A slew of events over the past few months have driven the price of oil higher.
The ISIS incursion in Iraq has set up the entire Middle East for a multinational civil war. It’s not hard to envision a reign of destruction across the Arab Peninsula to the oil producing regions of Iran.
Russia, the world’s largest producer of hydrocarbons, is stirring up nationalism and sending rebel groups into Ukraine.
China just sent four jack-up rigs into disputed waters off Vietnam to look for oil.
And two days ago, the Obama administration made it legal to export very lightly refined crude oil with a number of limitations.
At the same time, the global economy is stumbling toward recovery, and global demand for energy increases every year. Where and how this demand will be met has yet to be determined.
First, check out the charts…
The oil prices for both Brent and WTI just broke out of a five-year triangle formation. According to Thomas Bulkowski, who back-tested these patterns in his book Encyclopedia of Chart Patterns, oil prices have a 94% chance of going up 25-36% over the next three months to a year. The sample size was 310.
If that sounds preposterous and you don’t think it could happen, all you have to do is look at the spring of 2007, when the oil price broke out and went up over 100% in a year:
Next, you have to understand that fracking isn’t a global phenomenon. The geology only works in North America.
According to the Financial Times, “It is a striking fact that since 2005, all the increase in the world’s crude oil production has come from the US.”
Fracking attempts from Poland to China have failed despite billions of dollars invested.
The second problem is that fracking wells run out at a quick rate. The Bakken oil field is declining at a rate of between 40% and 63% per year — though they seem to be constantly finding new reserves.
And despite the joys that fracking brings, the peak oil mongers will be quick to point out that in 1970, the U.S. produced 9.6 million barrels a day. In 2013, the U.S. produced 7.4 million barrels per day.
Big Oil is Shrinking
You may not know it, but all of the large independent oil companies have growth issues. Companies like Exxon, Chevron, Shell, and BP all saw 2013 production decline. And this is despite spending more money.
According to Zacks:
“ExxonMobil reported an average production of 4,175 million barrels of oil equivalent per day (MMboepd), down 1.5 percent from 2012, and Chevron saw its production decline by .5 percent from 2012 to 2013 to 2,597 MMboepd. Shell’s average 3,199 MMboepd of production for 2013 was down 1.9 percent from 2012 levels, while BP saw its production volumes fall to 2,256 MMboepd, or 2.7 percent, from 2012 to 2013.”
I’m sure they are dancing in their Birkenstocks over at Berkeley, but those of us who still drive to work, eat food that was shipping in a truck, or invest in companies that have to pay more for fuel will be hard hit.
Despite the government telling us there is no inflation, electricity prices are at all-time highs, as are airline tickets. Grain and meat prices are off the charts.
And it matters. Jumps in oil prices have preceded every recession for the past fifty years.
Big Oil is getting squeezed by marginal or falling returns, though higher oil prices will help.
Over the past two decades, Big Oil has been constantly fighting and winning the game to replenish its reserves. That said, it seems to be on the brink of a negative spiral.
These companies are having a harder and more costly time in the attempt to replace their reserves. Production is down, cash is falling, and debt is up. Unless they find the mother lode, spending on new reserves or potential reserves must also fall.
Don’t get me wrong; this isn’t a cash flow crisis yet. ExxonMobil has $5.6 billion in cash and $20.37 billion in debt. Income was $32.18 billion over the last year.
That said, all of the big four are turning to the last resort of failing giants: taking on debt to buy back shares and boost dividends (XOM div yield: 2.7%). IBM has been doing this for years in an effort to keep up the share price despite falling revenues, and it works… until it doesn’t. IBM shares are up 100% in the last ten years. XOM shares are up 20% over the last year and are moving higher.
How to Play It
The way to make money in this environment is to buy stocks that benefit from other, cheap energy sources.
I like clean and abundant natural gas, which is at a tipping point for industrial and transportation uses. I just sold one company for 502% in two months, but now there is a pullback, which gives us a chance to get in on round number two.
The second way to play the rising cost of oil is to buy the small companies that are producing oil on the cheap here in North America.
All the best,
Christian DeHaemer
Check us out on YouTube!Christian is the founder of Bull and Bust Report and an editor at Energy and Capital. For more on Christian, see his editor’s page.
