By Amine Bouchentouf
Here's one way to take advantage of low oil prices.
When we look at the global petroleum market, we must differentiate between two separate and very distinct types of producers: low-cost producers and high-cost producers. When laymen look at the industry, they usually only look at the price per barrel to help determine whether the products they purchase (such as gasoline) will be high or low. What investors look at, or need to look at, is a far more important metric: the all-in production and operational cost per barrel.
Operational Cost Per Barrel
In times of elevated oil prices (more than $100 per barrel), it seems that all oil producers are equal because they are all generating returns well above their initial production costs. When the price a barrel fetches in the open market begins to fall, this is when the differential between low-cost producers and high-cost producers becomes very stark. And this is when laymen need to put on investors' goggles to truly understand the dynamics of the oil market, and to position to benefit.
In this environment of lower oil prices, we are seeing the winners and losers on the supply side of the equation (note I'm not using the term "low oil prices," because I don't qualify $80 a barrel as low by any historical standard; low oil prices are what we saw 15-20 years ago when prices were at $10 a barrel). Lower oil prices have an effect both on high-cost and low-cost producers; in this case, the low-cost producers are able to bear the brunt of lower prices while producers with a higher cost base are either going out of business or are taking huge hits to their operational margins.
Low Cost vs. High Cost Producers
In the spectrum of petroleum cost production, you find many different players, differentiated by geography, technology and quality. At the end of the day, cost is a function of reservoir operations. The lowest-cost producers are the traditional oil producers, such as Saudi Arabia, the UAE and even parts of the United States.
When you go down to the country level, cost is a function of reservoir location. Generally speaking, the lowest cost oil is located in onshore locations; offshore oil is generally more expensive than onshore, due to the technological extraction methods employed; and finally shale oil that requires "fracking" techniques to get it out of the ground is on the costliest side of the spectrum.
The lowest-cost oil can cost as low as $1.50 to $2 per barrel, while the most expensive oil can reach up to $90 for the heavy oil located in ultra-deep offshore reservoirs. Most shale oil can be produced at a cash cost of between $25 to $70. In this environment, it is no surprise why the industry is not putting up a united front against falling oil prices.
To put it clearly, falling oil price is having a disproportionately higher negative impact on high-cost producers relative to medium- or low-cost producers. As a matter of fact, lower-cost producers are actually pushing for a lower-priced barrel because it will reduce competition going forward. Sure it will hurt in the short term, but the calculation is that in the longer period, low-cost producers will benefit if there are fewer supply-side sources available.
As it turns out, many of the low-cost producers are OPEC members, led by the Saudis. The Saudis can actually sustain $80 oil, even much lower, since their costs are among the lowest in the world. (Obviously, we need to factor in budget spending and other programs that require a floor on oil prices.) But by and large, the low-cost producers can sustain lower oil prices, and are actually pushing for lower oil prices.
Picking The Winners
In analyzing this lower-priced oil market, you should identify companies that have low operational production capital expenditure programs; this information is generally found in the 10Q and 10K statements of publicly traded companies in the U.S. As a rule, the lower-cost producers are going to fare much better down the line; sure there will be volatility in the short term, but once prices stabilize again, these companies can use their large cushion base to exceed growth expectations.
One such company is Continental Resources (NYSE:CLR). Continental is one of the leading producers in the continental United States. Based in Oklahoma, the company has operations in North Dakota, Montana, Colorado and Wyoming. The company has been one of the earlier buyers of large acreage that is now producing significant amounts of oil.
Due to its first-mover advantage, CLR has been able to keep costs low while other companies are forced to shut down their operations in this lower-priced environment. An experienced management team can also help the company weather throughout the cycles.
Disclosure: The author doesn't have any positions in the stocks mentioned.
Amine Bouchentouf is a partner at Parador Capital LLC, an institutional advisory firm focused on commodities and emerging markets. He is the author of the best-selling "Commodities For Dummies," published by Wiley. Amine is also the founder of Commodities Investors LLC, an advisory firm dedicated to providing insightful information on all things commodities. He can be reached at amine@commodities-investors.com.
