In today’s interview, Keith Schaefer, editor and publisher of the Oil & Gas Investments Bulletin, explains what factors “sent the oil price reeling off a cliff“ and where he think the price per barrel will stabilize. He also gives investors two great oil stock picks, both of which would be able to sustain production at $40/barrel.
For more insight and advice we encourage you to subscribe to Mr. Schaefer’s newsletter: www.oilandgas-investments.com
SmallCapPower: As we approach the end of 2014, the oil price is one of the main topics of conversation. In your expert opinion, what are the major reasons for the decline?
KeithSchaefer: There are two reasons for the decline in oil prices. One, is that the U.S. shale revolution has finally caught up to demand in the world. What we’re seeing here is that the U.S. is increasing production by about a million barrels a day a year, and demand, globally goes up about the same, a million barrels a day a year. This year, we’ve finally caught up to all that demand. And this is reason number two: we have always relied on the Saudis to be the swing producer and manage supply. For example, last year they increased production by a little over a million barrels a day when Libya and a few other places went offline because of political difficulties. When all that production came on again much faster than expected, about the midpoint of this year, everyone expected the Saudis to give back that million barrels of production. Then, it became increasingly clear through the Fall that they weren’t going to do that, and that became set in stone on November 27 at the last OPEC meeting where they just said, “No, we’re not going to do that.” As soon as that announcement came out, that was the big shoe that dropped and sent the oil price reeling really off a cliff. It had been rolling downhill a little bit, but that really sent it off a cliff.
SmallCapPower: So, given that, what price do you think the oil will bottom out at?
Keith: Well, there’s two answers to that question. The short term is there is no bottom, simply because you’ve got so many derivative positions, financial calls on oil. There was a huge long position in oil before this collapse and so those guys have to get washed out so eventually, they will have to sell their financial contracts, and that actually does have a real impact on the physical price of oil. We saw in 2008, for example, where we went from $150 to $30 a barrel so quickly that there really is no bottom on a short term down spike.
Longer term, I’m going to suggest that if the Saudis are truthful in their wish to see the market find an economic price level on its own without their influence I’m going to think that’s going to be around $65 a barrel. The reason I say that is because most of the operating cost for North American shale is about $40 a barrel so when companies are making $80 or $90 or $100, that’s huge profit, but at $65 that’s only $25 a barrel profit. That’s not their all-in cost, they’re actually losing money on an all-in basis at that price but when you’re desperate for cash flow, you’re kind of willing to forgive that for a while.
I think that $65 that’s going to be the equilibrium where there’s enough pain with every well you drill, but there’s just enough cash flow to keep you going. That’s kind of why I think that number works.
SmallCapPower: So, what effect do you think that the price will have on the Keystone pipeline?
Keith: I don’t think it’s going to have any impact on the price. I’m considering Keystone pretty a much dead issue. I don’t see it going ahead, so I don’t see the lower oil price increasing its chances to move forward. We would have to see a very large pickup in demand with these lower oil prices, and history says that we don’t really see that. We see a small pickup in demand, but for Keystone to go ahead we’d need to see a big pickup. I don’t see that being any big issue.
I guess the real issue for Keystone was, certainly because of these low oil prices, if Venezuela had some civil unrest or had some production issues. They send a lot of heavy oil to the U.S. Gulf coast, and if that was to get interrupted our oil would be needed a lot more. Then, I think Keystone would become a lot more important. In one sense, that is an answer to your question. Yes, it would impact on a “what if” basis.
SmallCapPower: Is the current price decline going to have much of an effect on the price of Natural Gas or LNG?
Keith: Oh, LNG for sure. LNG is based on oil pricing. The global LNG price is generally 13% of the Brent price. With Brent sitting today at, do a quick check on the computer here, Brent is $60 even, so what’s 13% of that? About $8, not even $8 so an M.C.F., and at $8 an M.C.F., LNG makes no economic sense at all, zero.
SmallCapPower: Can you tell our Small Cap Power subscribers what jurisdictions and any specific opportunities that they should be looking at?
Keith: Gas has held up relatively well so far, but I’m actually quite a big bear on gas. Even though gas, right now, is comparatively doing quite well, we’re seeing such huge supply growth out of the U.S. there that I’m actually way more bearish on natural gas than I am on oil, so I’m sticking with oil myself and really just looking at companies with really strong balance sheets, so companies with very little debt because this industry uses a lot of debt. When I think of companies that have net debt that just kind of keep production flat in a very low price environment for a long time, I’m looking at companies like Canamax Energy Ltd. ( V.CAC ) , and Rock Energy Inc(RE:CN), they’ve got both light oil and heavy oil with almost no gas, so huge leverage to that commodity. They both can keep producing at very low oil prices. They would be able to sustain production at $40. At $40 W.T.I., those guys can still generate enough cash flow to hold production flat. Obviously, as soon as oil goes above there, they’re in a position to grow, and there’s very few companies out there that can do that.
Those are both Canadian companies. The U.S. is more tricky, because they have so much debt, so the leverage there is just crazy. In this kind of really volatile oil price, I don’t think that’s a place I want to go. I’m going to stick with the Canadian guys who have better balance sheets, a little more fiscal discipline, you know?
SmallCapPower: Thanks for that Keith. So how can viewers get more information from you?
Keith: Well, the best place is my website which is www.oilandgas-investments.com. We write a couple of free stories a week that we put on the blog to attract readers. We treat ourselves like the Calgary Herald or the Edmonton Journal or The Globe and Mail. We write real, unbiased stories about the industry and we actually even break a few stories that the rest of the market doesn’t get. It’s really worthwhile for people to get a really good layman’s understanding where everything is written in simple English at my site.
SmallCapPower: That’s great. Thank you very much for taking the time for today’s interview.
Keith Schaefer: Thank you and God bless.
