In my last article, The Truth About Oil Prices: Part 1, we discussed a few factors that should be understood before investing in the oil sector.
We talked about annual production rates. U.S. oil production is not falling, as some in the financial media suggest. This is an important point because any time you invest in any company, it’s critical to know that revenue and profits are going to rise in the coming months and years. An oil company that pumps less and less oil with each passing year is not going to be a very good investment.
We talked about the challenges of shale oil production and well depletion rates. 60%-65% of all U.S. oil production comes from shale formations, like the Permian and Eagle Ford basins in Texas and North Dakota’s Bakken. Because shale oil wells have a very high depletion rate, oil companies must manage their drilling programs carefully so they can bring enough new production online to offset the depletion of older wells.
And we talked a little bit about how supply and demand affect oil prices. The oil market is very sensitive to supply and demand issues. We just discussed how U.S. oil companies have to manage their supply so that they can show an increase in revenue from year to year. But they also have to make sure they don’t oversupply the market because that will cause prices to fall. And when prices fall, so do revenue, profits, and stock price.
Supply and demand is a great place for us to start today’s article because there was a very significant development in global oil supply just last week…
Saudi Arabia is at it Again
We talked on Friday about how Saudi Arabia tried to crush prices and drive U.S. oil companies out of business by boosting their output as high as they could. The Saudis managed to drive a few weaker U.S. oil companies out of business, the plan mostly backfired.
But $50 oil blew such a massive hole in the Saudi budget that they had to sell shares in Saudi state oil company, ARAMCO, to make up for the losses. With oil prices depressed, Saudi Arabia ended up selling low on Aramco, which is kinda the opposite of the “buy low, sell high” standard for what makes a good investment.
I still chuckle at how naive Saudi leadership was about basic supply and demand. Because not only did they squander a phenomenal amount of money, but they also made U.S. oil companies much stronger. When oil prices crashed to sub-$50 levels, U.S. oil companies responded by cutting costs. Within a couple of years, U.S. oil companies cut their average cost per barrel from around $60 to under $30.
Anyway, a couple of weeks ago, rumors started swirling that Saudi Arabia was planning to cut its oil production in a bid to drive oil prices higher. Oil prices rallied from $77 a barrel on September 26 to $88 a barrel on October 6. And prices jumped another $4 a barrel on October 7, when the Saudis announced that they were cutting supply by 2 million barrels daily.
Interestingly, Russian oil production has been up one million barrels a day since it invaded Ukraine. Virtually all Russian oil currently goes to Asia (China and India). But that still puts global supply down a net one million barrels a day…
Global Supply and Demand
To put that in perspective, global oil demand is currently just below 100 million barrels a day and is expected to return to pre-COVID levels of 102 million barrels a day in 2023. Global supply was running just over 100 million barrels a day before the Saudi production cut.
(Editor's note: How much is oil demand in the U.S.? U.S. oil demand runs around 20 million barrels a day. Any suggestion that the U.S. has been energy independent in living memory is baloney.)
But if we’re investing in oil companies, we need to know what the future of supply and demand will look like. Of course, the growth of renewable energy will likely be the most compelling for analysts and investors alike. Renewables could account for as much as 50% of global energy use by 2050.
However, even the most optimistic forecasts for renewables still acknowledge that global oil demand will remain around 102 million barrels until at least 2030. And that’s because future oil demand growth comes almost exclusively from growing populations in developing nations in Asia and Africa.
So with a little upside for global oil demand over the next year, a somewhat stable demand outlook into 2030, and a per barrel price that remains $20 below its highs from June of 2022, there’s a case to be made for investing in U.S. oil companies – especially when you consider that, because of the sanctions placed on Russia after it invaded Ukraine, Europe will be a welcome destination for U.S. crude exports.
Now let’s move on to the good part…
Three Oil Stocks to Buy
The most important metric for investing in U.S. oil is how much oil the company owns: its reserves. Because as we’ve noted, it is critical that an oil company increase production year after year.
So here are three U.S. oil companies to look at…
Don’t be put off by the $140 a share price for Diamondback Energy (Nasdaq: FANG). Diamondback operates in the Permian basin. It is currently valued at $25 billion and has 1.7 billion barrels of reserves.
Diamondback pays a sweet 8.5% dividend that is completely sustainable for years to come.
Matador Resources (Nasdaq: MTDR) is a $7 billion company also operating in the Permian Basin. It has 429 million barrels of oil equivalent reserves (oil equivalent includes natural gas). Matador doesn’t pay a significant dividend, but it has a lot of cash and relatively low debt, so a nice hike to the dividend is a strong possibility at some point.
You should also keep your eyes on Master Limited Partnerships (MLPs).
MLPs are a relatively new investment vehicle for pulling in some very serious, steady income. The average MLP dividend yield is 8% or so, which absolutely crushes the S&P 500 average.
An MLP must generate at least 90% or more of its income from the production, processing, storage, and transportation of depletable natural resources and minerals. Most MLPs are dealing with oil, gas, and petroleum products.
Enterprise Products Partners L.P. (NYSE: EPD) is one of them. EPD, simply put, is in the business of storing and moving gas and petroleum products. One of EPD’s major advantages is its location. Its network of pipelines and facilities comes very close to the Permian and Eagle Ford formations, which have – and will – see a majority of production growth in coming years.
It's a $53 billion company with a dividend yield of 7.99%. They have also increased its dividend for 24 consecutive years – one year away from coveted dividend aristocrat status.
Until next time,
The Profit Sector