Shale Offers Safety if Oil Prices Weaken
With apologies to Warren Buffett, when the tide of oil washes in, investors will discover who can and can't swim.
The U.S. exploration-and-production sector faces a tricky 2014, largely due to its own success. Rising domestic and Canadian output is leading to a glut in North American oil. When some refineries shut down for maintenance this fall, reducing capacity to process oil, West Texas Intermediate crude prices slumped by 16%–and stalled out this year's rally in E&P stocks by mid-October.
The glut looks set to grow in 2014. Goldman Sachs GS +1.00% forecasts U.S. and Canadian oil supply to grow by 1.45 million barrels per day next year. That alone beats projected global demand growth of just 1.35 million barrels per day. In that scenario, the most efficient E&P firms look best placed to ride out lower oil prices.
U.S. shale resources differ widely. PFC Energy, a division of IHS, estimates breakeven prices range from $40 to beyond $100 per barrel. Clearly, some firms face the risk of profits being squeezed or having to shut in production if WTI weakens next year, which would undermine growth targets.
The best assets usually lie at the core of prolific shale areas such as the Eagle Ford and Permian Basin in Texas. James Sullivan at Alembic Global Advisors pegs the breakeven price for the Eagle Ford core at around $55 a barrel. Areas closer to the Gulf Coast also enjoy better transportation options to refineries. Investors in firms operating in the Bakken region should bear this in mind. It is prolific and low-cost, but its location in and around North Dakota translates into bigger discounts on its oil.
Mr. Sullivan points to Concho Resources. CXO -4.14% Its development efforts are focused in the Permian area, where breakeven prices range mostly between the high $60s and $80 a barrel. Concho has also hedged the majority of 2014's oil output at more than $90 a barrel.
Another stock to consider is EOG Resources, EOG -3.23% which has assets across the Eagle Ford, Permian and Bakken and a proven track record on efficiency. Pioneer Natural Resources, PXD -3.92% with its large Permian presence, is another. Swimming in oil isn't a pleasant experience, but it's better than sinking in it.