The more things change, the more they stay the same. This phrase is unequivocally true when it comes to the stock market and investors. Once a market decline kicks into full gear, the talk of doomsday starts coming from all corners. To be sure, I am not an unwavering optimist on the stock market, but I am a long-term optimist on the power of capitalism.
And I believe capitalism offers investors an undeniable truth: If you are patient and bet big when presented with rare opportunities, the payoff will be quite lucrative. I believe such an opportunity is beginning to occur in energy.
To be sure, I do not think that the market has overreacted with the selloff in the energy sector. Almost all energy companies need $40 to $50 oil prices to maintain cash flow break-even -- and for many the price is higher. At $30 a barrel, no one is making money except those with a big hedge book -- and even the best hedge books only protect 2016 production, and perhaps some of 2017.
When all is said and done, I believe a lot of exploration and production companies will no longer exist -- either by going out of business or via asset sales that likely wipe out equity holders. Many more oil companies will make it, but probably never regain what they had when oil was trading for $100. Absent a major political event in the Middle East, $100 oil may be wishful thinking for a very long time. Any company needing $60 oil to make money probably won't make it.
But for those low cost producers that can do well when oil is above $40 barrel and -- this is the biggie -- have the financial liquidity to get to 2018, the payoff could be historic.
Small-cap producer Sanchez Energy (SN), which has increased production by over 20% year-over-year while reducing capital expenditures, is one possibility. A $400 million line of credit remains undrawn. Its earliest bonds are not due until 2019. In 2016, production is expected to stay flat or go up while the capital budget is going down.
Enterprising investors will also want to take a closer look at Antero Resources (AR) and pay close attention to its hedge book -- one of the best I've seen.
If you are going to dip into energy, these are the types of evaluations that need to be done. And if you buy, you need to have an unwavering, multi-year holding period. Then, and only then, will this historic payoff pan out.