Crude prices have plunged from 2014 highs of $107 per barrel to a 6.5 year low of $41 per barrel. Not surprisingly the media -- never one to pass on a chance to capitalize on a seductive tale of financial ruin -- is now awash in "energy experts" proclaiming that oil has further to fall.
This kind of oil collapse is nothing new, and history has shown us that times like these are often the perfect opportunity for long-term income investors to seize the opportunity to snatch up super cheap shares of vitally important "pick and shovel" oil stocks.
I'd like to tell you three reasons why I think you should ignore the oil bears and consider adding frac sand suppliers such as U.S. Silica Holdings (NYSE:SLCA), Emerge Energy Services (NYSE:EMES), and Hi-Crush Partners (NYSE:HCLP) to your diversified long-term income portfolio today.
Ignore the "experts"
Whenever crude prices are crashing, it's not hard to find analysts that will spin you a convincing tale of dread for the oil industry. Just take a look at some of these recent predictions about where crude could be headed over the next few months:
- As low as $32.4 per barrel (2008's low): Seth Kleinman, analyst for Citigroup
- $15-$20 per barrel: David Kotok, Cumberland Advisers
- $10-$20 per barrel: A. Gary Shilling, A. Gary Shilling & Co.
Personally, I tend to side with Warren Buffett about "being greedy when others are fearful" because I know that, in the immortal words of the Oracle of Omaha:
The future is never clear; you pay a very high price in the stock market for a cheery consensus. Uncertainty actually is the friend of the buyer of long-term values.
I don't know what oil prices will do over the next week, month, or quarter, but I do know that right now, frac sand producers are trading at fire sale prices.
|Company / MLP||Yield||EV / EBITDA|
|Emerge Energy Services||16.1%||5.9x|
Note that U.S. Silica's much lower yield is due to its being a c-corp while the other two are MLPs, for which yields are generally much higher than regular stocks. However, even for MLPs, the yields on Emerge and Hi-Crush are in the nosebleed section, indicating investors are pricing in imminent distribution cuts.
Now, there's a good reason for that. Emerge Energy, being a variable-pay MLP, has been forced by falling distributable cash flow to slash its payout twice this year, with management warning of another possible cut this quarter.
Hi-Crush also recently cut its distribution, not out of immediate necessity, but in order to err on the side of caution in the face of possible long-term low oil prices.
Even assuming additional payout cuts are in the cards, the extremely low EV/EBITDA ratios -- a great way of valuing capital-intensive companies because they take into account debt and non-cash items -- tells me these frac sand producers are priced as if oil prices will never recover, and frac sand has no future. In fact, the opposite is true; Wall Street is just too short-sighted to see it.
The best cure for low oil prices is... low oil prices
Don't get me wrong, there is a good reason oil prices are low. Record production from Saudi Arabia, Iraq, and the lifting of nuclear sanctions from Iran means the global oil glut is likely to continue into next year.
However, according to the International Energy Agency, 2016 is likely to see a rebalancing of global oil supply and demand, which should firm up crude prices with a recovery possibly starting in 2017. In the meantime, it's feasible that collapsing crude prices may actually help boost long-term frac sand demand.
Focus on minimizing production costs means more intensive sand use
Low oil prices force oil producers to hunt for the best low-cost way to minimize production costs, and increasing sand intensity -- when combined with horizontal drilling and an increased use of frack stages and lateral lengths -- is one of the best ways to do that.
In fact, according to U.S. Silica, oil producers are using as much as 10,000 tons of frac sand per well right now, and CEO Bryan Shinn believes the amount could eventually triple, likely resulting in an explosion of frac sand demand.
Bottom line: Don't try to time the oil market
I'm not saying oil or frac sand shares don't have lower to drop, because they might. However, if that occurs, it may just present an even greater buying opportunity. The fact is, oil prices will eventually recover, and the potential future demand for frac sand is gargantuan. Therefore, I think this is a potentially great opportunity for long-term investors to lock in exceptional market-crushing future returns.