Here’s a Free Tip… Avoid Crude Oil

Here’s a Free Tip… Avoid Crude Oil

People ask me all the time what stocks they should buy.

My answer: The one that looks the best.

I know that sounds like a flippant reply. But if you want to make real money in the stock market, you have to buy companies offering a promising future. You’ll usually find these in the most exciting sectors.

With that in mind, your free tip today isn’t a stock or sector to buy. It’s one to avoid: crude oil.

After months of trading above US$50 per barrel, oil prices have started to reverse. That’s telling for what’s to come — although you may not know it looking at the past few days of trading. Crude prices have bounced slightly, to US$50.28 per barrel today.

OPEC is back to its old tricks — manipulating the oil market.

Watching the oil price dip below US$50 per barrel, OPEC got nervous. OPEC’s now planning on extending its production cuts into the second half of the year. It cut output to 32.5 million barrels per day (bpd) into June. That’s still more oil produced each month than in 2015 — a year when crude prices were in freefall.

The OPEC cut, unsurprisingly, had little impact on global inventory levels.

US crude output has jumped 8.3%, to 9.11 million bpd, since August. That’s close to the 9.7 million bpd record hit in April 2015 — the highest since May 1971.

Forgive the pun, but OPEC’s in for a ‘crude’ awakening in the months ahead. Manipulating the crude oil market won’t do it any favours.

Why you shouldn’t care about OPEC

The mainstream media spends a lot of time focusing on OPEC, as if it’s the only topic that impacts the oil price.

They couldn’t be more wrong…

The proverbial elephant in the room is the US shale game, which is why I keep talking about it.

US shale is back, thanks to OPEC’s manipulation tactics. In the months ahead, expect a massive supply shock to hit the crude oil market.

It won’t matter whether OPEC extends its supply ‘cuts’ to prop up prices. Higher prices should see more shale production, which is likely to trigger another freefall in oil prices later this year.

OilPrice.com reported the risks at large last week (my emphasis added):

Thousands of drilled shale wells are sitting idle, unfracked and uncompleted.

The backlog of drilled but uncompleted wells (DUCs) grew dramatically beginning in 2014, as low oil prices forced drillers to hold off on completion in hopes of higher prices at a later date. After all, why bring production online in a low price environment when the same oil could earn more in the future if prices rebound. That calculation is particularly important given that a shale well typically sees an initial burst of production in its first few months of operation followed by a precipitous decline in output.

The surge in DUCs created an enormous backlog of wells awaiting completion. This “fracklog” loomed over the oil market, threatening to derail any sign of an oil price recovery. As soon as oil prices rebounded to some higher point, the shale industry would bring thousands of already-drilled wells online, and that sudden rush of new supply would push prices back down.

US Energy and Information Administration statistics show 5,443 wells drilled and uncompleted — a 91 increase in the number of wells from January to February.

You can see this in the table below:


Source: EIA
[Click to enlarge]

During the 2014–16 oil price crash, the number of wells left incomplete surged as companies shut down rigs, sacked workers, and retreated from the fields.

To complete a well, shale producers need to ‘frack’ it. That involves pumping the hole with sand, water and chemicals at high pressure until the rock fractures and releases the oil.

There is typically a lag of a few months between drilling and completion. That means some wells could be ‘fracked’ in the coming months…especially if crude prices remain inflated by OPEC’s jawboning.

US shale players couldn’t care less about OPEC’s endeavours. They are looking to make a buck and pay back debt. For that reason, seeing reasonably stable prices, they are drilling more wells.

The trend is your friend

Baker Hughes, a global oil-engineering firm, reported that the US oil rig count jumped by 10 last week — the 11th weekly increase in a row. The total US rig count now stands at 662, the highest since September 2015.

The US crude oil rig count peaked at 1,609 in October 2014.

Take a look at the comeback in the chart below:


Source: Investing.com
[Click to enlarge]

The longer crude prices stay above US$45 per barrel — a price where many shale producers can still turn a profit — the more vertical that chart should grow.

I wouldn’t be surprised if the rig count shoots towards 1,000 by 31 December. Imagine what that will do for crude prices, especially if OPEC is pumping out just as much as it did back in 2015.

The risks of a major, looming supply glut shouldn’t be ignored.

A lot of companies are drilling new wells to avoid forfeiting their acreage rights. Standard leases typically have three-year terms, with an option for a two-year extension. These players are drilling wells to save their leases. But they’re keeping the wells unfinished…for now. Of course, it makes sense to frack them. These companies need to pay the bills eventually.

OilPrice.com reported last week (my emphasis added):

Holding onto land is particularly important these days because land prices in West Texas have skyrocketed, with acreage costing five times as much as it once did a few years ago. Nobody wants to forfeit any prospects amid such a land rush.

Another element contributing to the [drilled by uncompleted wells] build-up is that market for fracking crews is tightening, according to Reuters. After a well is drilled, producers contract with fracking crews to complete the well.

As I reported last week, my sources (company oil executives) tell me that there’s a severe lack of technical manpower in the US. A lot of people who were laid off have now found new jobs — stable jobs. They are reluctant to move back to the oil game, with the threat of lower prices and lack of job security.

I believe the severe skills shortage is the main reason holding back the completions. Once this issue is addressed (by providing high salaries and better terms), we should see a massive supply onslaught…regardless of OPEC’s next move.

The chances of this happening look high…

Technology is a driving factor that must be considered. According to Norway-based industry consultant Rystad Energy, the well-head break-even costs for US shale plays declined 46% between 2014 and 2016.

Most analysts consider the shale game to be competitive at US$50 per barrel, with some areas like the Permian Basin as low as US$35. Having contacts in the industry, however, I’d say these levels are a bit high. US$45 per barrel is more likely the new breakeven target, with costs lower and technology improving.

As long as prices remain above that level, expect more oil production.

Once the uncompleted wells start producing, a massive amount of crude should hit the market. Wood Mackenzie, a global consultancy firm, said if the Permian Basin’s (the largest backlogged US region) wells are completed, it would add 300,000 barrels of oil per day in new supply.

Remember, that doesn’t account for any new wells drilled or the other US basins.

The bottom line: Don’t be surprised if US oil production hits record highs this year. That could put significant pressure on crude prices.

Regards,

Jason Stevenson,
Editor, The Daily Reckoning

PS: Although the oil and gas sector doesn’t look good, another energy sector does — lithium. I’ve tipped two lithium stocks that are drilling for ‘white gold’ in the weeks ahead. These plays are dirt cheap and located in strategic locations. If they tap the mother lode, their share prices could skyrocket. For details, go here.

Jason Stevenson

Jason Stevenson

Analyst at Markets & Money

Jason Stevenson is Markets and Money’s resource analyst. He shares over a decade’s worth of investing and trading experience across resource stocks and commodity futures and options.

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