Oil Prices Are on the Rise, and That Could Be Cause for Concern

You likely have noticed a steady run-up in crude prices during 2014. Are there identifiable reasons for the hike? What do they mean for your portfolio?

Feb 23, 2014 at 2:00PM

Could we be seeing the emergence of concerns about our long-term domestic energy viability? With a minimum of fanfare, the price per barrel of light sweet crude has moved up steadily during 2014 from the low $90s to near $102.50, a change of more than 10%.

There are several possible causes for the hike, including unseasonably frigid weather across the U.S. and a sinking dollar (itself hit by a plethora of soft economic indices). Then there are solid credit growth numbers from China and a new pipeline connecting the crude oil hub at Cushing, Okla., with Gulf Coast refineries. Any or all of these factors could -- at least for a while -- be pushing prices to heights that represent the polar opposite of predictions by a host of energy seers.

Is the peak oil notion back?
Or, it just might be that emerging doubts about the longevity of the U.S. oil boom are beginning to be felt. Of course, these trepidations aren't exactly brand new. Indeed, last summer Forbes magazine quoted none other than then-retiring EOG Resources (NYSE:EOG) CEO Mark Papa as maintaining that the boom is "not going to be as massive as people think."

Papa is as good a source as there is. In the decade-and-a-half since it was jettisoned by Enron, EOG has, mostly under his direction, become both a leader in North Dakota's Bakken shale and the discoverer of the now-prolific Eagle Ford in south Texas. The company, which will report its final 2013 results next week, has returned more than 650% to shareholders in the past decade and, through last year's third quarter, had boosted its U.S. crude and condensate production to 228,000 barrels per day.

A sharp acreage price slide
Nevertheless, despite its technological supremacy -- including the development of an upgraded approach to fracking -- even EOG probably won't be able to produce more than 8%-10% of the oil located beneath its Eagle Ford acreage. And while it wasn't more than a couple of years ago that producers were grabbing acreage in that play at almost any price, those days have definitely disappeared.

In fact, nearly a year ago, Hess (NYSE:HES) sold about 43,000 Eagle Ford acres to Sanchez Energy (NYSE:SN) for $265 million. That was a bargain price for Sanchez, which is doing nicely with the properties. But it was also about $800 million less than Hess shelled out for the same assets not long before.

Beyond that, all is not completely well in the Bakken. While the formation's total production continues to expand as more wells come online, the average output per well has been moving in the opposite direction. The latter figure hit a high more than two years ago with a rate of 144 barrels per day. Through the middle of 2013, the average had slid by 12%.

A thirsty way to produce oil and gas
While it affects the Eagle Ford to a far greater degree than the Bakken, there's also rapidly increasing concern about the water used in fracking. I'm not referring to the normal worries about contamination, but to the volume of water needed to blast open shale fissures in order to induce production.

After all, Texas remains in the throes of a decade-long drought. As such, with fracking competing with agriculture for scarce supplies of agua, oil production ultimately could be affected negatively.

The same is true for Colorado and California. And with a single well often requiring millions of gallons of H2O for the completion of a frack, the problem is anything but trivial.

According to a recently completed report on fracking and the water scarcity phenomenon -- which was described to Fools earlier this month -- fully three-fourths of the more than 39,000 wells hydraulically fractured in the U.S. during a 29-month span ending in May 2013 occurred in areas of insufficient water availability.

The same report noted that, of all the companies involved in U.S. fracking, Anadarko Petroleum (NYSE:APC) has drilled the highest proportion of wells (70%) in water-short areas. Anadarko, which is active in the Eagle Ford, the Permian Basin, and the DJ Basin, among a host of other international and domestic plays, reportedly used more than 6 billion gallons of water during nearly two and a half years of the study that led to the report.

The takeaway
There are other factors that could affect the future of fracking, obviously including a coming Environmental Protection Agency report on the practice. My conclusion about all of the issues noted in this article, though, is that, while crude prices may well sink beneath their current levels, a significant and prolonged slide is unlikely. That, to my way of thinking, renders energy stocks an ongoing must for well-balanced portfolios.

OPEC's worst nightmare
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David Smith 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 don't 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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