A couple of weeks ago, OPEC agreed to cut production for the first time in almost a decade and the oil market has rallied on the news.
In this week's episode of Industry Focus: Energy, Motley Fool analysts Sean O'Reilly and Taylor Muckerman dive into how the cut will affect oil prices in the short and long terms and how investors might want to think about this opportunity. Also, they also look at how Donald Trump's upcoming presidency might affect the energy industry -- from the president-elect's new pick for the head of the Environmental Protection Agency to his proposed expansion of the coal industry and more.
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A full transcript follows the video.
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This podcast was recorded on Dec. 8, 2016.
Sean O'Reilly: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. Today isThursday, December 8th, 2016, sowe're talking about energy, materials, and industrials.I'm your host, Sean O'Reilly,and I'm joined in studio by the one, the only Mr. Taylor Muckerman. How are you today, sir?
Taylor Muckerman: Youlet me back on the show.
O'Reilly: I missed you. What was this, multiple weeksthat we haven't hung out? I missed you. I forgot what you looked like.
Muckerman: I don't know much about airline investing,so it was probably a good idea to sub me out.
O'Reilly: I couldn't believe it, because I set up that show with Adama week or so ago in advance. I was like, "Hey, Adam, I want to talk about Warren Buffett and airlinesif you're willing to join me,"and then OPEC cut production that week! He wasactually very knowledgeable on the subject.
Muckerman: Where's yourcrystal ball when I'm around?
O'Reilly: Yeah, right?(laughs)I haven't told you about it yet.
Muckerman: OK, well, secret's out.
O'Reilly: I did get to talk to, last week, Adam Levine-Weinberg about the OPEC cut. We talked about it for five or sixminutes. But I did want to talk to you about it. How surprised we were you? Were you elated? Were you like, "I don't believe them at all, they're going to cheat?" What'sgoing on in the mind of Taylor Muckerman right now?
Muckerman: I was kind of surprised. You saw Saudi Arabia took it on the chin. They took the bulk of the cut.I mean, they had the bulk of the production.
O'Reilly: They wanted this bad.
Muckerman: Yeah, they did want it badly, and it shows. They gave into thedemands of Libya, Iraq, and Iran. Maybe not to the fullest extent thatthose countries might have wanted, but they did allow them to keep production where it's at. Rather than a cut, they just installed a ceiling on those three countries. It worked, prices are up --temporarily, at least.
O'Reilly: Yeah, it took a breather yesterday. Not that we care about daily prices or anything. Boy,the oil sector has been a good sector to own in the past couple of weeks.
Muckerman: Oil, banks, yeah, they're ripping, man.
O'Reilly: Yeah, post Trump's election, too.
Muckerman: He has a few things he's said thatobviously energy producers and people investing in energymight want to hear.
O'Reilly: Yeah. This week, we're hearing that OPEC is now going around to all the non-OPEC major oil producers, and they're trying to get them to cut.(laughs)
Muckerman: Yeah, we'll see how that plays out.
O'Reilly: Did you hear that they're going to accept natural decline rates as part of the cuts that they're looking non-OPEC producers to make?
Muckerman: I did not see that, no.
O'Reilly: Isn't that like playing whiffle ball?(laughs)
Muckerman: I mean, it's tough to hit or...?
O'Reilly: No,it just sounds ridiculous. Like, of course that's going to happen.
Muckerman: Yeah, it's the beauty of this beast.
O'Reilly: This is the circle of life.(laughs)
Muckerman: Especially when you're talking about U.S. oil decline rates.I don't think Russia is experiencing the same kind of decline ratesbecause they have more conventional oil. Yeah.
O'Reilly: I just thought that was ridiculous. Are you taking OPEC at their word? Has this changed your investmentphilosophy up there in Fool Canada? You don't doany producers -- you do mostly midstream stuff.
Muckerman: As far as our recommendations, yeah, you keep your eye on the producers because --
O'Reilly: They pay you, as owning pipelines and stuff.
Muckerman: As thepipeline companies and the services companies. You definitely want to maintain an eye on their activity. That's purelydictated by price nowadays. OPEC is cutting because we are oversupplied,not because we have so much demand that it would be illogical. Companies on the producing side arestrictly makingmoney on higher prices now. No one's really going out there and ramping up production. I don't think we'll see a production boom like we sawover the past several years again in the U.S. for at least, in thispresidential term, if nota handful of more, if ever,because it is purely price dictated now. Prices are in the $50s. It looks greatcompared to January but not so --
O'Reilly: Right, bottoming out at $27.
Muckerman: Yeah. Not so great compared to summer 2014.
O'Reilly: Moving on tosomething we briefly mentioned, which is the election of Donald J. Trump as the president of the United States --
Muckerman: What'shis middle name? I don't even know.
O'Reilly: I think it's James? Anyway.
Muckerman: Some Americans we are.
O'Reilly: I know it's J.
Muckerman: I know it's J as well.
