Energy investors the world over are still waiting for U.S. oil production to begin falling. With the rig count falling, seemingly by the minute, many believe it's only a matter of time and that prices will react favorably once wells start to dry up.
Unfortunately, for investors long energy, I just don't believe that to be the case.
There's a pretty simple reason behind my estimates that oil prices could remain low well into 2016: storage. Now, don't confuse low prices into 2016 with prices consistently staying this low for the next year or so. I'm of the ilk that believes prices are bound to fluctuate fairly frequently over this time, but a ceiling will remain due to dramatically building reserves of oil throughout the country's storage facilities.
Take Cushing, Oklahoma, for example. You might recognize this name as, along with being a massive oil storage hub, where West Texas Intermediate, or WTI, crude pricing is established.
Prior to the lower half of TransCanada's (TRP 1.49%) Keystone XL pipeline (or the Gulf Coast Pipeline) being completed in January 2014, Cushing was flush with the crude gushing from U.S. shale fields. There simply wasn't enough capacity to get it to the refineries scattered along the Gulf Coast until the 700,000 barrels per day project came online.
The month the pipeline opened for business, Cushing held 41.8 million barrels of oil. Seven months later, oil storage had dropped to a five-and-half year low of just 17.9 million barrels. Now, I'm not claiming 100% causation between the opening of Keystone XL and the deep plunge of Cushing's storage levels, but correlation would be hard to deny.
It certainly makes sense. Wouldn't you want to get your oil to market if you were a producer and petroleum prices were riding high? After all, oil entered 2014 in the $90 per barrel range.
Closed for business
Since the middle of last year, it's no secret that the price of oil plummeted, catching many off guard along the way. So it should come as no surprise that the amount of oil in storage is building again. No one has wanted to release their oil into a market where prices are half of what they were just nine months ago, especially if folks imagine prices rebounding rather quickly.
However, as we all know, prices haven't rebounded quickly.
The return to, and rapid ascension past, record amounts of oil in storage prompts my belief that oil producers better strap in for a longer ride than expected. With more than 450 million barrels of oil now stored across the country, we've blown by any level on record since at least 1982, according to the U.S. Energy Information Administration.
Data doesn't tell the whole story
To make matters worse for pricing, another form of "storage" has been building lately. The phrase du jour for it is the "fracklog." Basically, companies are drilling wells right up to the point of fracking and then holding back. This serves multiple purposes.
For one, fracking, or completion, is often the most expensive stage of developing a well. During these uncertain times, holding back is saving companies money, without having to forfeit leases.
Another reason, and one that could be more detrimental to oil prices, is that it allows those producers to be ready at the helm for when prices reach an economical level. However, if too many companies position themselves this way, the flood of fresh supply could drive prices right back to whence they came.
What's an investor to do?
Personally, I have used this time to take a closer look at the midstream portion of the industry. Many of these pipeline or storage companies' contracts are largely fee-based, take-or-pay agreements. This means they are mostly guaranteed the business producers sign up for whether they utilize the agreed-upon capacity or not. It's quite clear that oil companies are now taking advantage of their billed capacity; but even if things change, well-positioned midstream companies should maintain relatively stable income statements.
This doesn't always excite investors looking for rapid growth in the markets, but these companies' stability allows them to maintain dividends during times like these when many producers are slashing or eliminating them altogether. While I'm not advocating an entire portfolio built around stable dividend payers, if I'm putting money to work over the long term during times like these, I'm certainly leaning toward pipeline and storage operators.
Onward!
