By nature, the U.S. shale oil industry has a self-effacing business model…
That means to stay in business, shale oil companies have to hurt their profitability.
Think about it like this…
For decades, oil companies and government officials knew there were billions of barrels of reserves locked away in shale rocks in North Dakota, Texas, Pennsylvania, and Colorado. However, those reserves were not economically recoverable.
That is, not until oil prices started ballooning to never-before-seen heights in the 2000s. That’s when wildcatters like Continental Resources CEO Harold Hamm exploited new technologies to frack shale wells and recover what was previously uneconomical.
The tight oil producers could only get big with high prices — and big they got. But after a few years of unbelievable growth, these producers drilled so much (about 4 million barrels per day added to global supply in the last five years) that they created a supply glut.
Said glut began to take its toll last July, as supply outpaced demand and prices started their fall to the lows of December and early January. Prices dropped nearly 60% between June 2014 and January 2015.
With that drop came a drop in the profitability for frackers. These companies only existed because prices had erupted to all-time highs — but once the glut they created caused prices to drop, they essentially ruined their business models.
This means shale oil companies will continue on this painful, self-effacing trend. Every time the price goes up, these companies will be able to enhance production, which will, in turn, force prices back down and hurt profits.
For investors, it’s going to be a vicious cycle.
Uncertainty
Now, I’m not saying shale drillers are going to kill themselves off anytime soon, nor am I saying they are solely responsible for the decline in oil prices.
But it is noteworthy that in order to see the higher prices necessary to maintain exploration, these companies have to cut expenses on things like exploration and materials.
Investors need to be aware of how this will affect them over the next few months. Take a look at this…
The chart above shows the movement of WTI crude prices during the last month. As you can tell, oil prices have been moving like a seesaw. Up, down, up, down… over and over again.
The largest rise came at the end of January and beginning of February, when the barrage of news about job cuts and shrinking CAPEX for oil majors took hold of the market. Around 30,000 layoffs have been announced throughout the industry, while the big oil companies like Exxon and BP cut spending to keep up dividend payments.
But after that short period of relief for investors, prices fell back down. This time, Saudi Arabia and the United Arab Emirates cut prices to Asian consumers. Saudi exports to China rose 13% between December and the end of January.
And while the big OPEC producers have no problem slimming down export revenues, they alienate OPEC allies like Angola, Nigeria, and Venezuela who’ve seen Asian market share tumble to its lowest in over a decade.
This and news of conflict hitting oil fields and export terminals in Libya again has oil prices more volatile than they’ve been in many years.
The uncertainty is driving traders crazy… but as you know, my investment strategy relies on long-term growth.
When traders worry, I do not; I simply focus on what’s going to be valuable for years to come.
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MLP Safety Zone
When oil continues its volatility over the next few months, the only thing U.S. oil companies will spend money on will be the absolute necessities.
This includes midstream fees and expenses, which is where we want to look for investment. Not only have the midstream companies made themselves important to drillers, but share prices have also been relatively stable.
This chart shows the last month for the Alerian MLP ETF (NYSE: AMLP). Although the look of the chart can be misleading, you’ll notice that the largest jump or drop in price has been no more than $1.25 per share.
This is safety. This is what we want. When oil prices go up, the shares held in AMLP will also rise, creating a great opportunity for gains.
Buying shares of AMLP could be a great idea — but if you choose to do so, I hope you’re the patient type.
See, that’s the problem with this particular ETF: It takes a long time to generate big returns. I don’t mind it, but some investors do.
So if you aren’t the patient type and would like to find safety and great returns, I have a better investment for you…
In this presentation, you’ll find all the details on three midstream companies that are crucial to the flow of oil and gas in America’s heartland.
Good Investing,
Alex Martinelli
With an eye squarely focused on the long-term, Alex Martinelli takes the art of income investing to a higher level within the energy sector. His research has helped hundreds of thousands of individual investors identify well established companies that have a long history of paying out dividends to their shareholders. For more info on Alex, check out his editor’s page.
