According to a report on CNBC, the price of Brent Crude oil can fall 30% by the end of the year; meaning that it will be at $80 per barrel as against the current price of $117 (end-of-day February 16, 2013). The primary reason for this, according to Robert Levitt, CEO and founder of U.S. wealth manager Levitt Capital Management, is the expected increase in global production of shale oil.
Whether or not this actually transpires, it should be of concern to small and mid-size oil companies such as Marathon Oil Corporation (NYSE:MRO), Occidental Petroleum Corporation (NYSE:OXY) and Hess Corporation (NYSE:HES).
What is Shale Oil?
Shale oil is a type of unconventional oil produced from oil shale, an organic-rich fine grained sedimentary rock that contains kerogen, which is basically a solid mixture of organic chemical compounds. Organic matter from within the kerogen is converted into synthetic oil and gas through processes known as pyrolysis, hydrogenation or thermal dissolution. Shale is a substitute for crude oil, which occurs naturally in shales.
Modern shale oil industry started in mid-19th century and grew just before World War I. With easy availability of crude oil, the industry declined. With the price of crude oil increasing the way it is, shale oil exploration and production was revived and started to grow in a small way in the 1990s. In the U.S. a development program for shale oil was initiated in 2003.
Here is a brief look at the three companies I mentioned at the beginning.
Marathon Oil Corporation
Marathon is an international company engaged in exploration and production, oil sands mining and integrated gas. Apart from the U.S., the company operates in Canada, Angola, Indonesia, Equatorial Guinea, Libya, Norway, Poland and the U.K.
Since January 01, 2013 to date, the stock has returned 13%, and from June last year, it has appreciated almost 40%. MRO has been paying regular dividend and has a dividend yield of 1.96. At current market price of $34.66, it is trading at P/E of 13.58 and 1.37 times book value (25.59). The company's operating margin in 39.47% and reported an EPS $2.45 for the fiscal year ended December 2012.
Occidental Petroleum Corporation
OXY is a holding company that operates in oil and gas, chemical, and midstream marketing and other segments through various subsidiaries and affiliates. The oil and gas segment is engaged in exploration, development and production of oil and condensate, natural gas and natural gas liquids.
Occidental has returned 10.57% YTD. The company pays handsome dividends and has a dividend yield of 3.02. Recently, Occidental Corp raised quarterly dividend to 64 cents per share, an increase of 18.5% from the earlier 54 cents. The company also has a slightly better operating profit margin (41.31%). At $84.71, OXY stock is trading at P/E ratio of 11.64 and 1.24X to its book value of $49.96.
Hess Corporation is an integrated energy company engaged in exploration and production of oil and natural gas across the globe. The company's marketing and refining segment is engaged in refining, purchase, marketing and trading of petroleum products, natural gas and electricity.
The company's stock has appreciated 27% year-to-date. As compared to MRO and OXY, it has a lower dividend yield of 0.59 and also a lower operating margin of 10.81%. The stock is trading at P/E ratio of 10.35 and 1.09X to book value (62.83).
Is Price Of Crude Oil Really Going To Fall?
There is much substance in what Robert Levitt is saying. The increase in discovery and production of shale oil is a reality. There is so much natural gas there that there are concerns about the waste of natural resources because the unwanted gas is being flared off. So much so, the flaring up is visible from space.
Shale oil is transforming the dynamics of the U.S. oil and gas industry. The Chairman of Eni, Italy's multinational oil and gas company, Giuseppe Recchi, has even gone as far as comparing the transformation to the way the rise of the Internet changed the U.S. economy.
According to Levitt, transportation was the major the hurdle in shale oil delivery. Now that the issue has been resolved, the upward pressure on crude oil price will ease. A study by PricewaterhouseCoopers (PwC), on the other hand, predicts that the global boom in shale oil production is likely to result in a 40% drop in crude price by 2035. According to the study, shale oil production in U.S. grew by 26% from 2004 through 2011.
However, as far as the drop in price of crude oil is concerned, Levitt seems to be holding a view that is contrary to most analysts. Most of them expect crude oil price to remain at about the same level in 2013 as it is now.
Han Pin Hsi, global head of commodities research at Standard Chartered bank, said that the oil market is "not just about the U.S." and is primarily dependent upon the global supply/demand situation. If on one side shale oil production is increasing, so is demand increasing in China. Moreover, lower crude oil price often leads to cuts in production of crude oil by oil producing countries in the Middle East. Already, last month production levels in Saudi Arabia were at their lowest since the last 14 months.
One is forced to agree with the view that oil and gas demand can only increase with emerging markets showing healthy growth rates. The effect of increased production of shale is likely to have an effect on crude oil price but increase in demand has also to be taken into account. Investors can expect industry dynamics to change and there could be a flurry of M&A activity.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.