Why Are Some Oil Companies Still Increasing Production In the Face Of Low Oil Prices?
Election Day is getting closer, and big changes may be coming for America's energy industry.
In this week's episode of Industry Focus: Energy, Motley Fool analysts Sean O'Reilly and Taylor Muckerman go over Donald Trump's stated plans for the energy sector, and what it'll mean for the industry and the world if he enacts them. (Tune in next week for Hillary Clinton's plans.) Also, the hosts take a look at quarterly earnings from EOG Resources (NYSE: EOG), and explain why the company has sold off so many of its assets, what exactly is so special about the Permian basin, why Silver Wheaton's (NYSE: SLW) stock has nearly doubled in the past year, and more from this week in energy.
A full transcript follows the video.
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This podcast was recorded on Aug. 11, 2016.
Sean O'Reilly: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market everyday. Today is Thursday, Aug. 11, 2016. We're talking about energy, materials, and industrials. I am joined in studio by The Motley Fool's one and only Taylor Muckerman. What's up, man?
Taylor Muckerman: Hanging in there. Ready for 7:30 tonight.
O'Reilly: Yes. You're rocking your jersey. Why are you all excited, decked out?
Muckerman: They're playing in Baltimore. First preseason game of the year. The Carolina Panthers are.
O'Reilly: Are you driving up?
Muckerman: No.
O'Reilly: No?
Muckerman: Starters are only going to play maybe a few series. I'm not.
O'Reilly: My hometown team, the one and only Cleveland Indians, were in D.C. this week ...
Muckerman: Did you go see them?
O'Reilly: ... playing the Nationals. No. I was following them on my phone.
Muckerman: Near and dear to your heart. How did that turn out for you, the series?
O'Reilly: I don't know how the third game went. I think the Tribe won the first one. I'm pretty sure the Nationals won the second. Is that right, Austin? No. Oh, wow. We're crushing them. This is awesome.
Muckerman: Two out of three, then, at least.
O'Reilly: Yeah.
Muckerman: Two out of three, Austin says.
O'Reilly: I'm really just excited for September-October, because the first ranked team in each region is about 57 to 59 wins. I'm ...
Muckerman: Did they add LeBron to their playoff roster?
O'Reilly: They could. He played football and like, crushed it, in his high school team, too.
Muckerman: He could be a ...
O'Reilly: He could play baseball.
Muckerman: He could be a pinch runner, or something.
O'Reilly: He could pull a Michael Jordan and play outfield.
Muckerman: Yes. Right.
O'Reilly: It's earnings season across the stock market. I did want to mention a few companies within our own little sectors here. EOG Resourcesjust reported.
Muckerman: Yes. Reported a loss.
O'Reilly: Yes. They basically broke even, I guess, in the same period last year. Then, they lost 292.6 million, $0.53 a share. Revenue way down, 28%, 1.78 billion. The two interesting things that I wanted to get your thoughts on -- they talked about asset sales so far this year of 425 million. This isn't always going to be true, but aren't the strong players, which, supposedly, EOG is one of them, supposed to be buying things, not selling them? What's the dynamic there?
Muckerman: What EOG's been doing is kind of assessing their portfolio of drillable assets and trying to quantify which ones are those premium assets, where they think they can get a 30% return at $50 a barrel, or even higher than that as oil prices increase.
O'Reilly: At least 50.
Muckerman: Yes. At least $50 a barrel. I think what those assets sales are doing is basically just saying, "We're probably never going to focus on these based on what we have in our portfolio." I'm just raising cash so that when oil does, maybe, rebound, because we saw it rebound to $50 and now it's back down closer to the high 30s, very low 40s right now, maybe it's just them saying, "We've got our premium assets," and which, these premium wells, I think they increased from 3,200 premium drilling locations before the quarter, and during the quarterly announcement, they said that that's now up to 4,300. That's a 75% increase.
O'Reilly: That's a big jump.
Muckerman: Yes. I think that they've got a few decades, now, of premium locations that they can put this 425 million to work.
O'Reilly: I don't want to put words in your mouth, but if I understand you correctly, they have just so many good wells in Eagle Ford and, you know, they're primarily in Eagle Ford. They have X dollars, so many good options, they're like, "We don't need this other stuff."
Muckerman: Yes. That's right. To go back to what I was just saying, that's 30% return at $40 a barrel of oil, for these premium locations. That's 30% return right now if they decided to drill these increases up. They're looking at 10% production increases if oil is at $50 a barrel.
O'Reilly: That was the other cool thing in the report that I wanted to mention. They're planning on $50 oil, just for all their plans. We don't know what's going to happen. Some companies are more vocal, as we've seen.
Muckerman: This is out to like 2020. I think 50 might be conservative out with the next four years, but for the rest of this year and 2017, that might be spot-on.
O'Reilly: Right. They talked about how, and I guess this is why the stock surged after the report, but the company said that it expects well completions, this year, to more than top their previous guidance of 270. It's going to be, 350 wells are going to get completed. They think that they can grow production at 10% per year through 2020 at $50 oil.
Muckerman: Yes, and 20% at $60 oil.
O'Reilly: Did you like that?
Muckerman: I do like that. You know, it's coming from one of the best producers in the world. Granted, they're pretty much only in the United States. I'm sure if you took them elsewhere, and just plopped them down in a shale field, they'd figure it out and be the best in that area as well, over time. I don't think every company in the business is going to have the same metrics to throw out there if oil's at $50 a barrel. From EOG's perspective, I'm confident that what they say, they're going to do, because they never really go out and overextend themselves in terms of guidance or performance. I think that investors should feel good about that.