O'Reilly: He recently made his pick for theEnvironmental Protection Agency, the EPA.
Muckerman: Scott Pruitt.
O'Reilly: Talk to me. Who is Scott Pruitt?
Muckerman: I'm just going to say one word,and you might figure out which anglehe's leading toward. That's Oklahoma.
O'Reilly: Oh, boy.
Muckmerman: That'swhere he's from. He is very outspokenabout the fossil fuel industry --
O'Reilly: I thought you were going to tell me he used to work forExxonMobilor something.
Muckerman: I don't know all of his background. But his state isvery highly dependent on the production of fossil fuels. So, he's definitely come out andpublicly bashed the EPA beforehe took this position. So, I think he's going to be able to do some knocking of heads from the inside out now.
O'Reilly: Do we knowanything else about likely policy changes andhow this is going to affect oil companies? You haveContinental Resourcesdown there inOklahoma, I believe, at least the headquarters.
Muckerman: I don't think he's going to specify state-specific regulations. But I do expect them to try to follow through on some things that Donald Trumptalked about during his campaignand has talked about after his campaign.
O'Reilly: He did talk about,in the episode where we talked about his energy policies, he talked about federal lands, doing that a lot more.
Muckerman: Deregulating oil a little bit more. He wants to bring back the coal industry. I mean,if he can do that, he can do anything.
O'Reilly: Like, snap your fingers, right? This is about economics, this is not about...
Muckerman: It's about economics purely. Oil as well. You cansay all you want about being able totry to bring back jobs to these sectors,but it's dependent on a global demand and supply balance.
O'Reilly: Natural gas is a wonderfulsubstitute.
Muckerman: Yeah, and it's still reasonably pricedcompared to coal. But you're seeingmassive demand centerstalk about how they're only going to allow coal production of electricity in their countries for the next 13-30 years. Youtalk about Canada phasing it out completely by 2030 -- they just announced thatrecently. They get 7% of their electricity from coal. France, even faster, they want to get rid of coal as early as 2023. Only 3% of their electricity comes from coal, but still, fairly big country, so 3% is a fairly meaningful amount ofdemand. Germany wants to get rid of it by 2050,half of their demand by 2030. Finland,the largest of these big countries,12% of their electricity comes from coal,and they are targeting 2030 as well. All of these countries are talking about getting rid of it.
O'Reilly: Yeah. And China, theirpollution worries, they are getting rid of all of their coal plants.
Muckerman: They have a similar target date between 2030 and 2050. The U.S.,I don't think we have a specific date in mind. We have seen more than a handful of utilities shed a lot of coal assets in favor of natural gas. When youlook at a company likeAmerican Electric Power,they get about 60% of their electricity from coal. So if Donald Trump does free up the coal industrya little bit,maybe they would benefit. But again,you need demand and it's disappearingover the next 20 to 30 years, almost completely.
O'Reilly: This isentirely speculative, but I did want to talk to you about it. Donald Trump won, he has this new head of the EPA fromOklahoma -- take that for what you will, wink -- shale oil and the oil industry did pretty well under Donald Trump'spredecessor. Are we to expect gangbusterseven more deregulations, so shale oil is going to go crazy?
Muckerman: Again,it did great under President Obamafor nothing that he did. It was an abundance oftechnological advances and anabundance of newly acquired oil reservesbecause of those technological advances, and it caught everyone off guard, OPEC included, which is why they decided to not cut in 2014, a little over two years ago, November 24th.I had just come out of Nationals Park, turned my cellphone on, and saw that oil was down by 50% in a day. That was a nice surprise.
O'Reilly: Happy Thanksgiving!(laughs)
Muckerman: Right aftermunching on some Texas barbecue. But, yeah, you might see a little bit more shale activity. But I don't see it. If you do, you want to stick with thosebiggest and brightest players. If you look at Oklahoma and Texas, that'sEOG (NYSE: EOG) andPioneer Natural Resources(NYSE: PXD).
O'Reilly: Actually, on that note, OPEC just cut production for the first time in eight years, and they did it in earnest. The last time they did this that wasn't recession-based was 2001 or something. Thisdoesn't happen every day, so we have to talk oil stocks. Does this make Pioneer, EOG,Chesapeakeeven -- they'rea little bit more trouble because of that balance sheet...what should shareholders or potential investors in the oil sector be thinking right now?
Muckerman: I think you could look at companies that maybe havea lot of inventory of wells that are drilled but not fracked, because that's the last stage, so they can bring those on quite quickly if oil prices do rise further or kind ofplateau --
O'Reilly: I mean,we just named a couple of them. I mean, EOG has...
Muckerman: Yeah, they'reone of the biggest independent oil producersin the United States, and they havesome of the best acreage. Their management team is extremely respected in the industry. They're fairly integrated. They have the ability to supply some, if not all, of their own sand in the basins that they operate in. They're able to take oil away from their well sites on their own and get it to the pipelines. Again, theacreage is just prime for this company. If youlook at Oklahoma in particular, the Permian Basin, whicheverybody is raving about the opportunity here,in terms of the size and the scale that can beachieved, Pioneer is the largestacreage holder there and a very good operatorwith the ability to grow production at 15% a year in theenvironment that we're in. It's pretty impressive.
