We've been standing by, waiting for oil to "get real" and drop back into the $40s -- and give us another opportunity to buy quality oil stocks at value, instead of at a premium. I am still advising patience, although that patience is wearing thin, and we must be into quality stocks like Anadarko (APC) , Cimarex (XEC) , Concho Resources (CXO) and EOG Resources (EOG) before the OPEC meeting in Vienna -- because there will be an agreement.
We recognized in late August that oil stocks had "gotten ahead" of themselves and took profits on a majority of shares in Anadarko, EOG Resources and Cimarex. Since then, we've continued to look for stocks to realign their prices with real-time oil prices that have barely breached $50 a barrel, so that we could get back in. We thought we'd see oil stocks come down while oil prices stayed relatively steady. Instead, we've seen the outline of an agreement between OPEC and also non-OPEC members, which has helped move oil up to $50 a barrel. As we expected, it wasn't accompanied by a concurrent rise in oil stocks; that realignment has been happening, but perhaps not in the way we expected.
No matter how it happens, we're closing in on a moment to get back into oil stocks -- and particularly because of the Nov. 30 meeting in Vienna. Despite recent pessimism on the likelihood of an agreement or compliance afterward, I am convinced an agreement, and a fairly aggressive one, will be adopted by the Saudis and the rest of OPEC.
How can I be so convinced? We've seen the Iranians refuse to curb their production going into 2017, and the Russians only ready to, at best, stop increasing theirs. No one is counting the sure-to-increase production from Libya or Nigeria in their plans. So, looking at the broadest outlines of a 500,000-barrel-a-day decrease, you'd need a commitment of a drop of 2 million barrels a day from the rest of OPEC and Russia to ensure compliance.
And that's a tough order to expect from the busted cartel, and the reason for the pessimism.
But I still think it's sure to happen -- and the reason is the Saudis, who always hold the key.
Saudi Arabia's recent $17.5 billion sovereign bond offering was 6x oversubscribed, showing that the Saudis were selling bonds at a very cheap price, and that investors were quick to recognize it. While both may believe oil prices are unsustainable at $50 a barrel, only one can afford to wait -- investors. The Saudis are burning more than $5 billion a month in reserves. There seems to be some panic in beginning to monetize oil assets now, when oil prices are low. It also implies the Saudis will continue to monetize oil assets on their road to Vision 2030, primarily through more bond offerings and ultimately an IPO of their state-owned oil behemoth, Saudi Aramco.
They know prices are cheap. And they know only one thing can deliver a better bond price and a better offering price on the IPO when it comes -- a higher oil price. A.L. Hittle, the head oil analyst at Wood Mackenzie, estimates that the valuation of Saudi Aramco increases by $500 billion -- half a trillion(!) dollars -- if oil prices increase from $50 a barrel to $70. That's a heckuvan incentive to move prices higher -- and the Saudis have the means to do it coming up in November.
Even if every barrel the Saudis personally cut will be taken back by the Nigerians, Iranians, Iraqis and U.S. producers, they can overwhelm the oil supply chain and take the entire 2-million-barrel-a-day cut themselves if they have to. And I think, if it comes down to it -- and they get certain promises from Iran and other OPEC and non-OPEC producers for future contributions -- that's just what they'll do.
Such a huge commitment to cut production from the Saudis would drop them to just under 9 million barrels a day, but would only require a $10 rally in crude prices to break them even in terms of monthly oil revenue.
And the increase to the value of the bonds and shares of Saudi Aramco that they're looking to sell would be hugely increased -- making it much more than a useless wash.
For us as investors, it means we must be positioned into strong U.S. oil companies that will react very positively to an aggressive agreement being prepared for the end of November.
And we should also prefer players in the very hot Permian or Oklahoma Scoop shale plays -- names that I mentioned including Anadarko, Cimarex and Concho.
We'll find targets for them to be bought in the next column. But we must ready ourselves for an imminent opportunity.
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