The latest reports from the big Bakken shale producers are proving where we are in the crude bust cycle that we've been following and trying to time. Both Continental Resources (CLR) and Whiting Petroleum (WLL) reported that they'll not frack another new well for 2016, a major indicator of how close we're getting to the bottom in oil prices and oil stocks.
The outline for this oil bust cycle laid out in my book continues to hold true, and we've been waiting for a real decline in U.S. production (as well as Canadian and offshore) to tell us when the huge glut in domestic oil supplies will finally retreat, and we can get more aggressive in buying oil stocks. As inevitable as that retreat has seemed to me, it's also been painfully slow -- and helped to drop oil prices twice unexpectedly under $30 a barrel.
Continental and Whiting's decision to cease fracking new wells has confirmed some facts we've known about this bust but haven't been universally acknowledged yet. First, ridiculously low break-even numbers that have been touted by many shale producers and analysts have been just smoke. These are the two most prolific Bakken shale players with the choicest acreage admitting that a profit can no longer be made with oil at $30 a barrel. But it also affirms the accompanying nonsense of these shale players -- even the best of them -- to continue to increase production through the year merely with efficiency gains.
Both of these Bakken giants have reported big cuts in production targets for 2016. They've done it slowly, because they know how deadly it is to their share price to admit how deeply production will drop with the 73% and 80% capex slashing that Continental and Whiting are making, respectively. Continental is claiming a 10% drop for 2016 and Whiting a more realistic 21% drop. Both will turn out to be monumentally low estimates, I believe, once this year sees its end.
Let's go one further and call out the strategy of "Drilled but Uncompleted Wells" (DUCs). It is also common wisdom that these represent almost instant production taps, ready to put online quickly if and when prices increase -- they are not. First, these wells still require almost two-thirds of their total costs to frack to completion. Secondly, who will lend these firms the money to drill even when oil prices do recover? JPMorgan (JPM) was first to finally get defensive and is ready to start serious oil credit redeterminations, without waiting for the traditional examination period in April. The banks are finally feeling the risks of unrestricted lending to the shale E&Ps. No, the U.S. shale industry is changing forever and there won't be this kind of "free money" and "fast drilling" mentality returning to the patch any time soon.
So what does this mean for our investment strategy and particularly those in the Bakken? I've been a fan of one Bakken player only for accumulation -- Hess (HES) -- and have specifically warned away from both Continental and Whiting. But as I said in my last column, Continental, with its less-leveraged position compared to Whiting and the hard blow of junk bond rerating out of the way, starts to look investable again. Indeed, the final realization of "hunkering down" and stopping fresh fracking operations has caused CLR to rally strongly -- and I believe that is a real rally based on good business decisions and not a short-covering blast. I'm ready to add Harold Hamm's company to a list of value shale producers, if it finds its way again under $20 a share.
The way this bust is playing out ... it will.