How could there be a bear market in oil and a bull market in the oil stocks? That's right: oil just declined 20% from its highs, but most oil stocks I follow that have any balance sheets at all have been flying. Some of still are great investments, and were, right through the weakness.
I think the answer is the breakeven. We know that there are only a few places in the United States that are genuinely profitable at $40. But the fact is that they are very profitable. They are mainly, first, in the Permian, where the infrastructure is so built out and the oil deposits so high grade that there is no exploration issue: it's 100% good for the money. Pioneer (PXD) dominates the Permian. Second, there's the Eagle Ford, where Mark Papa, the previous CEO of EOG Resources (EOG) , the one who knew to get out of natural gas at its highs, described his prospects as oil that could be hit by a straw. (Eagle Ford is not as good as Permian and is declining quickly away from EOG)
Then there's SCOOP and the STACK, two acronyms for some high-graded areas in Oklahoma that are producing more now than they did a few years back, that's how fecund they are. That's an area that's so fecund that Oklahoma has passed a bunch of states to be a top oil producer in the last three years. Think Continental Resources (CLR) when you dream of that prospect.
All three of these companies have been opportunistic in this area. Take Pioneer. It shrewdly purchased 28,000 acres of Permian from Devon (DVN) for $435 million and then raised $827 million in the equity markets to exploit it. Subsequently, Pioneer said that it has $2 a barrel costs for some of this acreage and that it rivals the pricing of Saudi Arabia. Devon took the money and invested it in Oklahoma where it is based, and also lowered its cost of production.
It was a win for everyone, especially Pioneer, which then touted that it can have 15% oil growth a year until 2020, basically without any increase in hiring. Meanwhile, drilling costs have plummeted some 37% -- a level that might prove unsustainable, but is certainly giving Permian, Eagle Ford and Oklahoma producers great returns even at $40.
Now, the rest of the country is not so economic, and the offshore properties are way out of reach. One of the reasons why oil stays so weak is that Chevron (CVX) is flooding the U.S. with Gulf of Mexico oil, although it's not enough to truly cause the glut in crude.
But what's often missing in this downturn is the cleverness of the producers. Some have switched to natural gas liquids, which are way up in price. Others have shifted to natural gas production, which is well above the cost all in when it comes to Marcellus and Utica. And, needless to say as we have seen from every acquirer in these regions, you buy other properties, your stock goes higher.
Witness the nice run in SM Energy (SM) -- the old St. Mary's -- when it bought Rock Oil Holdings the other day for $980 million, or an astounding $39,000 an acre in rich Permian holdings. The stock jumped from $38 to $41 paid for by the issuance of 16 million shares, or $480 million plus a convertible senior note, both of which were oversubscribed. The notes bear 1.5% -- so much for distressed oil debt. It makes sense; SM was chiefly a Colorado-based oil company, where the costs are just too high. This deal makes the company investible again.
Yep, with costs very low and actually going lower, the rig count -- chiefly from Helmerich & Payne (HP) by the way -- goes higher. The money's available and cheap. The acreage is there and it's producing huge gains at $40.And that's how the bull market in stocks has overtaken the bear market in oil. Oh, and one more thought: almost every single stock deal in oil and gas has worked out fabulously, including the giant PXD deal in the $150s. I bet SM works out the same.