📖 Your Q2 Earnings Guide: Discover the Stocks ProPicks AI Highlights to Jump Post-EarningsRead more

Oil Overproduction: Time For An Asset Shopping Spree

Published 09/08/2015, 11:56 PM
Updated 07/09/2023, 06:31 AM

Despite what you might hear about the "resiliency" of shale oil companies and the technological advances that have made it possible for fracking to turn a profit at lower prices, the fact is that most companies need to sell their oil at around $60 a barrel to make a reliable profit. Given the global glut of oil, it is unlikely that oil will break the $50 a barrel mark soon.

For months, the prevailing belief has been that the longer the price of oil stays low, the more pressure this puts on oil producers to curb supply. This is a fundamentally flawed argument, and neither common sense nor history supports it. In the early 1930s, there was extreme overproduction in Texas, to the point where the price of a barrel of oil dropped to just a few cents. Oil producers lost money on every barrel they sold, but they continued to produce as much as possible because every barrel sold, even at just 6 cents, was more money then they could make not producing at all. Finally, the governor of Texas declared the oil producers in a state of "insurrection" and sent in the Texas National Guard to enforce production quotas. This, of course, resulted in a robust smuggling industry, but ultimately it did raise the price of oil into the $1 a barrel range.

The lesson here is that low oil prices only incentivize struggling operations to produce MORE, not LESS. As long as they have access to credit and financing, they will not decrease production. This is what has happened with shale oil production over the last nine months. However, these sources of capital finally seem to be drying up, and the only avenues left are private equity firms who are now scouring the industry for cheap deals on oil and gas assets. They may even acquire entire companies on the cheap as those firms look to avoid bankruptcy. Reportedly, private equity firms have raised over $100 billion to spend on energy acquisitions, in addition to the $80 billion they have to purchase oil company debt.

The real value in shale oil production is in the assets and the technology, not the companies themselves. When the dust settles, the assets will end up with companies like Noble (NYSE:NBL), EOG Resources (NYSE:EOG) Exxon (NYSE:XOM), Chevron (NYSE:CVX), Continental Resources (NYSE:CLR), Hess (NYSE: HES), ConocoPhillips (NYSE:COP), Saudi Aramco, Total (NYSE:TOT) and Statoil (NYSE:STO). These companies are better capitalized, do not face extreme pressure to produce and sell under any circumstances, and would certainly see 52,000 acres of proven oil resources in south Texas as a better bet than a billion dollar investment in off-shore drilling in the arctic circle.

Latest comments

Loading next article…
Risk Disclosure: Trading in financial instruments and/or cryptocurrencies involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Prices of cryptocurrencies are extremely volatile and may be affected by external factors such as financial, regulatory or political events. Trading on margin increases the financial risks.
Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Fusion Media and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.
It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Fusion Media and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website.
Fusion Media may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.
© 2007-2024 - Fusion Media Limited. All Rights Reserved.