OPEC held a scheduled meeting last week and, for the first time in a while, actually came to an agreement. Details are sparse, but a production cut seems imminent.
In this week's episode of Industry Focus: Energy, host Sean O'Reilly and analyst Taylor Muckerman explain how much oil OPEC is planning to cut compared to the daily global production total, what we might expect to see in the next few months, how Goldman Sachs (GS 2.67%) is looking at the price of oil in the next few years, and more.
Also, the duo examines why, according to EIA data, Americans used a record-breaking amount of gas this August, and why Enbridge (ENB 0.16%) is on their radar this week.
A full transcript follows the video.
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This podcast was recorded on Sept. 29, 2016.
Sean O'Reilly: Welcome to Industry Focus, the podcast the dives into a different sector of the stock market every day. Today is Thursday, Sept. 29, 2016, so we're talking about energy, materials, and industrials. I'm joined in studio by The Motley Fool's very own Taylor Muckerman, who I am extremely anxious to talk with about yesterday's big news. Stop the presses: OPEC agreed to, on a preliminary basis, cut production. What?!
Taylor Muckerman: Yeah, that's what they said. There's no details.
O'Reilly: There were a few, to be fair.
Muckerman: Well, there are estimates.
O'Reilly: Let's take a step back. OPEC surprised everybody yesterday, sent oil up 5% to 6%. They had been talking down these discussions in Algiers for one or two weeks. "We want to cut, but this is just preliminary, we don't expect to decide anything." Russia and Iran talked it down, Saudi talked it up. It's a little verbal chess game. Then, yesterday [it] hits the wires that they agreed to a preliminary cut. Details are going to be announced in a month.
Muckerman: Nov. 30.
O'Reilly: The symmetry there is pretty funny. That date, two years ago ...
Muckerman: That's their bi-annual meeting, it happens in November. That year, it was Nov. 24.
O'Reilly: So, right before Thanksgiving, they were like, "Yeah, we're not going to do anything," and oil plummeted. And here we sit two years later.
Muckerman: People were cooking their turkeys by the oil drum fires in 2014.
O'Reilly: Because it was so cheap. (laughs) But, correct me if I'm wrong, they're talking about, in a month, agreeing to actually setting firmly about a 750,000-per-day barrel decrease in supply.
Muckerman: That's what an Iranian representative suggested. But if you look across the board, there's a lot of people that aren't quite sure it'll even reach 0.5 million barrels per day. But even if it was 700,000 barrels a day --
O'Reilly: Or five.
Muckerman: Either way, that's only 0.7% of global oil production. It's not a huge earth-shattering thing. What is the big deal is that OPEC countries have returned to the table and reached a conclusion, rather than just walking away with their hands up in the air.
O'Reilly: Right, Saudi Arabia and Iran are actually talking. One of them closed the other's embassy in their country a year ago. They were mean for a while.
Muckerman: These countries traditionally don't get along. This isn't totally resigned to just oil markets, when you look at how these countries are playing chess against each other.
O'Reilly: The Persian Empire invented chess.
Muckerman: Yeah. There's a little bit of historical nature to that suggestion, as well. When you look at what they've been doing, Saudi Arabia is much more reliant, for budgetary reasons, on high oil prices, high oil revenues. Iran is just having a field day because they had all these sanctions against them --
O'Reilly: This is all free money.
Muckerman: Essentially. It's money they didn't have. So, they became less reliant on oil revenues over that time period, and now they can sit on more prices, higher production, for a little bit longer than Saudi Arabia can. You look at Saudi Arabia cutting ministers' salaries by up to 20%, cutting subsidies across the board to their civilians --
O'Reilly: They can no longer buy their solid gold Lamborghinis. I feel terrible for them.
Muckerman: I mean, you kind of have to at some point, because oil does represent a significant part of their overall budget --
O'Reilly: Their social programs, if you look at the oil ministries, it's everybody.
Muckerman: Yeah, everybody benefits when they sell oil at high prices. If you look at 0.7% of oil cutbacks, not a huge deal, especially when you look at the landscape in the United States with so many wells that have been drilled but not completed. You look at a research company like Rystad Energy suggests that 90% of wells that are drilled but not completed can be economically completed at $50 a barrel, which we're almost at. So, I think supply is going to be able to make up for lost ground, in terms of what OPEC is supposedly going to pull back on.
O'Reilly: On the other hand, I think it's minuscule compared to global daily production size.
Muckerman: Yeah. I think it's just the significance of them coming to an accord, rather than walking away from the table.
O'Reilly: In addition to that, just to play devil's advocate a little bit, when the fateful day occurred two years ago, OPEC said they weren't doing anything and they were going to go for market share, they weren't going to cut to guarantee a price, what was the global oversupply number per day?
Muckerman: More than it is today.
