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3 Overlooked Oil and Gas Stories Investors Need to Know

By Matthew DiLallo, Tyler Crowe, and Jason Hall - Sep 19, 2018 at 9:19AM

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A look at three under-the-radar story lines that investors won't want to miss.

Even when we're not writing about stocks, we're probably discussing some investment theme or stock that piques our interest. Here's a sneak peek at some of the conversations that go on behind the scenes with some of our writers here at The Motley Fool.

Our conversations tend to start out by one of us sending a link to an article or press release with a simple message: "Did you guys see this?" It's often on a theme that we think deserves more discussion since it could yield opportunities for those who are paying attention. Here are three under-the-radar story lines that have captured our attention. 

Stars are aligning for long-term tailwinds in American refining

Tyler Crowe2018 has, so far, been a fantastic year for refiners in the U.S. The abundance of crude oil in North America and the limited infrastructure to move it has created a situation where there are substantial price discrepancies in crude types depending on where they are from. A barrel of crude oil at hubs in Midland, Texas -- the heart of the Permian Basin -- sold for $18 less than that same grade of crude in Houston, where most of America's refining capacity is located. Even more extreme is the $28-per-barrel discount for heavy Canadian crude compared with the American benchmark price: West Texas Intermediate.

An oil field at sunset.

Image source: Getty Images.

Refiners have been able to exploit those price differentials, and have benefited from incredibly strong refining margins as a result. Conventional wisdom says that, as pipeline and crude oil export capacity gets built out, those price differentials will start to go away and refining margins would narrow again. After all, that has been the case for decades in this notoriously cyclical industry. However, there are some regulations coming down the pipe that could put American refining at a huge advantage over the rest of the world.

The International Maritime Organization, a regulatory body for global shipping, announced that by 2020, all ships will have to use fuel with a sulfur content of less than 0.5%. Traditionally, large vessels would use a fuel known as bunker fuel with a sulfur content of 3.5% because it was a residual fuel that was incredibly cheap. This rule will drastically change the way a barrel of crude oil is refined because demand for bunker fuel will fall through the floor and demand for distillates like ultra-low sulfur diesel will surge.

Globally, the American refinery industry is better prepared than almost any other because it has the process complexity to maximize the amount of diesel and gasoline produced per barrel of crude and minimize bunker and residual fuel yields. So while others will likely suffer as they invest heavily to upgrade away from bunker fuel production, American refiners will benefit from the high demand for distillates. 

I'm not saying that the cyclical nature of refining is a thing of the past, but American refiners' access to cheap shale oil and high global demand for higher-grade fuel products put them at a huge advantage over other refiners and should lead to very favorable market conditions for a few years.

America's next oil growth engine

Matt DiLalloMost energy investors have probably heard about the Permian Basin, which lies under parts of western Texas and southeast New Mexico. The resource-rich basin has been fueling high-octane growth for producers over the past few years and should continue doing so in those to come. However, because of all the attention on the Permian, most investors are overlooking the emergence of the Powder River Basin (PRB) in Wyoming.

That region's potential was a recurring theme in the second quarter. While shale giant EOG Resources ( EOG 1.84% ) first highlighted the PRB in 2015, it took center stage in the second quarter when the company unveiled that the Mowry and Niobrara formations hold vast oil and gas resources. That discovery led EOG Resources to upgrade its resource estimate for the PRB from 200 million barrels of oil equivalent (BOE) up to a stunning 2.1 billion BOE, which makes it the company's third-largest asset behind the Permian and the Eagle Ford.

Meanwhile, Chesapeake Energy ( CHKA.Q ) noted in its second-quarter earnings release that the PRB was "quickly establishing itself as the growth engine of the company." Chesapeake's production had already rocketed from 18,000 BOE/D at the end of 2017 to 32,000 BOE/D by mid-July. However, Chesapeake sees its output in the region reaching 38,000 BOE/D by year-end and then doubling in 2019 from this year's average daily rate.

Anadarko Petroleum ( APC ) also highlighted the PRB by announcing that it locked up more drillable land in the region during the second quarter, spending another $100 million to boost its position up to 300,000 acres. While Anadarko is still early in its evaluation process, the company noted that newly drilled wells delivered excellent results.

With the Permian Basin expected to slow down in 2019 due to pipeline constraints, investors might want to consider oil stocks with land in the PRB since they appear poised for fast-paced growth in 2019 and beyond.

An oil pump on rocky land.

Image source: Getty Images.

Weak upstream oil and gas spending is helping profits today, but could hurt production tomorrow

Jason Hall: Two years removed from crude oil bottoming out at well under $30 per barrel, the industry has made huge strides toward a full recovery. As a matter of fact, things have gotten so much better, the International Energy Agency says the U.S. shale sector as a whole could very well generate positive cash flows this year for the first time ever.

The industry deserves a lot of credit, practicing tremendous financial discipline coming out of the oil downturn. However, there's another side to this coin. Producers have focused on quick-turn, quick-profit development over the past couple of years, while significantly underspending on other resources.

Investment in bigger, more complex projects, such as deepwater offshore resources that can take years and cost billions, nearly ground to a halt during the downturn. Last year, the industry spent about two-thirds as much to develop new oil and gas supplies as it did in 2014. And that could take a bite out of global oil production sooner rather than later. The Permian is heading toward a major pipeline crunch, and even with new plays like the Powder River Basin coming online, shale may have a very hard time offsetting declines from underinvested oil assets. 

The good news is spending is starting to bounce back in some segments, including offshore. Transocean ( RIG 2.82% ) recently pointed out that offshore investments in the first half of 2018 actually exceeded total 2016 offshore spending, and full-year 2018 spending is expected to be about 50% higher than last year. But unlike shale development, which can lead to new production in weeks, it's going to take years for new offshore spending to bear results. 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

EOG Resources, Inc. Stock Quote
EOG Resources, Inc.
$87.57 (1.84%) $1.58
Chesapeake Energy Corporation Stock Quote
Chesapeake Energy Corporation
Anadarko Petroleum Corporation Stock Quote
Anadarko Petroleum Corporation
Transocean Ltd. Stock Quote
Transocean Ltd.
$2.92 (2.82%) $0.08

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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