled this year.

Many market analysts argue that because the fall in rig counts can easily be reversed any
sustained recovery in oil prices will be limited. The current consensus thinking is that at WTI prices much
above $60 - $65 shale oil producers will start bringing rigs back and with it more oil production. That’s
because, $65 WTI is deemed to be the current average breakeven price for these plays. Furthermore,
these same analysts argue that because productivity of wells and rigs is growing and the cost of drilling
and completing wells is falling the WTI price necessary to see an increase in production is also falling over
time and that will keep downward pressure on oil prices.

The problem with this analysis is that it assumes that U.S. shale oil producers are the marginal supplier. In
the longer term – that is to say over the full investment cycle - they are not, even if they currently have to
assume the role of balancing the market.

The reason that it has fallen on the shale oil producers to bring the market into balance is that they can
economically modulate their production in the short term. During a temporary period of low prices it
makes sense for a shale oil producer to stop drilling and completing new wells. The foregone production
from doing so can be recouped as soon as prices recover. Furthermore, because the decline rate of a shale
oil well is much greater than that of a non-shale well – typically as high as 60 to 70 percent during its first
year of production - any slowdown in the rate at which new wells are completed will quickly translate into
a drop in overall production. Non-shale oil producers on the other hand have little option but to continue
producing oil all the way down to their cash cost of production which can be very low. That’s because any
production they shut in during a period of low prices will not be recovered until the end of the life of the
well which typically will be decades in the future. Given the time value of money, this seldom makes sense
even though it will result in producing oil at prices that can be substantially below the full cycle cost.

That shale oil producers have this operational flexibility to modulate production in response to changing
prices does not make them the highest cost or marginal producer over the full cycle. It means rather that
they act as an additional level of oil storage capacity. By not producing oil today they are effectively storing
oil underground for tomorrow. With Saudi Arabia no longer compensating for temporary imbalances in
the market, changes in oil inventories have now become the balancing mechanism. Fluctuations in the
rate of shale oil production will effectively be part of that inventory change. So while prices at or above
$65 WTI (or $70 Brent) may halt and even reverse the decline in U.S. shale oil production as the more
efficient and better positioned shale producers bring back rigs and accelerate well completions, it still
leaves a lot of production elsewhere in the world uneconomic.

There is about 72 million bpd of conventional non-shale crude oil and condensate production globally,
with about 42 million bpd of this outside of OPEC. Without constant reinvestment this production would
decline by about 5 percent per annum on account of reservoir depletion.
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Let me add here that even at $100 WTI the U.S. shale plays were expected to peak at around 7 million barrels per day. That is because there is a point when all of the Tier One acreage will be drilled and there will be so many wells on decline that operators cannot drill enough Tier Two wells to offset the decline. The seeds of the next big oil crisis are being planted today. - Dan

Very good trading volume in the Sweet 16 on Monday, August 10. A lot of new money came into the stocks today.

I was surprised by the lack of volume with SM

The stock gains 7.8% and you are complaining!!!!!!!!!!!!!!!!!!!!