The Dumbed Down Version Of Oil's Chaos

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Includes: BNO, CHK, DBO, DNO, DTO, DWTI, LINEQ, NTI, OIL, OLEM, OLO, PGH, PSX, SCO, SZO, UCO, USL, USO, UWTI, WMB, XOM
by: David Butler

Summary

The energy production wars that have ensued between different players on the global scale have been a blessing to the typical consumer, and a nightmare to the industry.

Part of the blame lies within OPEC, and a great deal lies on US business for trying to drill up profits all at once.

Too many wanting in on shale oil turned to easy credit from banks and extended themselves into an environment built around pricey energy.

Now that supply and demand has caught up, we're looking at an overpopulated industry that faces a future of certain default and integration.

(I'm changing things up a bit on this article and working in a sort of op-ed of my take on our current market catalysts. I've been watching this thing closely and would like to spur some conversation on the catalysts shaping what is happening to the energy sector of our stock market. I welcome criticism and alternate points of view.)

It's fair to say thus far that 2016 has been a bit of a bumpy road. Energy prices are a dream to the consumer, and a nightmare to anyone invested in the industry. Banks are getting edgy on loan anxiety, and manufacturing...well when isn't manufacturing a headache anymore? The situation isn't as gloom and doom as back in 2009, but it certainly is interesting.

In my opinion, the current market conditions are spinning around 2 things. The Fed is not really there to protect as it has been for the past few years. The energy sector is causing fear in other areas of the economy. To me, it really comes down to this:

-Too many players in oil

-Too many players in oil that financed their endeavors in the wrong way.

-Supply and demand is biting us for not paying attention.

Too many wanted in on the energy pie.

It is absolutely 100% true that Saudi Arabia has been trying to burn us down. They've wholeheartedly devoted themselves to breaking the American Capitalist's intrusion into their market share. Why we aren't currently pursuing moves to tamper the amount of exports that OPEC can deliver to our docks and those of our allies is beyond me. Economic trade war ideology aside, I don't think that Saudi Arabia is the only culprit for our current energy sector woes. When we look at the shale boom that has hit our lands in the past decade, It's something that is relatively reminiscent of a gold rush.

From Canada to Texas, the advances in technology opened up new possibilities in the oil and natural gas industry. The massive hype that overlaid natural gas as the next big thing (principally when oil prices were so high that we were desperate for cheaper sources of energy) drove many into the market in the search for the next "boom". With the employment of fracking, companies like Chesapeake Energy (NYSE:CHK) and Pengrowth Energy (NYSE:PGH) acquired massive amounts of leases for land, and not wanting to pay those contracts without building inventory, drilled like there was no tomorrow. As an inhabitant of Pennsylvania where one of the largest natural gas reserves in the US resides, I can tell you first hand that wells went up over night all over the state.

This massive production of natural gas drove prices to a level that made it an incredibly affordable alternative to oil. In reaction, we've seen those heavily vested in oil increase production to lower prices and protect their own interests. This cheap American fuel started to cut into what used to be purchased from overseas. This was the first step of the "bidding war". Cue Saudi Arabia...

The Royalty bites back

As cheap North American energy has offset prices and lowered our need to consume foreign energy sources, we've seen Saudi Arabia lead OPEC into what was a primarily North American bidding war. They have done this for two reasons, cheap oil stops the desire for alternative energy, and they don't want to lose their market share. After all, their royalty might not be able to afford those massive mansions if they lose market share! With massive production increases across the spectrum, we've hit our current position of incredibly cheap West Texas Intermediate, as well as Brent Crude oil.

Good for some, bad for all

To the average consumer, no one is very upset about this energy crash. I use my SUV like a winter warrior this time of the year, and it has admittedly been a great relief on my wallet to be paying $1.95 for gasoline. I for one think we're going to see good in parts of the economy due to this massive saving on the consumers part. People are going to have some spare change to move around in other areas. It has however hurt markets, pensions, and workers in the energy sector. Anyone with a portfolio probably has some exposure to energy. Exxon Mobil (NYSE:XOM) is in a lot of mutual funds for very obvious reasons, they've been a giant behemoth of success. Equities, ETF's, ETN's, you name it. People are invested in oil, and while the giant price drop has benefited us in heating and at the pump, it has hurt 401k's and pension funds. Whether or not this will be a long term problem is questionable. If fund managers have done their jobs right at all, they hold energy assets that are involved in the more reliable energy firms.

