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Halcon And US Shale Vs. Low Oil Prices

I agree for the most part with the author's assessment of Halcon. It is a speculative play and the comparison to a start-up biofirm is fair. (Though I would expand upon that and mention that Halcon does have tangible assesses and is less risky than penny biofarm stocks.)

In the near term (next 3+ months) Halcon, like many other small to mid-cap oil exploration companies, will experience large swings in its share price as the bear market continues for the price of oil. Shorters and those that love volatility can do well with Halcon and other energy ETFs.

For more long termers, is the high two's / low 3's a good entry point? Possibly. From what I've been able to research Halcon can weather the storm of low(ish) oil prices through most of 2015 as they have enough credit and have hedged 70% of their oil contracts. I'd love to better understand Halcon's break-even point. Many articles point to the general shale industry and $85 a barrel as the break even average. But certain fields (much of Eagle Ford) are easier and cheaper to extract, than say something like the TMS. Drilling advancements also continue. Still, a sustained low price (a year+) below the $80 - $75 would begin to hurt US shale producers. Halcon included, and that far out, any hedges will no longer help.

Can oil stay low? I believe oil will still trade low in the short term, certainly in the next 3+ months.

Middle East Oil:
It is very unlikely OPEC (the Saudis in particular) will make any moves to reduce production to improve the price of oil at their November 27th meeting. The Saudis will look to maintain market share (exhibited in their price cuts to the US) and will take the hit in order to do so. To them its short term pain to 1) not concede market share, 2) Hurt Iran, and 3) hurt US shale producers.

The question is how long can OPEC survive low prices? To complicate matters further, not all OPEC nations are equal in this. I've seen articles throw $30 around as the price for which the Saudis' breakeven. This is misleading. Though $30 is the cost for their oil extraction, it does not take into account the fact that the Saudis' rely heavily on oil exports to balance their budget and pay for the many social programs that country has. $90 seems to be the general consensus at which the Saudi budget is balanced. Below that they will need to tap their (large) cash reserves to make up the deficit. How long they can sustain this pain will relate to how long this price war will go.

Further, not all OPEC countries are in the same position as Saudi Arabia or Kuwait (low production costs and healthy cash reserves). Libya, Iran and Venezuela in particular are already feeling the pinch. Both need over $100. Venezuela is already reeling, unable to provide even basic services to its people and has called for an emergency OPEC meeting (which has been denied, though the OPEC oil minister has made a trip their). And Iran, already in pain from sanctions limiting investment in its oil infrastructure (production is down 35% this year alone) is also unable to weather a price war storm. This may work out for Iran's nuclear talks, as they will be keen to remove sanctions. But for the price of oil, more oil on the market from Iran will only drive down the cost per barrel. And for Iran, increasing production will lessen the pain, but the pain is still there with a low cost per barrel.

Lastly Russia is also a player to watch in this space, as they too rely on oil export for GDP and need oil over $90. Though they have some cash reserves, it is not enough to maintain a drawn out price war.

BOTTOM LINE: There are many nations that NEED oil to trade much higher. These nations are only another revolt, invasion, or Arab spring away from increasing volatility.

What does this mean for US producers?
I think time will be a clear factor here. Most US shale producers (Halcon Included) can survive well into next year, but beyond, should prices stay low, it will be tough. Can they stay this low? Well, the large OPEC members (Saudi and Kuwait) could maintain this staring contest - but the others? Unlikely. Sustained low prices will see OPEC members break rank, and other oil countries (Russia) making moves to correct.

It's likely that we will see moves within Washington on this as well. Though the US is not an oil producing economy, the Shale boom has done quite a bit to bolster the country in recent years. Congress would be wise to not put that industry and the jobs it brings at risk. Already US producers have joined to lobby to allow the ability to export crude. Right now US producers are shackled to selling crude solely within the US to US refiners (who then can export it!). These refiners are geared more towards heavy middle-eastern crude over the light sweet crude produced here. The global market already is glutted with high inventory vs. demand and the US (NYSE:WTI) market is a further reinforcement of this - with a glut of light sweet crude and only the ability to sell it here. Removing this restriction would immediately bolster US producers (bringing the price of WTI closer to BRENT), however at the expense of US refiners who have been enjoying a monopoly on US crude.

This legislation would be great, but faces an uphill battle with average US consumers who are now enjoying low gas prices. Hopefully the argument can be made clear, that exporting will be good for America, and that we already do it (on the refined level).

Alternatively Washington could broker a deal reinstituting oil price floors and ceilings, reducing the volatility of the market.

BOTTOM BOTTOM LINE: The price of oil is cyclical. If the low price were to be sustained long enough (1-2 years) it would do significant damage to the US shale industry and force many players out or to merge, Halcon included. But then what will happen? The price will go up. And guess what, US shale production will be viable again and so the cycle will continue, albeit with new players. There so much volatility here, that though prices may go a little lower in the very short term, in the long term there will need to be stabilization and an increase. That stabilization will either be driven by drastic measures (war, civil unrest, etc) or middle ground via diplomacy.

Long story, but I'm long on Halcon, especially at this entry point. Halcon is a speculative play, its debt for its infrastructure investment is high and its ability to whether the storm may only be a few years - BUT it would be amazing if the storm of low prices lasted that long, especially given the stakes and players.

Disclosure: The author is long HK.