Ride Oil's Comeback

| About: The United (USO)

Summary

Don't believe the media: oil consumption is not declining - it's rising.

Oil exploration budgets have been cut and the results will be harsh.

See why an oil supply shortfall is looming on the horizon.

I spent the early days of my career at The Wall Street Journal - this is the mid to late '90s we're talking about - in the paper's Dallas bureau. It was there that I learned all I need to know about the oil market and how to make a small fortune.

My job back then was to effectively wander the state of Texas, writing a weekly investment column on the opportunities I came across in my travels and my interviews. It was on one of those wanderings that I came across an old oil hand in Houston who'd made a name for himself as one of the industry's savviest investors.

His office, decorated with Western art and overlooking the Houston skyline from about 20 floors up, smelled of long-dead cigarettes. His voice was gravelly; his face a topography map of the American West. And over the course of a couple of days - and several conversations on the phone - he shared with me much of what he'd learned in the decades he'd spent investing in oil.

I walked away from those lessons and immediately added shares of Diamond Offshore Drilling (NYSE:DO) to my portfolio. I bought the stock in the teens and rode it to more than $100 a share. After listening to my personal oil-field oracle, I reflexively understood why oil, then fetching a niggling price in the low teens, was about to launch to unimagined highs. It was the simple story of supply and demand, and sentiment.

That same story confronts us again two decades later, and it's why I am so bullish on oil-field service stocks at a time when they're about as well-loved as an ISIS terrorist.

Here's the story as it played out in the late '90s. You will undoubtedly recognize some similarities today.

By the spring of 1999, the oil patch was in a terrible funk. Prices had fallen more than 40% to just $15 a barrel from near $30 just two years earlier. I remember some West Texas stripper-well owners out in the panhandle joking with me that water was worth more than oil, and maybe they'd be better off investing in divining rods and wandering around the dusty scrubland looking for a gusher of H2O instead.

With prices so low, exploration and production companies big and small severely tightened their belts. That meant they stopped investing in the search for new sources of oil to replace their existing wells. Why invest money, the thinking went, to bring in oil that will cost more to develop than it's worth on the market?

But even as the exploration side of the business - the supply side - went into hibernation, two predictable trends played out:

  • Existing production continued to dwindle, since oil reserves are a declining asset
  • Demand didn't stop growing. It continued to march higher by roughly 1% a year, just as it had for many years

And one day, the world woke up to realize: Oh mother of god, what have we done!

Demand had caught up with and exceeded daily supply. Yet, the world's major oil producers had no spare capacity and no way to quickly add to capacity because they'd not invested in finding those new reserves - a process that takes years of searching and drilling, and permitting and well-construction.

The end result was the historic run in oil prices between 1999 and the historic peak in 2008.

With that I say: "Welcome back to the future!"

Reining in Future Production

This past February, oil slipped just below $29 a barrel, the culmination of a price collapse that saw oil fall nearly 75% in just two years.

Just as they did last time, oil companies have slashed exploration budgets. In 2015, they cut a quarter of a trillion dollars and they're expected to cut another third of a trillion dollars this year. In all, we're talking about nearly $650 billion in exploration spending that will not happen.

That represents a huge number of barrels of daily production that will not come online anytime soon. Just how much oil isn't a hard-and-fast number, but by some estimates, we're looking at a hole of roughly 19 million barrels of future daily production.

Let me put that into perspective:

  • The world consumes about 95 million barrels a day right now.
  • Oil prices fell off a cliff because supply exceeded demand by between 1 million and 2 million barrels a day (though that has now shrunk).
  • The potential supply shortfall because of the exploration that oil companies have foregone could be 10 to nearly 20 times larger than the supply excesses that sent oil prices crashing.

Question: What is the opposite of a crash?

You, no doubt, see where I am headed…

At the Heart of the Rally

Despite the mainstream financial media's inaccurate reporting, consumption is not declining.

Every year, BP (NYSE:BP) (the old British Petroleum) publishes an anthology of oil that recounts all sorts of numbing statistics - including this one: total world consumption. Since the end of the global financial crisis, oil consumption has grown by 1.6% a year on average. Even in America where we are continually fed a line of BS about falling demand, consumption has increased by 0.3% a year, on average, since 2009.

When I look at how much future production has been erased, and I look at demand that continues to grow around the world (despite all that's going on with green energy), I am left feeling today like I did when I walked out of my oil-investment lessons in Houston all those years ago.

I see a massive opportunity in oil-field service stocks. They're the ones that are tightly tied to oil prices because demand for their services rises and falls with exploration and production activity. And when the world realizes yet again "Oh mother of god, what have we done!" we're going to see exploration companies scrambling to find new reserves… and the oil-field service stocks are going to see prices that rise by multi hundreds of percent.

Many of them today are cheaper than a gallon of bottled water.

I won't detail any names here, though I can tell you there are several on my list that I am extremely excited about and will be writing about in my monthly newsletter, Total Wealth Insider, in coming months.

I will, however, direct you to the S&P Oil & Gas Equipment & Services ETF (NYSEARCA:XES). When this industry takes off - and it will! - XES, now in the $18 range, is going to soar magnificently.

Until next time, good trading…

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: As a lifelong world traveler, Jeff Opdyke has been investing directly in the international markets since 1995, making him one of the true pioneers of foreign trading. He is Investment Director for The Sovereign Society and the editor of Frontline Investor, a weekly trade alert, and Total Wealth Insider, The Sovereign Society’s exclusive monthly research newsletter.