O'Reilly: That's my point. It was 1.5 million barrels a day oversupply? So, the 500,000 or 750,000 barrels per day that OPEC is talking about cutting -- granted, at this point -- in addition to the gargantuan capital budget cuts that have occurred in the industry, I'm like, is the oversupply done?
Muckerman: Long-term, you could start to worry about that. But in the near term, like I said, you have almost 4,000, maybe over 4,000 wells in the United States that can be fracked at $50 a barrel. That could drive up U.S. production, which has been pulling back since November of 2014, from record highs. So, you're seeing the ability of companies like EOG and Continental Resources who have already started to complete some of these wells in the $40 range, and then a company like Whiting Petroleum that was shopping itself for what looked to be pretty cheap.
O'Reilly: But there were no takers.
Muckerman: There were no takers. And here they are saying, "Once $50 a barrel comes around, we're going to start completing some these wells." By that, I mean that the wells have been drilled, but they haven't been cemented, encased, they haven't been fracked. So they're not producing. But it's traditionally the more expensive part of the whole process. So companies have been drilling these sites and letting them idle until they reach a certain dollar value per barrel. It seems to be $50 per barrel is that magic number for the broad majority of these wells. It has to be such a big deal that the EIA has actually started to come out with a monthly report of how many wells are drilled but uncompleted. You have seen it come down a little bit since January because the price of oil has risen since January. If you look at January of 2014, there were around 2,500 wells that were drilled but not completed. You're looking at a little over 4,000 right now.
O'Reilly: Wow. It's a lot of fun to go to an investor presentation for an EOG and look at what they're broadcasting two years ago versus today, in terms of numbers. It's hilarious how it's come down massively.
Muckerman: A dramatic change of pace.
O'Reilly: Speaking of the EIA, they just came out with United States gasoline consumption, which they do on a monthly basis. Interested to get your thoughts on this.
Muckerman: I'm thinking August made news?
O'Reilly: A little bit, yeah. The United States consumed 9.7 million barrels of gasoline per day in August. That is a new record. It's a little bit more than the peak right before the Great Recession.
Muckerman: In 2007, right?
O'Reilly: Yeah. It's interesting to me because, correct me if I'm wrong, cars are way more efficient right now in miles per gallon.
Muckerman: Yeah, they're more. They're getting to be way more, but they're not quite there yet. There's still a few more years before all the CAFE standards fully kick in. But, there are year-over-year requirements. What you're seeing is, as short-sighted as Americans are, they're going out and buying record numbers of SUVs and trucks again because gasoline is cheaper than it's been since 2009. The cheapest Labor Day gas prices in the last 12 years. SUV and truck sales have been outpacing car sales for quite a while now. You're looking at, if not record, near-record sales for SUVs and trucks, still. It just continues to rise. Those standards, because of increasing fuel efficiency standards, applied to the car based on what is called a footprint. So you're looking at larger cars not having to meet as strict demand as quickly. So, these cars haven't really experienced the dramatic fuel efficiency gains as you've seen in smaller sedans like a Toyota Camry or Corolla or those hybrid vehicles that have come out that get 50 to 60 miles to the gallon.
O'Reilly: Right. So, we've thrown a lot of data points at our audience so far. You have OPEC who is notoriously untrustworthy. You have the supply and-demand statistics that are iffy on a global basis, but it is what it is.
Muckerman: Some people suggest the 2017 could be equilibrium for supply and demand.
O'Reilly: And then, the EIA, U.S., lots of gasoline. Everybody's favorite investment bank, Goldman Sachs, always broadcasting their views, came out with an oil call.
Muckerman: This was before the OPEC meeting.
O'Reilly: Yeah, granted, it was before the OPEC meeting.
Muckerman: They did address it, though. They addressed, "Hey, these are our thoughts if OPEC does X/Y/Z."
O'Reilly: How are they analyzing all this?
Muckerman: They're looking at U.S. production, they're looking at the fracklog -- which is drilled but uncompleted wells.
O'Reilly: Which is what you were talking about earlier.
Muckerman: They're looking at Libya and Nigeria bring back production. They're looking at major projects around the world that are coming online in Kazakhstan, Australia, things like that. And they're also looking at Russia and Saudi Arabia producing at record levels. They basically adjusted their prices downward for the end of 2016, they left their 2017 expectations at $52 per barrel.
O'Reilly: Which we're almost at.
Muckerman: Yeah, we're only a few dollars shy of that right now.
O'Reilly: Are they being too conservative? The supply and-demand balance next year.
Muckerman: I don't think it's all that conservative when you look at the overhang of wells that are not only drilled and uncompleted, but wells that could be drilled and completed next year in the United States at $50 to $60 per barrel.
O'Reilly: When you say that, are you talking about the Permian rush?
