A Fresh Look at the Oil Sector

The past ten years have brought unbelievable changes in oil and gas exploration. Foremost among them has been the revolution in “fracking.”

Geologists discovered that shale formations contained oil locked in the rock. This created a whole new group of players in the marketplace. Geologists then used their knowledge to plot the areas where the most oil could be found. North Dakota, Oklahoma and Texas proved to be the most lucrative possibilities. Then akin to the gold rush new upstart companies jumped in, leased land and began drilling. We think of Exxon Mobil (XOM), Chevron (CVX) and BP Plc (BP) as the dominant players. Make no mistake they still are. But then we started hearing names like Chesapeake Energy (CHK), Newfield Exploration (NFX), Noble Energy (NBL), Southwestern Energy (SWN), Devon Energy (DVN) QEP Resources (QEP), and Range Resources (RRC). During this past 10 year sprint they invested $53 billion in land leases developed the new fracking technology.

Now, ten years later the major discoveries have been made. Most of the potential new fields are known. As the years flew by drillers were able to drill horizontally for up to 5,000 feet (Bloomberg news). They have been drilling 10,000 wells a year. The key question on investors’ minds is: “how much profit do these companies make and will they be able to grow substantially over the next several years?” The focus has shifted from the exploration stage to the production stage. Investors are saying: “OK they’ve found the oil but what is next?” If we look back at all great success stories, taking Ford (F) for example, Henry Ford spent the first few years developing his cars. Then he had to find a way to market his cars to a mass market and reduce the costs at same time. We all know that then the “assembly line” was born.

The fracking oil industry has come to this same point. Yes, we all know that oil can be extracted from shale. The question is can these companies bring the costs down and increase profits? This is where the industry stands now. Profit margins for a barrel of fracked oil doesn’t come close to the profit margins for vertically drilled well. In fact Exxon Mobil’s returns are six times those of the frackers. Like Henry Ford, they must find ways to bring their costs down. Like Ford, some players shine above the rest. The two most successful companies in cutting costs are Denbury Resources (DNR) and Range Resources (RRC).

But there is another potential money cow that the frackers are sitting on and that is natural gas. Natural gas is overflowing. We have an excess of it.

Again, what do we do with it? Here we have still another new group of players who are exploiting the uses for natural gas. We can refine it into liquefied form or LNG. We can transform it into diesel fuel and then refine it still further into gasoline. Still another by product is propylene. This is a basic building block for making plastics. Two of the dominant players are Newfield (NFX) and EOG Resources (EOG).

With natural gas prices rising and cost cutting, the oil fracking industry still has plenty of growth ahead.

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