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Oil Investing: 3 Bold Predictions for 2016

By Matthew DiLallo – Jan 16, 2016 at 10:45AM

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The bottom for oil, the end of upstream master limited partnerships, and a megamerger.

It's tough to make predictions where there isn't a lot of visibility in the oil market. Image source: Flickr user Paul Wordingham.  

It seems like everyone these days is talking about the price of oil and how low it can go. Analysts are fighting to guess just how low it will go, with many jumping on the bandwagon that oil will bottom out at $20 a barrel while others think it will go all the way to $10. These low oil prices are leading to other predictions such as how much of the industry will go belly up, with one report suggesting that a third of producers will go bust, while another expects that half of the industry could be vaporized by the low oil price.

Given that predictions are the in thing to do, I've decided to throw my hat in the ring with three of my own. Here's what I think could happen in 2016, though not necessarily what I think will happen.

Bold prediction No. 1: Oil will bottom out at $20.16 per barrel
The price of oil seems to have fallen into a bottomless pit due to three big concerns:

  • Record oil storage levels
  • Resilient shale production
  • The reentrance of Iranian exports

The biggest near-term worry for the oil price is the amount of oil currently in storage, which remains at levels not seen in at least the last 80 years, according to the U.S. Energy Information Administration. With America's oil storage capacity nearly filled, it's pushing the price of oil down in a signal to producers to stop pumping and leave their oil in the ground. Unfortunately, no one is listening with many shale producers continuing to grow production in large part because they've become so much more efficient over the past year. That said, there will come an oil price where producers not only won't be able to grow production, but will be forced to shut in currently producing wells because they are losing money on them.

The breakeven price points vary tremendously by region and producer. For perspective, the average well in the Bakken shale's core recently required a $29 oil price to break even. Because of this, the price of oil might not bottom until it falls well below this point, forcing producers to start shutting in wells. I predict that oil will bottom out at $20.16 a barrel, because it wouldn't be bold if I didn't have a few decimal places.

Bold prediction No. 2: A big bankruptcy wave will hit
Oil could very well be bouncing around the bottom in the early spring, because that's when oil refiners begin their turnaround to switch from making winter blend gasoline to summer blends. That turnaround period typically reduces demand for oil. The problem with this scenario is that the spring would be a terrible time for oil to be at the bottom because it's the next time that banks will be redetermining the credit limits of oil companies, which are based on the value of the their reserves at the current commodity price deck. The concern is that these credit limits could face big cuts, forcing those close to their limit to scramble.

Upstream master limited partnerships like Vanguard Natural Resources (NASDAQ: VNR) are particularly vulnerable because they borrowed heavily on their credit facilities to fund acquisitions in prior years. As of its last report, Vanguard Natural Resources' borrowing base was $1.8 billion. However, it had $1.69 billion borrowed on that facility, leaving it with just over $100 million of breathing room. Since then, the oil price is down almost 30%, leaving a real possibility that its credit facility could be cut below its borrowing base.

While I'm not so brave as to predict that Vanguard Natural Resources will succumb to bankruptcy this spring because its overall leverage is lower than that of many other producers, this spring could very well see dozens of oil companies filing for chapter 11. 

Image source: Anadarko Petroleum.  

Bold prediction No. 3: Chesapeake Energy will be rescued
The continued weakness in oil and gas prices has had a very deep impact on Chesapeake Energy (CHKA.Q), with its stock plunging amid worries about its debt. Analysts are currently split on whether the company goes bankrupt or survives. My prediction is that it will be rescued and that Anadarko Petroleum (APC) will be its savior.

There are three reasons why I think these two make a good match, other than the fact that Chesapeake Energy CEO Doug Lawler is a former Anadarko executive:

  • Anadarko Petroleum has already made an offer for another North American-focused driller, but has been turned down. So, it is known to be on the hunt for acquisitions.
  • Anadarko Petroleum and Chesapeake Energy are currently the No. 2 and No. 4 natural gas producers in the U.S., and if they combined, they'd be the largest producer by a wide margin.
  • The bulk of Anadarko's growth is coming from long-cycle projects such as offshore assets and LNG. Chesapeake would give the company an enormous short-cycle resource base to tap when conditions improve.

It's a long shot, to say the least, but plausible enough to be possible.

Matt DiLallo has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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