checking in

I'm going to do a post that looks at the sell off in energy debt over the past several months, but before beginning I should also note that I’ve now sold my small position in EOG at 96.58 per share on 12/23/14, having bought it for 101.32 per share in early September.  I still think this is the best quality US E&P, but its modest decline in share price does not fully reflect the very bad situation in world oil markets, so I’ve elected to sell it.  I now only hold WLL, and I wish I had sold that months ago.  Oil may have found a bottom here with WTI at $55 and Brent at $59, but I don’t think we can be at all certain of that.  Natural gas, though not as much discussed, has been rocked by a warm winter in the north east and some of the gas producers have seen huge declines.  

My sense when I was reading various articles today is that people are being complacent about how low oil can go.  So far we have seen serious curtailments to E&P capex, but almost all still claim they can grow production even with capex cuts of up to 50% compared to 2014 levels.  The price of oil must go low enough to spur more demand, or to limit supply.  Without a functioning cartel, it may take truly drastic price movements to get supply and demand inline with each other.  I believe that people have been buying E&P companies because they believe the price of oil will soon go back up, which I think is dangerous.  The inflows into the oil ETFs has been huge apparently.  Someday the price of oil will certainly be higher than it is now, but it may go down more first, and it may take a long while to rise again.

I also think that if oil were to stay at current levels, US E&Ps will do better than some might expect.  With both oil and gas prices low, we should see a major drop in rig count next year.  This may cause very large declines in service costs, rig lease rates, completions services, etc, which will cause a big increase in capital efficiency.  Also, it will be the least efficient rigs in the least efficient plays that will be laid down.  A 30% drop in oil rigs might have a surprisingly small effect on production.  This is similar to the effect we saw after the price of gas crashed in 2008.  Gas rig count plummeted from a peak of over 1500 down to about 340 currently, while gas production continued to increase the whole time.  You constantly see estimates of the "breakeven" oil price in various regions.  Those breakeven numbers will continue to decline as service costs go down and operator efficiency continues to increase.