On a positive note, oil refiners have had a nice little time due to better margins on their refined products due to their access to cheap oil. Northern Tier Energy (NYSE:NTI) had some great quarters this winter due to this very scenario.

Where is it going from here?

So where is it going from here and how do we play it? If you've been watching this situation, you probably heard about Saudi Arabia and Russia working on capping out oil production rates. Don't get overly excited about this. Yes, oil has run up a bit since this discussion began, but I don't think it's a permanent trend. Consider this. Saudi Arabia and Russia are halting anymore "increased" oil production. This seems to be an attempt on Saudi Arabia's part to appease Venezuela who has arguably suffered the most from lower pricing. They're still going to remain at the levels they produced in December and January. These are still levels of production that are hurting us. To add fuel to the fire, after the extended sanctions imposed on the country by the US, Iran is eager to get their oil back onto the market and make up some of their financial losses. This infusion of new product is going to further damper pricing. These factors just do not show me any proof of possible relief to oil's downslide.

One anomaly is Russia, who could definitely benefit from better oil prices. I don't know whether they have a deeper plan, or if Putin just doesn't know what to do at this point. Regardless, it seems to me that the US is the one that will suffer the most if this production war lasts another year. Unlike some of our corrupt counterparts, US corporations answer to shareholders. Furthermore, many of these companies have a lot of debt to service. The Williams Companies (NYSE:WMB) for instance, had $21 billion in debt as of September, while putting up revenues under $2 billion, and failing to turn a profit. For less endowed firms, the credit markets are drying up. Continental Resources CEO Harold Hamm recently stated that his company needs oil at $60 a barrel in order to stabilize cash flow. All I can say to that is: YIKES!! Linn Energy (LINE) is also a victim in the current "kill or be killed" market. When you consider their revenues last December were over $2 billion, it's quite frightening to anyone who still (stupidly) owns this stock to see their 3Q'15 revenues at a measly $449 million.

The hurt isn't over yet

The Shale revolution caused so many to try to grab a piece of the energy play. It caused a lot of companies to drive up debt to acquire the equipment and financing to stake their claim. That was back when prices were high. Now that prices are down, these companies NEED to cut back on production in order to correct supply and demand. None of these companies can afford to do this though because they need to keep enough income coming in to service their debt. It's a lose-lose situation. They either stop drilling and default, or they keep drilling and default slower. Natural gas producers have put themselves in to the same dilemma. They also face a weaker demand since petroleum is so cheap. It won't be shocking to see Linn Energy (NASDAQ:LINE) or nat. gas firms like Chesapeake Energy file chapter 11 in the coming months. The simple fact is that the energy sector is overpopulated and far too competitive for its own good at this point.

How to buy???

Obviously what matters to us is how to use the macroeconomic situation to our advantage. Let's face it. This whole oil scenario is scary. We cannot be sure what is going to happen 6 months from now regardless of what anyone tells you. If you're gutsy, I like things like investing into the actual oil price itself. Getting into things like the United States Oil ETF (NYSEARCA:USO) keeps you away from fooling around with unpredictable earnings reports coming in early 2016. It's tradable, and easy to track in regards to oil's momentum moves. If you want equities, I think the stalwarts are the best. I can't help thinking that if the weak start to bite the bullet, the big guys like Exxon Mobil will most likely come out of this thing better than when it started if I know them. You'll see them snatching up defaulted assets for a dime on the dollar and having larger production leverage. That company (for better or worse) knows how to win. Snag some of its stock on dips if you want to be safe. I'm looking for a move in the refining end of the business. Buffett sure is inspiring moves in his buy ups of Phillips 66 (NYSE:PSX). WHATEVER YOU DO, do not fall into the nightmare that is exchange traded notes. I did, and it was a painful experience.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in MDIV, XOM, PSX, USO over 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.

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