O'Reilly: Before we head out here, your specialty is midstream guys. How does this affectKinder Morgan(NYSE: KMI)? Does this all of the suddenmake some more attractive? Because obviously everyone is going to be paying their bills.
Muckerman: Yeah, you can renegotiate a little bit more, which the services companies are trying to do, trying to bring those prices back up,because people saw the cost of producing oil go way down. Butthat's not only because of technological advances, it's also because of concessions from companies likeHalliburtonandBaker HughesandSchlumberger. Once they try to recoup that a little bit, you're going to see the cost of producing oil go up a little bit, because it was kind of a handout to keep these companies running during the downturn.
O'Reilly: That's a really good point that I don't think many people are talking about.
Muckerman: Yeah. The cost per barrel of oil is likely to tick up a little because of that, because of thesecontract renegotiations,because Halliburton and Baker Hughes and Schlumberger, whoprobably handle the vast majority of oil productionand natural gas production in the United States and worldwide over 50%,I would imagine these guys were giving some handouts to keep their customers in business and keep the oil and natural gas flowing. And now it's their turn to say, "All right, we have to mean revert a little bit here price-wise." But, on the midstream side, Kinder Morgan is a company werecommended in our Pro Canada service. It'swidely recommended here at The Motley Fool in general. I don't necessarily look at thembenefiting from a deregulation side, but if taxes get cut likeDonald Trump has said he wants,all the way down to a 15% flat corporate tax,that would be extraordinary. The oil and gas sectorsover the past five years have been the most heavily taxedin the United States. You're looking at an effective tax of around38.7% --
O'Reilly: A little bit higher than 35%.
Muckerman: A little bit higher, yeah. Youcompare that to biotech at 19%,insurance at 20.2%,and pharmaceuticals at20.5%. Those three sectors, almost half.
O'Reilly: Just toclarify for the layman, is that basically, they took the entire sectors and said, "What is the total amount the sector paid in taxes? What's the total gross income? And that's the percentage."
Muckerman: Yeah, they take their earnings before taxes and then you apply that, so that's theeffective tax rate of those sectors from 2010 to 2015. When you look at insurance, maybe that's why Warren Buffettreally didn't care whether orcorporate taxes were cut or not becauseBerkshire's--
O'Reilly: Aha! The truth comes out!
Muckerman: -- has all those insurance companies under its umbrella. But,with Kinder Morgan in particular,they were the highest taxed last year on an effective tax basis.
O'Reilly: So, that's all thelocal taxes and the state and all that?
Muckerman: Yeah. So, they're like 73%,international taxes, domestic taxes. If you trim that down to an even more conservative amount,if you take that down to 25%, say, they would have saved an extra $371 million last year, which amounts to about 10% of their long-term debt, which has been a stated goal of theirs to pay down. So, right there, you knock 10% off your long-term debt.
O'Reilly: And that ups yourinterest coverage ratio, whichallows them to increase their dividend.
Muckerman:Yeah,might get their credit rating back up to where it used to be. And yeah, the long-term goal hereis to get that dividend back up to where it was before the cut.
O'Reilly: That would help.
Muckerman: Freeing up 10% of your long-term debt to pay down wouldcertainly accelerate that process.
O'Reilly: Awesome. Thank you for your thoughts, Mr. Muckerman. Have a good one.
Muckerman: You got it. You, too.
O'Reilly: Before we head out,I want to take a second to give a special shoutout to our producer, Mr. Austin Morgan.Austin, we love you. Before we conclude our podcast,do you own anAmazonEcho? You can now get a brand-new skillfrom The Motley Fool. You can get stock quotes, create a watch list,ask Alexa how your portfolio is doing -- and it's all free. Formore details,including a demo of how it works, go towww.fool.com/alexa. Lastly, thank you, Mr. Muckerman, again, for joining me on the show.
Muckerman: One more thing -- we have a Motley Fool flash briefing you can add. When you say, "Alexa, give me the news," that would be a flash briefing. It's a 90-second clip on one big header news topic of the day.
O'Reilly: Do you do that 20 times a day?(laughs)
Muckerman: No, it's only once a day. We generally have an analyst from MarketFoolery stick around after the show and tape that.
O'Reilly: Awesome. Cool.As always, people on the program may have interests in the stocks that they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell anything based solely on what you hear on this program. For Taylor Muckerman, I am Sean O'Reilly. Thanks for listening and Fool on!
Sean O'Reilly has no position in any stocks mentioned. Taylor Muckerman owns shares of Halliburton. The Motley Fool owns shares of and recommends Berkshire Hathaway (B shares) and Kinder Morgan. The Motley Fool owns shares of EOG Resources, ExxonMobil, and Halliburton. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.