Will Soaring Domestic Production Crush Oil Prices?

As the oil boom in the U.S. heats up, major independent exploration and production companies may soon worry about oil prices.

Jan 26, 2014 at 1:18PM

Oil prices face a number of headwinds as 2014 begins. One is the Federal Reserve tapering its stimulus programs, which has resulted in higher interest rates and a stronger U.S. dollar. Perhaps no bigger threat looms over oil prices than soaring oil production in the United States. The U.S. is on the brink of a true energy renaissance, thanks to huge amounts of resources that are suddenly viable as a result of rapid technological advancements.

The combination of higher interest rates and a domestic supply glut would likely be bearish for oil prices. That's why investors should consider the possibility of a downside to the oil and gas boom in the United States.

The other side of the coin
There's a great deal of evidence that suggests the modern-day oil revolution in the United States is for real. The Bakken and Eagle Ford plays are each nearing one million barrels per day in production. In all, the International Energy Agency concludes that the United States is expected to become the world's top oil-producing nation as early as 2016, surpassing Russia and Saudi Arabia. There's no doubt that consumers stand to win from soaring domestic oil production.

From the perspective of oil producers, however, there's a mixed effect. On the surface, rising domestic oil production should naturally result in higher profits for companies like EOG Resources (NYSE:EOG), one of the biggest oil producers in the country. However, there's a flip side to the argument: that a new-found flood of supply would only serve to lower oil prices, and as a result crimp margins. After all, while growth in demand in the emerging markets is impressive, the mature U.S. economy isn't seeing demand increase nearly at the same rate as oil production.

EOG has a huge presence in three of the top-producing domestic regions in the United States, including the Bakken, Eagle Ford, and Delaware Basins. EOG is ramping up production of oil and gas, but in particular, its crude oil dominance is simply stunning. Its crude oil production grew by 38% compounded annually over the past six years. This is only expected to continue, as EOG prides itself on its high-margin oil production profile. Of course, those margins won't be so favorable if prices go south.

Ditto for Apache Corp. (NYSE:APA), which is the No. 1 onshore driller in the United States thanks to its 80 rigs. It operates the most rigs in the Permian Basin and the second most rigs in the Anadarko region. In addition, at the beginning of last year, Apache held nearly 3 billion barrels of oil equivalent in proved reserves.

Oil prices may feel the effects of Fed tapering
West Texas Intermediate crude oil in the United States crept toward $100 per barrel toward the end of 2013. This trend is beginning to reverse as 2014 gets under way. Should oil prices continue lower, major independent producers could be in trouble.

The value of proved reserves would of course fall if oil prices decline substantially. Consider how much value Kodiak Oil & Gas (NYSE:KOG) has stored in its reserves. As of the beginning of 2013, Kodiak's proved reserves totaled 95 million barrels of oil equivalent for a pre-tax value of nearly $2 billion. The company's entire enterprise value stands at $5 billion.

What's more, Kodiak generated an average price received of $98.19 per barrel in the last quarter, and if that represents a high point over the next, its results will surely suffer.

The Foolish takeaway
Soaring oil production in the United States seems like a great thing for the biggest oil producers. However, if oil prices don't cooperate, margins will suffer. That means a mixed bag for the major independent producers in the United States, including EOG Resources, Apache, and Kodiak, and it's something for investors to keep in mind as 2014 gets under way.

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Bob Ciura has no position in any stocks mentioned. The Motley Fool owns shares of EOG Resources. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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