Lost in all the headlines about the oil's price plunge was an ominous comment by the energy minister of the United Arab Emirates earlier this month. Just weeks after OPEC shocked global energy markets by refusing to support crude prices with a supply cut, statements by decision makers seem to point to an oil price war.
The U.S. energy revolution will still be a strong investment theme over the longer-term, but can your portfolio survive several years of price wars?
Oil Prices: How Low And For How Long?
Suhail Al-Mazrouei, UAE Energy Minister, said OPEC would be comfortable with crude prices as low as $40, which was followed by a nearly 5% price plunge in West Texas Intermediate -- a benchmark for oil.
The statement was a shot across the bow of world oil production and a full commitment to protect market share against surging North American production.
The twelve members of OPEC produce 40% of the world’s oil supply. The cartel is adjusting to a world of lower prices, in part because it can’t constrain output by non-OPEC members such as Russia, the United States and non-member Middle Eastern countries.
The descent in oil prices has seemed to slow around $55 per barrel lately but that doesn’t mean this game of international chicken is quite over yet.
Production in North America is likely to keep increasing into 2015 as record investment spending over the last several years keeps unconventional wells open. Several members of OPEC, notably Venezuela and Iran, which have seen economic stability crash with oil prices, are also likely to exceed production quotas as they try to balance their fiscal budgets.
But for investors that can ride out the volatility, there are several catalysts that could provide short-term support and long-term upside.
Fourth quarter earnings reports, slated to begin in late January, will enable energy companies to address the weakness in prices and revise their plans for capital spending. If reduced plans for investment come through as lower near-term production, then oil prices could find a floor.
Thirty-two of 39 U.S. shale projects are unprofitable with oil below $60 a barrel, according to a survey by Bloomberg New Energy Finance. Permian and Bakken assets generally need oil above $70 a barrel, while some Eagle Ford assets are profitable all the way down to $50 a barrel. With prices in the mid-$50s per barrel, spending plans for the next year could come down significantly.
Against the near-term weakness, the long-term upside for those in the energy space is still very positive. Even on surging non-OPEC production, BP, Plc (NYSE: BP) forecasts an annual deficit in oil supply from 2015 onward in its 2035 outlook.
Growing demand for energy from Asia and the U.S. has been responsible for higher oil prices since 2000 and the supply deficit may get more pronounced as some marginal production gets cut on lower near-term oil prices.
Annualized production growth in the five years to 2010 beat consumption growth for the first time in more than a decade. However, production growth is forecast to underperform consumption growth in every five-year period through 2035, leading to a growing shortage of more than 2,500 million tons of oil equivalent over the next several decades.
Safety In Size And Financial Health
As for the near-term, there are still downside risks for oil prices. First, the dollar may keep rallying, which has an inverse impact on global oil prices. Second, the multi-year period of higher capital spending on North American fields may still lead to higher output in the near-term.
Offsetting this, the supply side of the equation may support prices. Higher global economic growth may come from a combination of lower energy prices and further monetary easing by the European Central Bank.
There are several ways to maintain your exposure to the revolutionary change in North American production while protecting your portfolio against what could be several years of price weakness.
Large integrated companies like Exxon Mobil Corp. (NYSE: XOM) and Chevron Corp. (NYSE: CVX) have the resources to withstand weak prices. And their downstream segments will benefit from lower prices. Lowered production estimates at unconventional fields will also have a smaller impact on total revenues of these globally-diversified behemoths, compared to the impact felt by smaller operators.
Midstream oil companies like Williams Partners LP (NYSE: WPZ) should also do well since revenue is typically more closely linked to fee-based volume than to energy prices.
Williams Partners is also relatively protected as a natural gas pipeline operator. It recently closed on its merger with Access Midstream, a deal that was named the best of the year by the Global Energy Awards for its strategic significance.
Most of the company’s gross revenue (80%) is fee-based and additional pipeline capacity over the next several years should translate to steadily higher revenue.
Within the services space, Cameron International Corp. (NYSE: CAM) provides oil and gas pressure control equipment. Cameron is a vertically-integrated service provider with revenue from pipeline and refinery operations as well, so it has multiple revenue streams that can withstand low oil prices.
Though Cameron will feel some industry impact, its exposure to strong subsea tree demand should help to limit downside. Subsea trees control and monitor the oil production of offshore wells.
The company just announced a major seven-year contract with ExxonMobil for wellhead equipment and production trees at the Hebron development, which should help protect near-term revenue.
Risks To Consider: Oil prices could move lower and have the potential to stay there for a couple of years as the impact of previous capital spending supports production. Stick with the strongest long-term names and be ready to dollar-cost positions if prices go lower.
Action To Take --> Take advantage of oil weakness to snap up deals in long-term energy names across the value chain. Larger integrated companies are likely the safest, but valuations in midstream and equipment providers can offer long-term upside as well.
If oil, natural resources or commodities are what interests you, look no further than StreetAuthority's Scarcity & Real Wealth. Our resident natural resources expert Dave Forest has more than a decade's experience as a trained geologist and analyst. His industry insight allows him to read the markets and provide the most timely, potentially lucrative advice for everything from oil and gold to molybdenum. To gain access to Dave's latest research, click here.