As an Ohio resident, my average retail gas prices approached $4.00 a gallon in the summer of 2014. Half a year later, that price was cut in half. The cause of the dramatic drop in prices was labelled by many as OPEC’s war on fracking. You can find one the New Yorker‘s articles about the topic here. As U.S. oil companies started to extract more oil than ever, Saudi Arabia along with the other members of OPEC refused to scale back on their production in order to protect their market shares. An example of the results could be seen at the retail level in Ohio:
Weekly Ohio Regular Retail Gasoline Prices (Dollars per Gallon) – EIA
Historically, U.S. oil production has been over shadowed by OPEC, and the U.S. has often been dependent on oil imports from other countries. U.S. dependence on imported oil was over 50% from 1997-2010. See EIA’s article on U.S. oil import dependence here. Such dependence complicated the political relationships with the U.S. and OPEC member nations in many ways. The U.S. had to be careful to make sure there was enough oil supply for the growing demand in the country. In an attempt to protect the country’s supply, there was a ban on U.S. oil exports that lasted for forty years. See CNN’s article on the ban.
However, some dependence was broken, some political pressure was relieved, and the ban on exports was lifted with the help of technology, specifically fracking technology.
“Fracking is the process of drilling down into the earth before a high-pressure water mixture is directed at the rock to release the gas inside. Water, sand and chemicals are injected into the rock at high pressure which allows the gas to flow out to the head of the well. The process can be carried out vertically or, more commonly, by drilling horizontally to the rock layer and can create new pathways to release gas or can be used to extend existing channels. The term fracking refers to how the rock is fractured apart by the high pressure mixture.” – BBC
Although fracking is not always cheaper than conventional vertical drilling, having the ability to drill horizontally does make it easier to increase production. U.S. oil companies have taken advantage of the new technology, producing a 47 year record high of 10.057 million barrels per day in November 2017 (Reuters). Oil supplies have started to outpace demand, relative to the recent past, and oil prices have decreased globally. The blatant relationship of supply and demand on falling prices illustrates that the global oil market is one of the purest free markets today. (However, global demand is the highest it has ever been. You can find the historical global oil production and consumption levels here).
WTI crude oil price per barrel went from upwards of $90 in 2013 to less than $40 in 2016. While the price of a barrel halved, stock prices for some oil companies decreased much more. Some of the large cap companies like Exxon Mobil and Chevron have fared better than smaller stocks, some of which have lost nearly all of their value because of the possibility of bankruptcy. A lot of oil companies had major debt leading into the price dip, as the companies had made investments while planning on selling oil at high prices. High debt to equity ratios have lead to a wave of bankruptcies. An example is Goodrich petroleum’s chapter 11.
While bankruptcy has ended some companies, it has created buying opportunities in others. If you play the long game with these companies, and if they do eventually regain their pre-dip levels, the returns could multiply your investment. Here are a couple examples of companies that could be deals:
Even if you do not invest long term with these companies, short term buys could have doubled your money. If you were smart enough, or lucky enough, to buy Denbury Resources in October of 2017, your money was doubled by January of 2018. The recent pattern with oil has appeared to be that OPEC and the U.S. will scale back on production as WTI prices get below $45, and they will increase production as prices rise above $55. The result is the price range staying within $35 – $65, and stock prices have been mirroring the WTI prices.
Aside from their debt to equity ratios, there are several other factors that can help determine whether an oil company can weather the storm. The method of how the company extracts oil has a big impact on how profitable the company is. Off shore drilling is generally more expensive than conventional drilling or fracking. Operating expenses overall have been a big focus for companies in trying to stay profitable. Companies have cut dividends and gutted staffing in attempts to stay in business. The attempts have produced results, as companies that were once profitable at WTI of $60 and above can now make profits with WTI at $40 – $50. Here is a Reuters article on such companies’ profitability.
Your perspective on the current oil play can be supported whether you think it is a risky gamble or an opportunity of a lifetime. I would like to see renewable energy blossom and become the staple of our energy sector. However, Tesla has still yet to turn a profit. Also, even though the sales of electric cars in the U.S. rose by 30% in 2017, less than 200,000 electric cars were sold in the U.S. last year (LA Times).
[Investing in oil can also bring up a moral question that should be discussed on its own. Gasland is a popular HBO documentary that explores the effects of fracking on the environment. We still have yet to find a solution to our dependence on fossil fuels. Electric vehicles can, at times, use more energy than conventional cars as discussed here.]
