The good news is, the U.S. energy patch is back.
It’s pumping oil at record levels, it’s price is high enough that producers can make a good profit and it looks like it may go higher from here.
Just don’t count on the good times lasting forever. Oil is like gold; it’s one of those commodities that is good to have around, but when it’s down, you have too much, and when it’s up, you don’t have enough.
The best idea is to get in slowly.
But I’ll get back to that in minute.
There are a few other things happening in the oil patch now that bear some explanation to give you a good idea of the big picture here.
You see, I think in the short term oil could easily hit the mid to upper $50 per barrel range. But farther out, say 6-8 months from now, it may more likely settle in the mid to upper $40s. That’s still good for U.S. exploration and production (E&P) firms, but don’t expect it to hit $100 a barrel unless we invade Iran or bomb North Korea.
It takes three to contango
Right now the big story is that U.S. producers are causing some trouble for Saudi Arabia and Russia.
The news is all about their extension of oil-production cuts farther into 2017. That’s what a lot of this flurry of activity has been.
There has also been talk about the U.S. inventories getting hit harder than expected. But don’t be mistaken, this isn’t a resurgence in demand. It’s a game the oil companies play to manage contango in the markets.
Investopedia defines contango this way:
Contango refers to a situation where the future spot price is below the current price and people are willing to pay more for a commodity at some point in the future than the actual expected price of the commodity.
It’s a pretty funky concept, but it’s the way that that the energy industry works.
Basically, most of U.S. production is sold into the futures markets, so U.S. E&Ps want higher futures prices so they can hedge their production and their ability to grow.
Established producers like Saudi Arabia want higher spot, or current, prices since their oil is already discovered and they don’t hedge out and want to maximize their output now.
The crazy thing is, as Saudi Arabia talks up continued production cuts to get a boost on spot prices, it also helps U.S. producers since they’re seeing futures prices rise as well. Now that U.S. producers are back and they’re repaying the banks for the lines of credit and outstanding loans, both sides are playing the contango to their own advantage.
This is not the scenario Russia and Saudi Arabia want, but it’s difficult to stop it from happening.
What’s more, U.S. oil production is making any cuts from mature producers a moot point. And there are plenty more OPEC and non-OPEC countries all ready to fill the gap. For example, OPEC member states are supposed to cut production by 1.8 million barrels a day. The U.S. is producing about 9 million barrels a day.
Mature producers are the only ones that are going to have trouble in this scenario over time.
The real challenge is whether the global economy will ever rev up again so that demand will increase with supply.
The dollar/oil myth
Another thing you see in the press a lot is talk about the connection between oil prices and the dollar. The theory goes, higher oil prices mean a lower value of the dollar. Conversely, lower prices mean a strong dollar.
And that was true in the 1970s and ‘80s. Even into the ‘90s. But the U.S. energy industry has broken the back on this “tradition.” When the U.S. was the No. 1 importer of oil, the dollar and oil prices were inextricably linked.
But now that the U.S. is a major exporter, this relationship is more abstract, even though oil is priced in dollars. The great issue here is as we transition to a new paradigm, whether the petrodollar makes it through the change. It’s not unusual for the law of unexpected consequences to play itself out just when you think everything is working out just fine.
Where to put your money to work
Starting with the last scenario first. If our energy “partners” the Saudis, Russians and Chinese decide to tear down the petrodollar, then you want to be hedged in gold and silver. Bob Livingston has put together an exclusive report on how best to do that.
In the oil sector, midstream is still the safest way to go right now. E&Ps are still to volatile and given the Great Contango Battle going on now, it’s too early to be overly optimistic — or greedy. Enterprise Product Partners (NYSE: EPD), Williams Companies (NYSE: WMB) and Plains All American (NYSE: PAA) are all good choices.
In the grander scheme of the energy business, Bob has written a very compelling report on select companies that he sees as the future winners in energy that is a very important read.
— GS Early