Capitulation

Jim Brown
 
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You know it is time to buy energy stocks when analysts begin to capitulate on the entire sector. Barrington analyst Rudolf Hokanson said current fundamentals are so badly flawed that any investment in the sector would be purely speculative.

The analyst slashed his forecast for crude oil prices and said he could no longer recommend any stocks in the sector. However, he promised to monitor the sector over the next 12 months and notify clients when it deserved renewed attention.

When analysts become so frustrated with the fundamentals that they kick the entire sector to the curb you know we have to be close to a bottom. However, Brent crude prices traded down to $27.67 late Sunday night after the Iranian sanctions were lifted.

The Iranian oil minister said Iran would immediately begin to sell the more than 30 million barrels they have stored in tankers in the Persian Gulf. He also surprised everyone with his promise of rapid increase in production. Iran was set to export about 1.1 million barrels per day in January even before the sanctions were lifted. The minister said they would immediately raise output by 500,000 bpd and add another 500,000 bpd by the end of March. He also said they would add another 500,000 bpd by the end of 2016. That is an additional 1.5 mbpd in 2016 and they expected to be at 6.0 mbpd by 2020. Iran has 167 billion barrels of proven reserves or the fourth largest in the world.

The minister said they would immediately begin accepting bids from international companies on $185 billion in planned oil & gas projects. These projects will raise Iran's output to 10 mbpd by 2025 and threaten Saudi Arabia and Russia for dominance in the producing world.

Oil prices should continue to fall with more and more analysts now predicting prices as low as $20 if only for a brief period. Since no shale producers can make a profit at $30 oil, much less $20 or $25 we are rapidly approaching the point where they will actually have to stop producing. With cash production costs from $15 to $20 depending on the producer and the location and overhead expenses an additional $18-$20, everyone is losing money on every barrel.

This is especially true in the Bakken where the oil sells at a $8-$10 discount to WTI. They are now getting less than $20 per barrel for their oil and Canadian producers are getting even less.

They have two choices. They can continue to produce at $30 and sell for $20 but that would quickly put them into bankruptcy. If you are losing $10 a barrel you can't make it up in volume. A producer like Continental Resources (CLR) with production of 228,000 bpd would be losing roughly $2.3 million a day not counting their capex expenses and overhead. Since almost everyone believes prices will recover later in the year it makes no sense to continue producing at a loss rather than shut in production and wait for prices to rise.

Pioneer Natural Resources (PXD) is the lowest cost shale producer. Pioneer said its Q3 production costs were $11.62 per barrel with expenses averaging $18.77 for a cost per barrel of $30.39. Q4 estimates were $12 to produce and $19.50 for expenses or $31.50.

Analysts are now predicting that from 30% to 50% of U.S. producers could file bankruptcy. Oppenheimer's Fadel Gheit warned last week that half of all shale drillers could go bankrupt. If they continue to produce for a loss rather than shut in production and wait for better times the chances increase.

Most of the major producers are sitting on large piles of cash but those piles are shrinking. They can extend their lifespan by slowing that burn rate and going into hibernation mode. It has been done many times in many prior energy cycles. Those that are prudent and make the hard decisions survive and those that are over extended and under managed will fail.

Fortunately, sector cycles bring great opportunities. When oil was trading under $10 in 1998 nobody would have believed that it would be nearly $150 in 2008. Many companies failed and entire generations of oil field workers lost their jobs and were forced to take up another occupation. The energy sector cycles about every ten years and we are nearing the bottom of the current cycle.

The price of crude will find a bottom in the next 10-12 weeks as inventories build ahead of the summer driving season. Once that demand cycle begins we will see prices begin to rise. The IEA expects demand to grow by 1.2 mbpd in 2016. With gasoline prices well under $2 and still dropping, consumers are buying big cars once again. That shift back into gas guzzlers means higher demand for fuel for years into the future.

U.S. auto sales topped 17.4 million units in 2015 and that was a 9-year high. Sales are booming all around the world because of the cheap gasoline. That is cementing demand for the next decade.

The wild card here is the Iranian production. If they can actually produce at those levels they claim we could see prices lower for longer. However, Iran has a habit of promising things they cannot deliver so we will have to wait and see what the future brings.

As energy investors we are approaching the buying opportunity of the decade with oil falling into the mid $20s. They say buy stocks when there is blood in the streets. The same is true with oil. Buy energy stocks when the oil glut seems the worst and you will be richly rewarded.

The equity market follows oil prices so we should expect equities to decline further in the weeks ahead. Get out your shopping list and check off the companies you want to buy while they are on sale. The markdowns are huge this year but there is another decline just ahead. Analysts are capitulating. It must be almost time to buy.


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  Active Rigs

Active drilling rigs declined -14 to 650 for the week ended on Friday 1/15 and that is a 10 year low. Oil rigs fell -1 for the week to 515. Active gas rigs declined -13 to 135. Active rigs have now declined -1,281 since the high of 1,931 in September 2014. Active offshore rigs fell -1 to 26.


Oil Inventories Week Ended 1/8/16

Crude inventories rose +0.2 million barrels to 482.6 million as refiners accelerated production of gasoline and diesel.

Refinery utilization declined slightly from 92.5% to 91.2%. That is up from the low of 86.0% on October 9th.

U.S. production rose +8,000 from 9.219 to 9.227 mbpd. That is a four month high.

Cushing inventories rose from 63.9 million to 64.0 million and a record high.

Gasoline inventories rose +8.4 million barrels to 240.0 million as refiners converted as much oil as possible into refined products to capture the high crack spread.

Distillate inventories rose +6.1 million barrels to 165.6 million.

Details in the graphic are for the prior week. All numbers are not available until the Friday of the following week.

In the graphic below green represents a recent high and yellow a recent low. The blue-green represents a record high.


The weekly OilSlick Newsletter is a publication of OptionInvestor.com. Please visit OilSlick.com to sign up for the free email newsletter that comes out weekly.

This is a publication of the Option Investor Newsletter. Learn how to profit with options on stocks and indexes. If you would like daily market commentary and option recommendations you can sign up for a free trial and have the daily plays and commentary delivered to your inbox. No credit card or phone number necessary.

Free Trial Now

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