There is big change brewing in the nation's energy markets. It will affect all oil and natural gas investors. Some folks will get hammered as the industry jives in a new direction. Others will see big gains merely because they were smart enough to anticipate the next move.
Where you fall all depends on the decisions you make today.
If you paid attention, you know the nation's onshore natural gas rig count just struck a 16-year low. The number of folks drilling for gas these days has not been this low since the Clinton administration.
The idea goes contrary to the idea of an American natural gas boom. But as I've said over and over, we don't need to drill any new natural gas wells. The nation's oil wells are producing more than enough gas.
It is a phenomenon that has caught many investors by surprise.
Here's what Bloomberg had to say Sunday about the situation.
The overall US onshore rig count has dropped 9% this year, seeing the most sustained declines since the recession-led plunge in 2009.Those declines, caused in part by the gas industry's shift to oil production, are eating away demand for drilling services and worsening a shale-equipment glut that's pushing down prices.
This where it is important to understand how the industry works. We hear the terms "upstream" and "downstream" a lot within the energy industry, but they're vague words that don't tell us much. Instead, I like to divide the industry into thirds: explorers and producers (E&P), drillers, and energy transporters.
It's the E&P crowd that controls the industry's fate. They are the firms buying the leases, expanding the industry's reach and controlling the floodgates. All the other folks are at their mercy. If the E&P industry doesn't need new wells, the drillers take the hit. And if the producers aren't producing, the transporters have nothing to move.
Right now, oil production is healthy. The Bakken is awash with crude and natural gas. In fact, there's almost too much production. The transporters can't keep pace. Plus, the gloomy American economy isn't exactly sucking wells dry.
Here's a chart that shows domestic oil and gas production. Clearly, producers are doing their jobs.
It's the drillers that we need to watch. As more wells go online and the initial "shale rush" slows, companies like Schlumberger (SLB:NYSE), Halliburton (HAL:NYSE), and Baker Hughes (BHI:NYSE) will take the hit. These are the folks that drill the wells or sell the services to get the job done.
Right now, they are not in high demand. In fact, the industry is expected to lose over a billion dollars' worth of income this year... all thanks to dwindling demand for new wells.
But here is where our storm starts to take shape.
Let's not forget – despite the government's forceful attempts to kill the idea – the markets are still somewhat rational. If the phones at Schlumberger and Halliburton are not ringing as frequently as they were two years ago, these firms do what any company would do. They make themselves more competitive by lowering their prices.
Again... from our friends at Bloomberg:
Pricing for shale work is expected to tumble further as the contracts that were signed at higher rates begin to expire and new deals are signed at lower prices. For exploration and production companies that have seen profits strained by the higher costs, those prices can't fall fast enough.
This ties in perfectly to what I said at our resource conference in Toronto last spring. All that talk about the "fact" natural gas prices must rise is nonsense. The industry doesn't set its prices... the market does. The only thing the industry can do is lower its costs and hopefully make a profit. And that is exactly what we're seeing today.
As contracts expire and the domestic surge slows, it's the drillers and the service providers that will take the hit. In fact, this is going to be a very big week for the sector. All three of the companies listed above will post their latest quarterly results.
Most folks agree that earnings will take a hit. But the market's greatest surprise will be the increased talk of moving more business overseas. As the domestic market matures, the greatest opportunity for today's investors will erupt in Asia and Africa. Later this week, we'll get a good glimpse of what the first chapter of that story looks like.
There's trouble ahead for investors who focus solely on domestic opportunities. The boom days here at home are coming to an end. But overseas... oh boy... good fortunes are on the way.
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