The chart below is the latest in the drilling rig count. Clearly, the rig activity is tied to not only current pricing for both oil and natural gas, expectations of commodity values. The operators across the U.S. felt that crude oil prices were headed to $50, and above, a few weeks back. Since, oil prices retreat to what should close today around $43 a barrel. The short term EIA report (link included below) is also an indication of excess daily supply being flushed out of the market. The flushing of oil supply will only come in two ways: increased demand or reduced supply.
With reduced supply requiring less drilling, and oil companies in the US needing to drill to shore up their balance sheets and sustain cash flow, causes resistance of U.S. supply. It is like taking a bone out of my dog’s mouth. Good luck with that!
I stated earlier this year that crude oil prices will close 12-31-16 at $42.50 a barrel. I still hold to that number. I do see a better than 50-50 chance oil prices for a short period will trade back south of $40 a barrel for WTI. The price below $40 a barrel will only be more of a test of the bottom trading range for now, but surely deepen the concern producers have of another retreat in prices. The lowering of crude has more of a long term effect on future prices than a short term effect. Wells being drilled to date are based upon budgets already committed and financials already making accommodations for those capital expenditures. The future is the testing of the “emotional nerves” of the various corporate decision makers. These decision makers will have to believe, with any degree of confidence, if the energy market is expected to be trading stronger or weaker for prices of commodities. That is the psychological effect of a drop of oil below $40.
In a strange way, I am glad prices are staying down and retreating. It allows the assets and the opportunities of high quality drilling, midstream and service related businesses and assets to be acquired at a discount. The downturn had many owners hanging on like it was their last life line. The quick rebound last spring, 2015, to over $60 only fueled their resistance to seeing and throwing in the towel. The bounce back this summer to near $50 was further Velcro that only delayed the flushing that still needs to occur. The bankruptcies are still coming and there is still about 12 months of pain to be delivered. In the next 12-months the real rally will begin. I am guessing the rally starts 4th quarter of 2017 and really shows its strength by the middle of 2019.
Now, what to do? I am buying new reserves via mineral acquisitions, new exploration ideas that make sense at $30 oil prices, buying distressed assets like service and product oriented companies and building my income and asset base for a liquidation of certain assets in 2021 and 2022. This is when I feel we will see another frothy market for buyers and that is whom I intend to sell to and when.
Have a great weekend.
Troy W. Eckard