How To Play The Imminent Rebound In Oil Prices

In my last column, I pointed out the lockstep insanity being followed by US oil companies in increasing production, no matter whether or not the end product was profitable in today's depressed oil market. Happily, I was also seeing an end to that destructive strategy, with several independent E+P's guiding lower on production and cutting capex yet again.

I won't replay last week's column in its entirety. But now that oil is showing real signs of being ready to break out of its 2017 range, what oil companies do now will really matter for our investments. Will they turn open the spigot again at the first sign of recovering prices? Or have they been cowed enough (or just plain out of leveraging options) and will stop trying to forecast oil prices and just let the market dictate their plans?

There are signs that the oil companies will be more conservative if oil does reach $60 or even $70 later this year. This story outlines the plummeting use of sand, a major input cost for frackers. This is important particularly because ever more efficient drilling technologies, which maximize acreage and initial volumes of oil from fracked wells, all rely on ever larger volumes of sand.

The sudden drop in sand orders could mean that oil companies are taking a real break on breakneck drilling. Or, it could mean that they're just fed up with rising sand costs. Or, it's possible they are experimenting with other (cheaper?) compounds.

What do I think? For a start, I think that sand frack companies like Emerge (EMES) and US Silica (SLCA) are going to be the wrong place to be for a while.

There are those that do not agree with my outlook on reduced drilling and production. Here's one Canadian fracking services CEO who believes Permian oil production is on the verge of another big volume boost. He's seeing the 72% year-over-year rise in 'drilled but uncompleted wells' (DUCs) and expecting what the EIA is expecting - a new flood of oil.

Despite the increasing inventory of DUCs, I don't think that's how it'll all work out, even with an oil price boost. I think Permian producers like Pioneer (PXD) and Diamondback (FANG) have seen the light and grown tired of losing money on ever greater volumes of oil.

I have recently finished a free report that I am calling the "Five Things You Don't Know About Oil - But Need To", accessible later this month on my website. All five of them play into my long-term thesis of $100+ barrel oil, but the last is about where we are in the timeline of the "US shale oil boom". One piece I noticed agreeing with my long-standing view of where we are in the cycle was in the Wall Street Journal, and needs to be read closely.

Is shale oil really going to deliver on any of its promises of energy independence? Continuing cheap prices? Long-term domestic supply?

Ultimately, the answers to all of these questions is no. And we need to keep these ultimate disappointments in mind as we carefully choose the right energy companies to invest in. Money can be made, and great money will be made in the next several years - but we will do better understanding that shale is ultimately a limited opportunity. Only the best of the best of US shale producers, those with a deep portfolio of assets and a minimum of leverage will yield great long-term returns. The others will do nothing but lose money.

Continue to look for those few US frackers that will be ready to benefit fully from a rebounding oil price - those like EOG Resources (EOG) and Cimarex (XEC), and you will be rewarded. Many of the others will continue their share price retreat, even if oil prices rebound sharply.