Time for a Texas Shopping Spree

(also in investing.com)

Despite what you might hear about the “resiliency” of shale oil companies and the technological advances that have made it possible for fracking to turn a profit at lower prices, the fact is that most companies need to sell their oil at around $60 a barrel to make a reliable profit. Given the global glut of oil, it is unlikely that oil will break the $50 a barrel mark soon.

For months, the prevailing belief has been that the longer the price of oil stays low, the more pressure this puts on oil producers to curb supply. This is a fundamentally flawed argument, and neither common sense nor history supports it. In the early 1930s, there was extreme overproduction in Texas, to the point where the price of a barrel of oil dropped to just a few cents. Oil producers lost money on every barrel they sold, but they continued to produce as much as possible because every barrel sold, even at just 6 cents, was more money then they could make not producing at all. Finally, the governor of Texas declared the oil producers in a state of “insurrection” and sent in the Texas National Guard to enforce production quotas. This, of course, resulted in a robust smuggling industry, but ultimately it did raise the price of oil into the $1 a barrel range.

The lesson here is that low oil prices only incentivize struggling operations to produce MORE, not LESS. As long as they have access to credit and financing, they will not decrease production. This is what has happened with shale oil production over the last nine months. However, these sources of capital finally seem to be drying up, and the only avenues left are private equity firms who are now scouring the industry for cheap deals on oil and gas assets. They may even acquire entire companies on the cheap as those firms look to avoid bankruptcy. Reportedly, private equity firms have raised over $100 billion to spend on energy acquisitions, in addition to the $80 billion they have to purchase oil company debt.

The real value in shale oil production is in the assets and the technology, not the companies themselves. When the dust settles, the assets will end up with companies like Noble (NYSE:NBL), EOG Resources (NYSE:EOG) Exxon (NYSE:XOM), Chevron (NYSE:CVX), Continental Resources (NYSE:CLR), Hess (NYSE: HES), ConocoPhillips (NYSE:COP), Saudi Aramco, Total (NYSE:TOT) and Statoil (NYSE:STO). These companies are better capitalized, do not face extreme pressure to produce and sell under any circumstances, and would certainly see 52,000 acres of proven oil resources in south Texas as a better bet than a billion dollar investment in off-shore drilling in the arctic circle.