Crude oil prices have been a cruel mistress over the last year or so. After the Organization of the Petroleum Exporting Countries decided against cutting supplies, the world became awash in cheap oil.
Meanwhile, rising fuel economy, energy efficiencies and a hefty dose of dwindling economic growth has caused demand for crude to drop. This dynamic between rising supplies and falling demand has obliterated crude oil prices since crude reached its zenith last summer.
The price drop has put a massive hurting on energy stocks as well.
On average, energy stocks have tanked about 30% over the last year on the lower crude oil prices. Earnings have been crimped, cash flows reduced and, in some cases, bankruptcy has become a common occurrence.
However, investors should not fret. As the wheat has been separated from the chaff, the remaining energy firms have gotten better at drilling. Now, breakeven points for many shale drillers are lower than current oil prices.
For investors, that could mean its game on for the energy stocks. The time to buy is now.
Oil Prices Below $30 Per Barrel
Fracking is built on technology, and that technological know-how continues to grow in the oil patch. New completion techniques, walking rigs, multi-pad drilling and better seismic research have all helped energy producers realize lower total costs per well. So much lower, in fact, that breakeven points for drilling in many shale basins have absolutely plunged below to today’s $40 to $60 trading range for oil prices.
Ratings agency Moody’s recently concluded that the average North American independent exploration and production firm — meaning strictly upstream operations — can survive and thrive at a price of $42 per barrel of oil equivalent. Moody’s looked at the full-cycle cost of production when conducting its analysis, which includes the cost of producing each barrel of oil equivalent (drilling, completion, etc.), as well as the cost of exploration (essentially finding a new barrel to replace the one produced.)
And while some of you may be saying, “That’s great, but energy stocks have other costs not regulated to drilling and producing,” both administrative costs and debt expenses are included in the full-cycle cost of production. On average, Moody’s calculates that these expenditures cost $4.52 and $5.60 per BoE, respectively. Although, some independent energy stocks — like Occidental Petroleum (OXY) — barely crack $1.
Moody’s calculations look at the total picture of North American energy production. However, certain shale basins are doing even better. For example, in the prolific Bakken formation, costs for many of the largest producers have now fallen to an average of $29.42 per barrel. That’s about half of what many analysts and investment banks thought would be breakeven this time last year.
Many energy stocks are winning the costs war on the physical drilling front. E&P firms paid an average of $13.68 in order to bring one barrel to the surface. New drilling technics and advancements have allowed energy stocks to spend about 30 to 40% less in U.S. shale basins.
Also helping on that front has price war among the oil services stocks. Everyone from giants like Halliburton (HAL) to small-fry’s like Basic Energy Services (BAS) has cut prices for services to hold on to market share. Oil service providers are currently charging 15 to 20% less for drilling rig rentals. Moody’s estimates that more price cuts will be on the horizon in the second half of the year as well.
All of this means that the shale boom might not be bust after all. At $42 or less per barrel, the average energy producer should be OK with crude oil prices where they stand right now. In fact, Bloomberg Intelligence energy analysts predict that even at these prices, energy stocks should still generate 10% profit margins per well.
Time to Buy Energy Stocks
While we most likely won’t see $80 per barrel oil anytime soon — at least not with the dollar being as strong as it is — this trading range of $40 to $60 is still in the sweet spot for many energy stocks.
Based on the new breakeven point, many firms will still be able to profit in this range. And some of the most cost efficient, such as EOG Resources (EOG), will still be able to turn a handsome profit.
The beauty of energy stocks now is that many of them have already taken their lumps. Share prices have tanked, and many energy stocks now sit near 52-week lows. And yet, they are better and more efficient at drilling than this time last year. That means that energy stocks could finally be big buys now, as witnessed with some of the lowest cost E&P firms like EOG or EQT (EQT).
However, a better overall energy stock play may be the SPDR S&P Oil & Gas Exploration & Production ETF (XOP). Unlike some energy ETFs, including the Energy Select Sector SPDR (XLE), XOP is basically a play on the production of crude oil and natural gas. There is some refining exposure in the fund, which is experiencing its own renaissance thanks to low oil prices, but the equal-weight ETF has more than 75% of its portfolio in energy producers.
XOP makes a prime pick to ply the entire E&P industry as breakeven costs continue to fall in North America’s shale. Ultimately, that will drive earnings and multiples for energy stocks in the ETF. Expenses for XOP run a dirt cheap 0.35%, or $35 per $10,000 invested annually.
The Bottom Line: The breakeven cost of production for many energy stocks continues to fall. So much so, that even at today’s low oil prices, many energy stocks are profitable. The time to buy the energy stocks could be now and the XOP ETF is a great way to do that.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.
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