Are Oil Prices About to Skyrocket?

Source: Seadrill Ltd. 

There are a handful of companies every investor should follow whether or not they own its stock. This is because they just seem to have their fingers on the pulse of their industry, the global economy, or even the future direction of oil prices. By checking out what these leaders have to say each quarter, investors can stay one step ahead.

Seadrill Ltd  (NYSE: SDRL  )  is one of these companies. As a leading deepwater driller, it has keen insight into the oil and gas market, which is a key driver of the global economy. What it has to say about what it's seeing can really help investors position their portfolios to capture future profit opportunities. What's particularly interesting is what Seadrill has to say about the future of oil prices. 

This past quarter Seadrill provided investors, and anyone who would listen, with its outlook on the oil marketplace. In its earnings release, the company noted: 

Oil market fundamentals continue to be strong with high and stable oil prices. Except for very brief periods, oil prices have remained above US$100 for the last 3.5 years, and the global economy continues along its growth path following the financial crisis.

Given that oil markets are strong, one would think oil companies are making a lot of money with oil prices above $100 per barrel. That, however, couldn't be farther from the truth. Seadrill went on to note:

Even with these strong macro fundamentals, oil companies seem to be unable to generate free cash flow to grow their businesses and have entered into a period of selectivity on projects as costs escalated across their entire portfolio of projects.

This has been well documented as big oil is simply drowning in high-cost projects. Large LNG projects like Chevron Corporation's  (NYSE: CVX  )  Gorgon in Australia have run so far over budget that it has producers holding off on new projects. Gorgon was expected to cost Chevron and its partners $37 billion; however, it's now expected to cost well over $54 billion. In fact, it's these high development costs that are leading the mighty Chevron Corporation to seek help in funding its developments in Canada, while others like Apache Corporation  (NYSE: APA  )  are abandoning LNG projects and even deepwater projects in the Gulf of Mexico for safer, less expensive shale development.

This pullback in spending, however, isn't something that's new to the industry. In fact, according to Seadrill, we saw the same thing just a few years ago, and what happened next as a result of the pullback in spending was a spike in oil prices:
  

Photo credit: Apache Corporation. 

The current situation has some similarities to the situation in 2002-2003, when oil companies had limited free cash flow to develop new reserves. This led to an increase in oil prices between 2003-2008, when Brent moved from approximately US$40 to US$100 and resulted in increased investment by the oil companies. Today, the majority of low-cost inventory has been produced, and oil companies are entering a new phase in which recently discovered oil must be developed in order to grow production. These reserves are in the deep and ultra-deepwater and are far more complex than reserves discovered in prior periods. We can thereby assume that the amount of rig capacity which is needed to produce a barrel of offshore oil in the future will increase.

The question that only time will answer is if it's different this time, which always could be the case. Remember, in 2008, America didn't yet fully realize that oil could be economically produced from shale. Now the world's largest consumer of oil is slated to become its biggest producer.

However, that's not the only thing different this time, as Asia's hunger for energy appears to be insatiable. Further, as long as America's oil remains land-locked because of the export ban, its supply might not have as big an impact on world oil prices as it could otherwise.

If nothing else, Seadrill's thoughts on oil prices potentially moving a lot higher are worth noting. Most of the world's cheap oil is gone, yet oil producers won't produce expensive oil unless money can be made doing it. At some point, either oil prices will head higher, or costs will have to dramatically come down. Given the direction costs have gone for complex oil supplies like those in the deepwater, I wouldn't be shocked if oil prices did move significantly higher in the future.

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Read/Post Comments (15) | Recommend This Article (7)

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 September 03, 2014, at 2:45 PM, rickscomments wrote:

    Oh come on, give us a break! Oil companies have been showing record profits for several years now. They overproject so they can say they aren't making money. It's like GM saying that they lost money because they didn't make their projections. A profit of 30 billion is still profit, just because it wasn't 33 billion doesn't mean they lost 3 billion.

  • Report this Comment On September 03, 2014, at 3:32 PM, BrettJameson wrote:

    @Robert

    Exactly right. These people are nothing but terrorists ruining this country. The sooner someone drops the boom on them, the better.

  • Report this Comment On September 03, 2014, at 7:06 PM, TMFmd19 wrote:

    @rickscomments - profits and free cash flow are very different. Because oil and gas wells deplete energy companies need to reinvest a lot of their profits to drill new wells. These are capital expenses and are funded with free cash flow, debt, asset sales, etc. So, oil companies can be profitable, but still not generate cash flow as its all going to new wells.

    Matt

  • Report this Comment On September 03, 2014, at 7:25 PM, badbernanke wrote:

    The article refers to the cost of capital projects. Major projects can cost cost billions of dollars beyond what cash flow comes from profits and the money has to be invested years before the finally completed project starts adding cash flow. This issue affects not just the major oil companies, but smaller exploration and production companies as well.