Muckerman: The Permian, Eagle Ford, all these basins can still be produced in -- well, not all of them, but a significant portion of these heavy-producing basins, the Eagle Ford, the Bakken, and the Permian, which is the darling of the day right now, can be produced in that $50 to $60 range. So, there's definitely some downward pressure as you see upward movement in prices. I don't think that overhang is gone. We still have that accessible oil that can weigh on prices whether it's being produced or not, because there's always a threat of production. So they've lowered their global oil price forecast for the end of this year from $50 per barrel to $43 per barrel. They did say that any OPEC decision could add some near-term upward momentum. And we saw that 5% to 6% jump yesterday. But, "near-term" is the key term there. I do think in the next couple years there's going to be downward pressure. I don't think, unless it's just a temporary spike, $70 is way out of the picture in my mind for the next year or two.
O'Reilly: Again playing devil's advocate, Goldman in the end of 2014 was in the "$90 forever" camp.
Muckerman: The unpredictability of OPEC, right? If something happens, that unpredicted spike that we talked about could happen. But if OPEC only lowers production by 500,000 to 750,000 barrels, you don't see any civil arrest in countries like Iran, Nigeria, Libya --
O'Reilly: There's always a nice little possibility.
Muckerman: There is. I think, now, that would have an impact on prices.
O'Reilly: Because things are a little bit tighter.
Muckerman: When you look back to 2014 or 2013, there was a lot of unrest. In 2012, you had all of Arab Spring going on --
O'Reilly: That's why I always thought the drop was all the more surprising.
Muckerman: You didn't see any upward movement when countries like that were shutting in production due to some volatility among the countries there. That should have been a warning sign for a lot of people, when countries that are heavy oil producers, that impact the global supply, are shutting in supply, and prices aren't spiking.
O'Reilly: Yeah, I remember when Libya first started blowing up -- there are human beings there, so I don't want to begrudge what happened there. But, oil would go up, oil was going up, this was, what, 2011? Anyway. Before we close out here, we covered a lot of awesome info, I got your insights on whether OPEC can be trusted or not. The answer is no. (laughs)
Muckerman: Well, until they actually detail specifics --
O'Reilly: They're hurting, though.
Muckerman: They will cut. But you have to understand that now, the discussion is coming down to which countries cut, how much does each country cut, for how long are they placing this cap on production. And also, we're at record production for a lot of these countries.
O'Reilly: Yeah, absolute peak. Russia is that, what, post-Soviet highs?
Muckerman: Yeah. And they weren't really included in that cut, so they're just going to be sitting in high clover --
O'Reilly: Darn you, Putin! Darn you! You played them for fools! The bad kind.
Muckerman: That's what we're looking at now, is specifics in two months from now.
O'Reilly: Before we close out, I'm anxious to get your thoughts on a stock to watch, maybe a good stock for everybody here to look into, given all the information that we've covered.
Muckerman: I think one aspect of oil and gas that could benefit from an increase in U.S. or North American production, based on the supply cuts and rising oil prices, would be a midstream company. I'm a Spectra Energy shareholder, so I've been uber interested in the past few days, because the news cycle has died down on Enbridge.
O'Reilly: It's a stock-for-stock deal.
Muckerman: Yeah. I really want to dive in. My blink reaction is, "Yes, I'll be happy to own Enbridge." It's becoming much more a balance between an oil and natural gas with this acquisition. The footprint is just massive. So, I just want to really dive in. I think shareholders of either company right now are going to be well rewarded for the long term. And I think people could probably buy into Enbridge right now, but I just haven't given it the time necessary. But I love the fact that they predicted a 10% to 12% dividend hike each year for the next eight years. I've never seen an eight-year prediction.
O'Reilly: That's surprising.
Muckerman: It's the longest I've ever seen. So, I'm not necessarily trusting it completely, because eight years is a long time in the oil and gas sector.
O'Reilly: Plans make fools of us all.
Muckerman: Yes. But, just the fact that management is confident enough to come out and say that in the face of a lot of upstream companies cutting dividends, Kinder Morgan cutting the dividend, I appreciate the safety that you see on both of these balance sheets. I think it's going to be a happy marriage.
O'Reilly: Bottom line, we don't know what will happen with prices, per se. But it looks like the supply flow, which is good for people that move oil and natural gas, is going to be good now.
Muckerman: Especially in North America. You've seen production cutbacks because of low oil prices, and then you see all these companies now talking about efficiency gains and being able to produce more at $50 to $60 a barrel. So, if prices to continue to rise slowly, you're going to see North American production come back.
O'Reilly: Awesome. Thanks for your thoughts, Mr. Muckerman.
Muckerman: Yeah, thank you.
O'Reilly: Have a good one. That is it for us, folks. We'd like to give a special shout-out to the one and only Austin Morgan who is back there working his studio magic. If you're a loyal listener and have questions or comments, we would love to hear from you -- just email us at [email protected]. Once again, that is [email protected]. As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against those stocks, so don't buy or sell anything based solely on what you hear on this program. For Taylor Muckerman, I am Sean O'Reilly. Thanks for listening and Fool on!