Investors and market analysts are split on which way the fracking industry is heading. Some point to falling rig counts in the shale industry as a sign that prices are ready to rebound, which helps the surviving frackers, whereas others see a persistent glut of oil continuing to depress prices and bringing everyone down. What investors really should be looking for is one (or more) of the following signs that will indicate when the fracking industry is ready to rise.
1) Falling oil production from a major OPEC producer:
This could be as simple as a change in policy announced at a regular OPEC meeting or as sudden as the outbreak of war. Saudi Arabia, OPEC’s most influential member, already signaled a long-term commitment to expanding production and reached an unprecedented 10.6 million barrels a day in June. The kingdom shows no signs of ending the massive flow of oil from its fields, and even if crude exports from Saudi Arabia have declined, they are exporting refined product instead which equally depresses the market.
On the other hand, tensions between oil producing countries in the Middle East continue to grow – particularly in the wake of the Iranian nuclear accord, which Saudi Arabia and other Gulf countries consider a threat. Saudi Arabia recently vowed to defend neighboring countries from growing Iranian aggression and has already been involved militarily in Yemen. Though outright war between Saudi Arabia and Iran is unlikely, future proxy fights between the two powers in Syria, Iraq, and Yemen could destabilize key oil transport routes or decrease oil exports.
The oil market will finally bottom out when more small shale oil companies can no longer sustain operations and either put themselves up for sale or go bankrupt. Larger, better capitalized companies are waiting in the wings, ready to purchase valuable assets or entire companies at the right price. BPZ Resources Inc (OTC:BPZRQ), WBH Energy, American Eagle Energy, and Quicksilver Resources Inc (OTC:KWKAQ), are already bankrupt. Houston based Milagro Oil & Gas and Sabine Oil & Gas – with $2.9 billion in debt – are just two of the very latest casualties. When major firms like Continental Resources (NYSE:CLR), ExxonMobil (NYSE:XOM), or even Saudi Aramco come in to sweep up valuable assets, we will know the bottom has been reached and shares in the surviving companies are set to rise.
A major factor depressing oil prices in the United States is the lack of refining capacity for West Texas Intermediate (WTI) oil. WTI is a light and sweet grade of crude oil that requires different refining processes from heavy crude or sour (high sulfur content) crude oil. Most refineries in the United States (and around the world) are outfitted to process heavy grades of crude oil that come overwhelming from the Middle East and Venezuela.
However, the fracking industry has recently generated large amounts of this type of crude oil that most North American refineries are not equipped to process. Those that do take light crude are running constantly to keep up with incredible backlog, and returning almost 25% to shareholders. Most crude oil produced in the United States cannot be exported due a 1970s-era oil export ban. However, finding global outlets for the excess light crude would not be easy either since most global refineries cannot handle light crude and those that can are largely saturated with light crude from Nigeria, the North Sea, Iraq, and soon to be Iran.
When new refineries open in the United States and old refineries are retrofitted to process the light crude, we will finally see the bottlenecks relieved and rising market value return to shale companies.
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