  • Report this Comment On September 03, 2014, at 9:42 PM, Mark1946 wrote:

    Nothing but a bunch of ambiguous B.S....Oil Companies...Just like their buddy Wall Street corporate elite speculators...DON'T lose money, any so-called loses are far overshadowed by their tremendous profit margins.

  • Report this Comment On September 04, 2014, at 1:00 AM, exmilitary wrote:

    They probably are because they have to keep our gas prices above three dollars.After all the speculators and others on wall street don't want to make less money.I believe the truth of the matter is that if we were producing enough oil to support ourselves they'd still keep the prices high.I also believe oil will always be high no matter how much less we depend on foreign oil or even our own.No matter how much wind or solar power,or even electric cars we switch over to the oil companies will always need more profits so nothing will change,not even with added use of natural gas.

  • Report this Comment On September 04, 2014, at 1:22 AM, RenegadeIAm wrote:

    "Terrorists?" "B.S. Elite Speculators?"

    Why do so many INVESTORS here on MF HATE oil companies?

    You can always divest of them and/or boycott them if you truly view them as evil.

  • Report this Comment On September 04, 2014, at 2:23 PM, watson14 wrote:

    Their oil reserves get depleted - don't they get an "oil depletion allowance" to shelter their profits?

  • Report this Comment On September 05, 2014, at 10:27 AM, RLStanton wrote:

    Wow! My first time to read an article over here and the comments. Shocking how few of the comments have any bearing on the article.

    I find it interesting that so many left leaning folks still have such deep distrust of the companies that power our past, present and future. Just easier to call them liars then to analytically understand complex macro trends.

    The oil market is one of the most complicated commodity markets that exists and I think it is comical that people still blame big oil for higher gasoline prices.

    How many every day folks understand the complexity of the process to get the oil out of the ground, refine it, and get it to your car? Why would folks just assume this is an easy process.

    Let the demagoguery continue, but understand the cost of getting oil out of the ground is not going lower - it is going higher.

    The horizontal drilling you hear about is expensive, fracking is expensive, getting proppant to the well is expensive, transportation from the well to the refinery is not free.

    While new deposits of oil are continually found, they are not bigger than those of yesterday - they are smaller.

    So while oil markets will continue to be volatile - demand appears to be relatively healthy which basically in my mind means oil prices should continue to escalate (not in a straight line).

    North America right now is in an advantaged position because of unconventional / shale oil, but we are currently not allowed to export crude oil. We are however allowed to export crude products - gasoline, diesel, etc which should mean that incremental rents should continue to be captured by the refiners (MPC, PSX, VLO, etc..)

    So basically, I thought this was an investing site not a left wing big oil is bad site.

    Lots of ways to make money in energy right now and you who want to make money can find ways so to do.

    For the rest of you, build windmills and solar panels,

  • Report this Comment On September 05, 2014, at 2:23 PM, drborst wrote:

    @RLStanton, Thanks for the investing insight based on the article. BTW, A lot of comments on this and every web site are just plain stupid. I don't think it makes sense anywhere to complain about comments (left or right). (and I hope that isn't a complaint about yours)...

    O.K. Matt, Oil prices will likely rise. As RLS pointed out, this is an investing site. Does this mean we should be looking at Seadrill, or the refiners RLS mentioned..

  • Report this Comment On September 05, 2014, at 3:07 PM, Randy47tx wrote:

    Relax RL

    These are people that don't like Union members making good money. They also don't like big Government since they make more per barrel of oil than the Oil Co.

    Let us not forget all the Hundreds of small businesses that supply Technology, Knowledge, and Parts..... down to the lowly Photographer like me...

    People that have never done it are much smarter than the people that do it... Just ask them

  • Report this Comment On September 06, 2014, at 8:53 AM, TMFmd19 wrote:

    @RLStanton & @drborst @ RenegadeIAm - This article went viral so some of the comments are from those that typically don't read these type of articles. So, thousands of readers with a small handful that had to say something because...well...why not. Anyway, the investing takeaway is that if you agree with what Seadrill sees then that would be good for its stock as well as the stocks of those companies that profit from higher oil prices (oil cos, refiners, service cos, etc). - Matt

  • Report this Comment On September 06, 2014, at 9:00 AM, Mathman6577 wrote:

    As long as the shale boom continues and there are no "black swan" events (which can't be predicted) prices will not go up significantly. No one has been able to predict the direction of prices w/ any degree of accuracy. All the analysis in here, while good, will not improve accuracy.

  • Report this Comment On September 06, 2014, at 9:03 AM, Mathman6577 wrote:

    @RenegadeIAm: many investors (and many of the MF writers) hate oil companies because they have been brainwashed by the left-wing elitists who are pushing a "green" agenda and are generally anti-business anyway. Try heating your house w/ solar or wind for the same price that you paying now.

  • Report this Comment On September 08, 2014, at 7:34 PM, Heidikitty wrote:

    I have been trying to get Apples new smart gizmo as I am with Stock advisor and Rule Breakers and all I get is Motley Fool One which I know will be good but I do not have the money you need to invest and I still get Motley Fool One every time I click on to get info on anything

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