Lower Oil Price Is a Double-Edged Sword

It's hard to believe that only a few months ago, US drivers were talking about the possibility of $5/gallon for gasoline. Now, the average price has fallen to below $2/gallon in most areas, and may fall further with the recent drop of 20% in oil in just the past week alone.

While the lower price of oil no doubt acts as a form of stimulus to the economy (as it puts more money into cash-strapped consumer's pockets), is it really the best thing for everyone in the long run?

First, only a few months ago, everyone was talking about how they had to conserve energy. While this was mostly in the form of driving less and even downsizing their vehicles, I actually started to hear more about people using low-energy light bulbs and solar power for their homes. Recently, such chatter seems to have died down. One has to fear that people really haven't changed their long-term habits when it comes to consuming oil.

Even scarier however, and more to the point of this article, is that the lower cost is causing the temporary delays and cancellation of many oil sands and off-shore projects. While this will not have any significant effect on the supply of oil over the next year or two, I fear what it might do in the 2012-2018 timeframe.

Many forecasters (when they were predicting their expected oil supply in those years) had factored in the continued development of the Canadian oil sands, the Venezuelan oil sands and off the coasts in South America. Most of these projects are not feasible at the current level. The delay in the beginning of these projects, combined with some projects in the North Sea slowing, will likely have a huge impact starting in 3-5 years.

So, how do you play this trend, long-term?

1. Look for companies which are low-cost producers and are producing today. Companies such as Devon Energy (DVN), Canadian Natural Resources (CNQ) and ConocoPhillips (COP) would fall under this category. These are companies which can slow down their exploration and still produce significant revenue off of their current properties.
2. Large multi-national companies which are sitting on a large hoard of cash. This is a great time to have cash on hand, as it may be cheaper to find Oil on the NYSE / Toronto Exchange than by using the drill bit. ExxonMobil (XOM), Royal Dutch Shell (RDS.A) and Total (TOT) would be three to look at.
3. Mid to large cap companies that have great properties, but have been heavily punished. These companies are likely going to get significant premiums to their stock prices today, if they were to be acquired by a company in point #2. Companies with plays in the Barnett Shale, Bakken and Montney regions immediately come to mind. Companies to look at include: Hess (HES), Crescent Point Energy Trust (CPGCF.PK) and Anadarko (APC).

While energy services companies, especially those with strong ties to the nationalized energy programs, will do well in the long-term, they also will be quite volatile for the next little while and may be best to avoid for the time being. However, if you have a strong stomach for volatility, check out Schlumberger (SLB), Weatherford (WFT) and Transocean (RIG).

Disclosure: Long CNQ, RIG, SLB, WFT.

Comments

[tipalia:]

nice article Larry as usual. Lower price of oil is the equivalent or even better than a tax cut and that s exactly what we need in this world today.
Did you mention anything on natural gas in your previous articles ? I have been looking at also the pipelines and thought that KMP looked attrative lately. I know I changed the subject, I am sorry , and I will uderstand if you can t comment on it. Enjoy the rest of the week Larry.

2008 Dec 09 12:21 PM

[Larry Belle...:]

Thanks, 138602. Natural Gas would likely fall under the same sort of idea, as many of the Horizontal Drilling projects / Deep Wells start to loose their attractiveness with sub-$6 Natural Gas. I do see two key differences, however. Although Natural Gas can be transported in LNG form, it tends to be more of a "local" fuel and one that is only affected by local production. The other key difference is that there seems to be a lot of of production coming online already that will not be halted, especially in the Montney/Barnett Shale areas. Natural Gas should find a bottom soon, as the Inventories will be starting to draw down for Home Heating more. I suspect that it will return to $7-$8 before the end of the winter.

As for Kinder Morgan, I think that most Pipeline companies are a good play here. I don't follow that one as closely enough to give an Intelligent opinion (and have no position in it). I like TransCanada (TRP), which I have a considerable position in, as it offers not only exposure to the Pipeline space, but also to the Power Generation space. Their acquisition of the Ravenwood facility that powers much of New York City was a good entry point for their stock. I also like Enbridge (ENB, no current posiiton), as it has some good exposure to the Increase in Oil coming out of the Oil Sands down to Chicago with their Alberta Clipper line.

Hope this helps...
Larry

2008 Dec 09 04:38 PM

[tipalia:]

many thanks Larry,you seem to see in another angle than we do and it helps us a lot.Hope to read you again before xmas but if we don t merry xmas to you and all your family. Since you have a french name
Joyeux Noell et bonne et heureuse nouvelle annee.

2008 Dec 09 08:20 PM