In the last few columns on winners and losers of $80 oil, I tried to construct an investment strategy we could use, for the duration of what I'm calling the $80-oil winter. Some positional moves should be made in portfolios right now, as stock indexes streak higher, while most energy shares lag.
We've seen capital expenditure reduction at big and small energy companies, such as Royal Dutch Shell (RDS.A), ConocoPhillips (COP), Continental Resources (CLR), Rosetta Resources (ROSE), and Halcon (HK). These companies tried to spin the capex cut in a positive view, but the final result of lower spending will be lower volume growth.
The markets will inevitably instill discipline into an U.S. oil sector that has expanded on breakneck drilling pace, expensive leases, and high-yield bond leverage.
A recent Bloomberg article highlights areas in the Mississippi Lime and Eaglebine that put over 400,000 barrels per day at risk. I have outlined various players in the Bakken Shale and the Tuscaloosa Marine Shale that I believe put almost 500,000-barrels-per-day of production that is at risk. That is before counting the better-capitalized players in more core areas, who will also inevitably lower growth rates in an $80-oil environment. All this will take time to unfold.
How long will it take? Production declines will come as a last resort for U.S. exploration and production companies (E&P). In general, bondholders and Wall Street hold production as the Holy Grail stock price metric. Nevertheless, another three to six months of $80 oil will surely begin to show obvious cracks. I think we're destined to stay at that level for that duration, or longer.
Given the circumstances, how do you play? I've already said several times that oil's trip below $80 is unsustainable. The next leg up, after this necessary period of consolidation and enforced discipline, will be much higher. Oil price would likely break the highs of $147, which we saw in 2008.
Shale oil is the most scalable of expensive oil sources. It won't be the only non-conventional source to suffer in the $80 oil winter, as offshore deep-water projects get shelved, and oil sands production is throttled back.
As bad as the glut looks today, we are going to face a global supply shortage when these production cuts happen, and I think it'll be unexpected and deep. Add to that the resurgence of commodity investment that always accompanies a fundamental thesis of supply shortage, and you've got a winner of a rally on your hands.
Again, that will take a lot of time. We're at least a year away from that, but it doesn't mean you can't begin to reshuffle your portfolio to look for that trend change. There are three places you can go to.
One, you can find the winners in the shale shakeout, targeting the well capitalized, efficient oil players. My picks include EOG Resources (EOG), Cimarex Energy (XEC), and Anadarko Petroleum (APC).
You can also play the inevitable rebound of oil services. For that, I would recommend Halliburton (HAL), a strong value choice on the back of its Baker Hughes (BHI) buyout. You could also reach for more beta with shale specialist Helmerich and Payne (HP), which has also taken a massive beating recently.
Finally, you could just bet long-term on the unsustainability of $80 oil with mega-cap oil companies. Conoco-Philips, with its 4% dividend, strikes me as the safest of the mega-caps, and a tremendous long-term value.
With an overextended U.S. stock market, the time is right for serious rotation into an energy sector that has recently gone the other way, even though that pressure is unlikely to be released for several months. Smart positioning will not only save losses from some overpriced U.S. sectors, but also yield tremendous gains, when the energy sector stages its inevitable rebound.