An Oil Certainty: Higher Prices, Lower Supply

 | Jul 24, 2017 | 1:00 PM EDT
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Oil has been meandering in a range for most of 2017 -- and I've outlined the reasons we're likely to see a continued "small move" type of oil market for the next quarter or so. While there are some values emerging in the space, I'd like to concentrate for a second on the basic thesis I continue to hold for oil -- it's inevitable big price rise -- then end this column with a quick recommendation for some value right now. 

We could get very deep into the oil weeds in explaining why I know current oil prices are ultimately unsustainable, and only prices well over $100 a barrel are necessary to continue to drive consistent exploration and production of crude, but I'd like to keep this column as simple as I can. For those looking for more in-depth discussion of what I'm about to lay out, I refer you to both of my books on the oil market, particularly my last, Shale Boom, Shale Bust

Oil is a disappearing resource. I mean that two ways: Certainly, oil is a finite resource that ultimately grows scarce and runs out. But that idea, known as "peak oil theory," is not much in play in recent oil markets, considering new shale and offshore finds and the enhanced technologies that are in use. The second way is more of what I have in mind -- oil can be drilled on land, deep in the sea or mined as with oil sands in the Athabasca or Orinoco -- but in all cases, those wells, drill sites and mines are ultimately spent, and new ones need to be found. That's what oil company capex is mostly all about and the "exploration" part of an oil E&P -- finding new sources of oil. 

Oil's bust cycle, with prices well below $70 for much of the last three years, has brought two difficulties to oil companies: First and most obviously, it has made much of their production unprofitable, or only marginally so -- don't believe the hype oil CEOs use to claim breakevens of $40, $30 or even $25 a barrel -- if these breakevens were true, we'd have seen much better quarterly reports from them the last two years, instead of a steady diet of losses. 

But second, it has absolutely decimated the free cash flow they use to explore and open new wells, drill leases and mines -- new production for when the old production slows and stops. Industrywide, exploration capex is down 70% from 2014 to the end of 2016 -- a virtual stop on all but the easiest, cheapest and most efficient exploration. 

What we know right now is that we're living through a boom time for global production, not only in U.S. shale plays where we have seen the most press and coverage, but also with conventional production among OPEC and other Middle East producers. For example, there was a time not long ago when Saudi Arabia's production was thought to be capped at 9 million barrels a day. Today, Saudi production is well over 10 million, and their "swing capacity," a hot topic five years ago, almost never gets questioned today. 

These oil gluts must, by definition, end soon. Complex oil production, in long-term deepwater and Arctic projects and with more difficult conventional projects, has been all but scrapped -- and that oil was being depended upon to meet still-increasing demand in 2020 and beyond. 

There is a very deep and inevitable shortage on the horizon. 

In an upcoming column, I'll explain the "marginal barrel" pricing scheme for oil and why this supply shortage must translate into huge price jumps. But for now, here's the stock opportunity I promised. 

With the prospect of decimated capex creating an inevitable crude oil supply shortage, the correct positioning puts us in efficient producers with a stockpile of production opportunities that can last with minimal capex expense well into the future. 

One such producer that's been recently beaten up and becoming a value again is Permian specialist Cimarex (XEC) . Once well above $120 a share, it's been overly punished for correctly restraining production growth in a wholly unprofitable oil market. Now priced near $95, it is again becoming the value play that I recommended and made a great profit on first in early 2016. (Cimarex is part of TheStreet's Action Alerts PLUS portfolio.)

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