Oil Declines Bring Down Producers

US oil producers showed today that they can make more money with $50 oil than had been expected. The result of which is that they are producing more than ever and oil prices are declining yet again.

Last fall, when the OPEC producers got together to cut production, their goal was to reduce volumes to a level such that there would be a price recovery…but not enough of an upswing to get US shale producers drilling holes all over Texas. The strategy seemed to work as oil headed towards $60 a barrel, a level that was profitable for shale drillers, but not high enough to unleash large drilling budgets. Or, so it was assumed.

What was not anticipated was the dramatic cost reductions and drilling efficiencies that are becoming more evident in the US, as well as the prolific nature of the Permian Basin. Instead of setting oil at a level where US producers would just scrape by, OPEC’s cuts set off a second rush in the Permian that is spiking total US production to levels last seen in August of 2015.

The increases in US production had been ignored by the market until today, when the proverbial drill bit hit the fan, with oil dipping below $46, a level not seen since November.

Shares of U.S.-based oil and natural gas producers were crushed, despite a spate of unexpectedly positive first-quarter profit and production reports. Pioneer Natural Resources Co. saw as much as $1.44 billion in market value wiped out on Thursday. Chesapeake Energy Corp. lost as much as 9.8 percent of its value despite reporting strong numbers.

Like Chesapeake, Occidental otherwise would have been expected to be rewarded by investors after disclosing a first-quarter per-share result that was more than twice the average of analysts’ estimates. Instead, its shares closed down 4.9% as well.

Billionaire wildcatter Harold Hamm’s dire prediction of a potential self-inflicted disaster may be coming true. Two months ago, the Bakken shale pioneer and founder of Continental Resources Inc. urged colleagues to take a “measured” approach to lifting production, or risk a new glut.

U.S. production “could go pretty high,” Hamm said in March at the CERAWeek by IHS Markit conference in Houston, one of the largest gatherings of oil executives in the world. “But it’s going to have to be done in a measured way, or else we kill the market.”

U.S. crude output rose by 28,000 barrels a day last week for the longest run of gains since 2012, according to Energy Information Administration data. Crude stockpiles fell by 930,000 barrels, less than one-third of the median estimate for a 3 million-barrel drop in a Bloomberg survey.

Favorite names here at Tailwinds, Lilis Energy and Earthstone Energy were both hit hard on the selloff. These companies are both Permian focused producers, fast growing and undervalued. Equally important, they are well capitalized with strong balance sheets. Expect them to be volatile with the group, but outperform over time. We would look to add to our holdings when it appears that oil has bottomed, or on any capitulation in the shares.