The price of a barrel of the benchmark West Texas Intermediate – WTI – has fallen from the mid $90s to below $60, resulting in a an energy sector selloff the likes of which the markets have not seen for half a decade. The big drop in crude oil and energy stocks has put a lot of fear into the market.
To “help”, experts who never saw the coming drop in WTI are now saying lower prices are here to stay and going lower. I say the experts are as wrong now as they were six months ago. The reason is that crude oil has a unique, built-in self-correcting mechanism that will push the price of crude higher as we go through 2015.
The current fear in the market plus the recovery in oil next year makes the current low prices and high yields of the upstream master limited partnership – MLP – companies very attractive. If you have the guts to buck the experts and current energy sell-off and invest in these high yield energy companies, you should be very happy with your choice as we move through 2015 and beyond. Let me explain why the consensus of continued lower crude oil prices is wrong.
The major cost to produce crude oil comes from the drilling operations to bring in a producing well. Once the energy company has a producing well, the costs to maintain the well and gather the oil are relatively low, something in the $20 per barrel range. With a high price of crude, energy producers can spend excess profits to drill new wells and increase the ongoing daily production of crude oil.
According to the U.S. Energy Information Agency, in 2014 the world will consume 91.4 million barrels of oil per day. The EIA forecasts that consumption will increase to 92.3 million bpd. That 0.8 million bpd means that energy companies must find and produce an additional 290 million barrels over the course of a year. Global consumption is expected to increase by 1.5% each year.
Even more important when looking at crude oil production and consumption is the natural decline rate of oil wells and oil fields. Once a new well starts to produce, the energy company will be able to collect oil from the well for years. However, the rate of oil coming from the well will decline every year. On average, across the world, the decline rate of existing wells is 8% per year. This means that energy companies must drill wells to bring in new production gains of 9% to 10% above current production rates each year. In the U.S. in 2014, it took 62% of the new well production to offset the decline from existing wells. In 2015 that percentage is forecast to climb to 78% and then up to 90% towards the end of the decade.
