1 Real Threat That Could Kill America's Oil Boom

The one thing you see in the energy section of any news publication is the price of oil. Most of the time, it will give some doom-and-gloom reason that has little to do with the price of oil, or it will be some analysts making claims that oil will be double what it is today, or that it will drop 20%-30%. The most fascinating part of these prognostications is that they rarely give any real reason. A great example is a quote from Peter Flynn in an interview with Bloomberg, where he gives his reason that oil prices are going to drop:

We've crossed the Rubicon when we crossed that $100-a-barrel threshold; now the fundamentals are heavy, and people are starting to try to protect their oil position on the downside.

It sounds as if he's saying is oil prices are going to drop because people are afraid they'll drop, and that the sacred number of $100 is the tell-all sign. So the reason oil prices will drop has no correlation with what's going on in at the oil fields or at the gas pump -- just "heavy fundamentals." Does anyone understand what "heavy" fundamentals even means?

There's a reason oil prices in the U.S. could drop and bring the nation's oil boom to a screeching halt, and it's easier to understand than "heavy fundamentals." Let's look at what this very real threat and what we can do to prevent it. 

The cork in the bottle
The U.S. oil boom has resulted in a massive uptick in light, sweet crude production. This has been a dream for refiners, because these types of oil typically command the highest prices and cheaper, domestic sources have taken a large chunk off their feedstock bills. But U.S. refiners need more than light, sweet oil, and the nation is coming very close to its total refining capacity for this type of oil.

Source: U.S. Energy Information Administration.

And here's where the problem lies.

Since the oil embargo of the 1970s, the U.S. has banned the export of domestic crude. Up until now, no one probably noticed, but within the next 12 months, light, sweet crude production could outpace refinery capacity. If this were to happen and the U.S. were to maintain its export ban, then we could see a severe drop in oil prices as producers fight to get their crude in the door at U.S. refiners. 

The first victims
Each shale play in the U.S. is unique, and all of them have different economics, so let's do a comparison of three major shale and tight oil drillers in the U.S. -- EOG Resources (NYSE: EOG  ) , Pioneer Natural Resources (NYSE: PXD  ) , and Continental Resources (NYSE: CLR  ) . Each of these three companies more or less represents one of the nation's three major shale oil formations. EOG is the top driller in the Eagle Ford, and Continental in the Bakken. Pioneer's largest production comes from the Permian Basin. 

Company Realized Prices for Oil (Q2 2013) Cash Margin Per Barrel of Oil Produced (Q2 2013)
EOG Resources $103.73 $40.25
Continental Resources $88.50 $52.51
Pioneer Natural Resourcces $90.82 $37.50

Source: Company presentations and 10-Qs.

Even though the price for oil is about $100 in the U.S., that doesn't mean companies are all able to realize that price. The issue with the Bakken is that its location makes transportation costs greater, and therefore the price realized at the well is less than, say, EOG's resources in the Eagle Ford, which is the next-door neighbor to the heart of America's oil refining capacity. At the same time, though, the well economics in the Bakken make for very attractive cash margins, and it's not unique for Continental. Kodiak Oil & Gas (NYSE: KOG  ) has cash margins on its production -- which all comes from the Bakken -- of greater than $61 per barrel produced. 

In the event that we were to reach the light, sweet crude refining capacity and no crude exports were allowed, it's very likely that all oil prices would fall, and it's also very possible that places such as the Permian and the Eagle Ford could see the biggest difference in price. Both of these regions primarily supply Gulf Coast refiners, while the Bakken has the ability to move more than 1 million barrels per day via rail, which could serve the East Coast and West Coast refiners more easily. 

Using the prices realized on crude, the amount of money that can be made per barrel of crude, and the current flows of oil, it's possible that some of the disadvantaged regions in the Permian and Eagle Ford could be some of the first regions to see major downturns in production and profitability if oil prices were to decline. 

What a Fool believes
When looking at investing in U.S. oil and gas for the long term, rarely should you take the prophecies of oil-price oracles into consideration. There are, however, some real market drivers that could affect price, and it's those that you should keep an eye on. The ability for the U.S. to export light, sweet crude is one of those drivers. If we were to be able to start exporting oil as the market commands, then a severe drop in domestic oil prices is not as likely. If we were to maintain the course we're on, though, we could see some companies, including EOG and Pioneer, suffer because of it.

Who will join EOG in dominating the American energy boom?
EOG is carving out a position as a top American energy company, but it isn't alone. The transformation of the American energy space is creating investment opportunities everywhere, but picking the right ones will mean the difference between a flash in the pan and a long-term jewel. For this reason, we've put together a comprehensive look at three energy companies set to soar during this transformation in the energy industry. Find out which two companies have joined EOG on our list of companies that are spreading their wings by checking out our special report, "3 Stocks for the American Energy Bonanza." Simply click here and we'll give you free access to this valuable investing resource. 


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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 27, 2013, at 10:24 AM, Jeffkory wrote:

    Our government would rather give our tax dollars to foreign countries and continue to have REFINERY problems here- Why don't these MORONS use our money to better our country and build more refineries HERE. But not in the gulf with all the other refineries that have to shut down when threatened by a hurricane.

  • Report this Comment On October 27, 2013, at 1:10 PM, exfedagent wrote:

    Not a bad article but it overly generalizes an important point to the point of error. The U.S. Government has NOT banned the export of domestic crude. Crude oil is classified as Export Control Classification Number (ECCN) 1C981 and is controlled on the Commerce Control List (CCL) for reasons of Short Supply. Licenses from the U.S. Commerce Department's Bureau of Industry and Security are available to permit the export of crude petroleum. Granted, it takes time to apply for and receive a (free-no fee) BIS license, but licenses to free world destinations are usually granted. This information should have been considered by the author before writing the article. BTW, I worked for BIS for 20 years and was involved in investigating the unauthorized export of crude petroleum during that time.

  • Report this Comment On October 27, 2013, at 3:18 PM, glenns45 wrote:

    Obama, Al Gore that is the real threat to any prosperity.

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