Be nice to investors on the way up because you always meet them again on the way back down.
This is the harsh reality for those who have placed their money in the fracking space this year.
Fracking was the hottest sector in the market in 2013; however, investors have recently fallen on hard times, with the price of oil collapsing from a $107 high in June, 2014 to under $26 in January, 2016, a haircut of some 76%.
Since then, it has struggled back up to $52, only to give up much of the recent gains.
Prices seem to be immune to all the good news that is thrown at them, be it ISIS, the Ukraine, Libya, or Syria.
It wasn’t supposed to be like this. Using this revolutionary new technology, drillers are in the process of ramping up US domestic oil production from 6 million to 10 million barrels a day.
The implications for the American economy have been extraordinarily positive.
It has created a hiring boom in the oil patch states which substantially reduced blue-collar unemployment. It added several points to US GDP growth.
It has also reduced our dependence on energy imports, from a peak of 30 quadrillion BTUs in 2005 to only 13 quadrillion BTUs at the end of last year.
We are probably shipping in under 10 quadrillion BTUs right now, a plunge of 66% from the top only 9 years ago.
The foreign exchange markets have taken note. Falling imports means sending hundreds of billions of dollars less to hostile sellers abroad.
This led to unexpected strength in the Japanese yen which saw its oil bill cut by several hundred billion dollars. Fewer dollars for oil means less yen are sold in the foreign exchange markets
Am I the only one who has noticed that we are funding both sides of all the Middle Eastern conflicts? The upshot has been the igniting of a huge bull market in the US dollar that will continue for decades.
That has justified the withdrawal of US military forces in this volatile part of the world, creating enormous savings in defense spending, rapidly bringing the US Federal budget closer to balance.
The oil boom has also provided ample fodder for the stock market, with the major indexes tripling off the 2009 bottom. Energy plays, especially those revolving around fracking infrastructure, took the lead.
Subscribers lapped up my recommendations in the area. Cheniere Energy (LNG) soared from $6 to $85. Linn Energy (LINE) ratcheted up from $7 to $36. Occidental Petroleum (OXY) moved by leaps and bounds, from $35 to $110.
Is the party now over? Are we to dump our energy holdings in the wake of the recent calamitous fall in prices?
I think not.
One of the purposes of this letter is to assist readers in separating the wheat from the chaff on the information front, both the kind that bombards us from the media and the more mundane variety emailed to us from our brokers.
When I see the quality of this data, I want to throw up my hands and cry. Pundits speculate that the troubles stem from Saudi Arabia’s desire to put Russia, Iran, the US fracking industry, and all alternative energy projects out of business by pummeling prices.
The only problem with that theory is that these “experts” have never been to Saudi Arabia, Iran or the Barnet Shale, and wouldn’t know which end of a solar panel to face towards the sun.
Best case, they are guessing; worst case, they are making it up to fill up airtime. And you want to invest your life savings based on what they are telling you?
I call this bullpucky.
I have traveled in the Middle East for 46 years. I covered the neighborhood wars for The Economist magazine during the 1970s.
When representing Morgan Stanley in the firm’s dealings with the Saudi royal family in the 1980s, I paused to stick my finger in the crack in the Riyadh city gate left by a spear thrown by King Abdul Aziz al Saud when he captured the city in the 1920s, creating modern Saudi Arabia.
The only mistake I made in my Texas fracking investments is that I sold out too soon in 2005, when natural gas traded at $5 and missed the spike to $17.
So let me tell you about the price of oil.
There are a few tried and true rules about this industry. It is far bigger than you realize. It has taken 150 years to build. Nothing ever happens in a hurry. Any changes here take decades and billions of dollars to implement.
Nobody has ever controlled the market, just chipped away at the margins. Oh, and occasionally the stuff blows up and kills you.
As former Vladimir Lenin advisor and Occidental Petroleum founder, the late Dr. Armand Hammer, once told me, “Follow the oil. Everything springs from there.”
China is the big factor that most people are missing.
Media coverage has been unremittingly negative. But their energy imports have never stopped rising, whether the economy is up, down, or going nowhere which in any case is rigged, guessed, or manufactured.
The major cities still suffer brownouts in the summer, and the government has ordered offices to limit air conditioning to a sweltering 82 degrees.
Chinese oil demand doubled to 8 million barrels a day from 2000-2010, and will double again in the current decade.
This assumes that Chinese standards of living reach only a fraction of our own. Lack of critical infrastructure and storage prevent it from rising faster.
Any fall in American purchases of Middle Eastern oil are immediately offset by new sales to Asia.
Some 80% of Persian Gulf oil now goes to Asia, and soon it will be 100%. This is why the Middle Kingdom has suddenly started investing in aircraft carriers.
So, we are not entering a prolonged, never ending collapse in oil prices. Run that theory past senior management at Exxon and Occidental, as I have done, and you’ll summon a great guffaw.
It will reorganize, restructure, and move into new technologies and markets, as they have already done with fracking.
My theory is that they will buy the entire alternative energy industry the second it becomes sustainably profitable. It certainly has the cash, the management and engineering expertise to do so.
What we are really seeing is the “growing up” of the fracking industry, from the rambunctious teenage years to a more mature young adulthood.
For years I have heard complaints of rocketing costs and endless shortages of key supplies and equipment. This setback will shake out overleveraged marginal players and allow costs to settle back to earth.
Roustabouts who recently made a stratospheric $200,000 a year will go back to earning $70,000, if they can get a job at all. This will all be great for industry profitability.
What all of this means is that we are entering a generational opportunity to get into energy investments of every description.
After all, it is the only sector in the market that is now cheap which, unlike coal, has a reasonable opportunity to recover.
My take here is that oil will continue to trade in its current $40-$52 range for a while.
But eventually we break out to the upside as a Clinton win in the presidential election unleashes a new wave of global economic activity.
This will lead to a revival of Chinese oil consuming GDP growth.
I expect oil to go out of 2016 near its highs at $52, add $10 in 2017, and another $10 in 2018. That neatly takes us up to $72 a barrel.
When it does, I’ll be shooting out the Trade Alerts as fast as I can write them.
Where to focus? I’ll unfurl the roll call of the usual suspects.
They include Occidental Petroleum (OXY), Exxon (XOM), Devon Energy (DVN), Anadarko Petroleum (APC) Cabot Oil & Gas (COG), and the ProShares 2X Ultra Oil & Gas ETF (DIG).
CH4 has been the main show so far which has rocketed by an eye popping 120% to $3.30 since March, thanks to the advent of export markets. We are now close to the highs for the year in natural gas.
The cost of production of domestic US oil runs anywhere from $28 a barrel for older legacy fields to $100 for recent deep offshore.
By the way, can any subscribers tell me if my favorite restaurant in Kuwait, the ship Al Boom, is still in business? The lamb kabob there was to die for.