O'Reilly: They're not the only low cost shale producer to talk about upping production, like now. The other one that caught my eye was, of course, Continental Resources (NYSE: CLR), good old Harold Hamm. He's, yes, God bless that man. How do you feel about them just upping production like this? I'm like, why not just leave it in the ground and wait for higher prices? What's the calculation that they make there?
Muckerman: A, they have to keep the lights on. They have debt to service. They need to produce at least that much oil. At the same time, you don't want to lose market share. You don't want to not produce and then have your customers turn elsewhere, your downstream customers. I think that when you're talking about EOG and Continental and Pioneer Natural Resources (NYSE: PXD), itself, said that at $55 a barrel, it's looking at 15% production growth for the next few years. You're seeing the bigger names with a lot of diversified assets within the United States saying, "Hey, we're ready to now continue business as usual, for the most part." I don't see a problem with that. Yes, you might forfeit some future growth, but at the same time, you don't know if oil is going to be at $40 next year, while it's, so, you know, you're going to have to continue to challenge your people to drill and produce at low oil prices, hoping that oil prices rise. Again, you have to keep the lights on.
The energy industry is very reliant on debt markets. They need cash flow.
O'Reilly: Got it. We've been talking a lot about the travails of the oil and gas industry, over the last, I don't know, 18, 19, 20 months now. Apparently, it is not all bad. Came across this article in The Wall Street Journal about Parsley Energy (NYSE: PE), that I want to talk about, because it's a happy story. Taylor, this is a positive, happy story that's going on.
Muckerman: OK! Let's hear it.
O'Reilly: I don't know.
Muckerman: Well, so it's production increases.
O'Reilly: I mean ...
Muckerman: Kind of.
O'Reilly: I don't know. They're growing, I guess. These guys are more than increasing production. Only been trading since May 2014. They had an IPO to help pay down their debt. It is now reaching all-time highs and has solidified its founder, 38-year-old Brian Sheffield, as his status as a billionaire. The energy industry minted a brand new billionaire in the last two years. I don't know. I was like, "Wow." That last name, Sheffield, that sound familiar to you?
Muckerman: No. I don't think so.
O'Reilly: His dad is the current chairman of -- drum roll, please -- Pioneer Natural Resources.
Muckerman: He's got some legacy there.
O'Reilly: He's a third-generation wildcatter, basically. What's interesting, in the article it talked about how his dad always harped on him about his debt, his debt load. He'd see him at Christmas and be like, "So, how's your leverage, son?"
The interesting thing is, this is what I actually really wanted to talk about, Parsley is primarily based in the Permian Basin of West Texas, up there, and Oklahoma. So it's Pioneer, so he's competing with his dad for leases and stuff. I mean, you tell me.
All I've heard for the last few years is Permian, Permian, Permian, Permian. They're not talking about dinosaurs, so ...
Muckerman: Well, in some ways, they are because apparently oil, it came from dinosaurs, right?
O'Reilly: Supposedly. It's mostly algae.
Muckerman: Mostly algae and what-not.
O'Reilly: Why is the Permian so great?
Muckerman: A, it's relatively new compared to the Bakken and the Eagle Ford, in terms of drillers rushing toward it. It's also multiple, we call it a stacked play. There's multiple shale plays stocked on top of each other.
O'Reilly: That's not the case in Southern Texas with Eagle Ford?
Muckerman: To some degree, but the Permian is a deeper field, for the most part. It also is projected to have tremendous reserves. When you look at it, it's the largest production per barrel, per day, of any field in the United States, for oil. It's second in gas. It's producing both at very high levels.
O'Reilly: Wow. Is Marcellus top for gas?
Muckerman: Marcellus is more than double, almost triple, the Permian, in terms of gas.
O'Reilly: They've been hitting that for 15 years.
Muckerman: Yes, but Marcellus has next to zero oil. Whereas the Permian is offering that almost one-for-one blend in terms of being the leading oil-producing region and the second-leading gas-producing region. There's a lot more for investors, maybe, to be cheery about, because there's some diversification in terms of what you might be drilling for, and if the reserve calculations are correct, there's a very long timeline for this field, depending on where you're drilling. Obviously, it's a huge field. Not everyone is going to have the same timeline. The prospects for having decades' worth of oil and gas to drill for are there in this field.
O'Reilly: Got you. Cool. I can't believe how well the stock's been doing. I want to get your thoughts on Silver Wheaton.
Muckerman: Silver Wheaton. Yes. Yes.
O'Reilly: The thing I've not forgotten, that it was your No. 1 pick last year, when we did the little stock-picking thing.
Muckerman: Yes. Crushing it.
O'Reilly: The thing's like what -- 200%? Yes. Why are they doing so well, and how are their recent earnings?
Muckerman: You've seen, they're doing so well because you've seen prices of silver and gold rally a little bit. Obviously, it's sold off pretty tremendously.
O'Reilly: You didn't like them because you saw silver prices increasing, though. They're a good producer, is what you liked, right?
Muckerman: They're not even a producer. They just, they're a streamer. They pay base metal mines, miners that are producing lead, zinc, iron ore. These companies like Valeand even some Goldcorp. You know, you look at other big base metal miners that aren't necessarily in the business of selling silver and gold. It's almost just like a castoff, like a by product for them.
O'Reilly: These people that are going after iron ore, they get some ancillary gold or silver or something.
Muckerman: Right. Silver Wheaton will help finance the mining and then pay, basically, a royalty for each ounce of gold or silver that they're given. That's agreed-upon cost upfront. Their all-in cost is known years in advance of what it's going to be down the road. It's a very high-margin business for them.
O'Reilly: They're not having to deal with operating these stinking mines.
Muckerman: Right. They sell it at market prices. That's their business. They're the first company to really do it.
O'Reilly: That's awesome.
Muckerman: They're the largest streamer in the business. Then, their dividend is tied to the previous four quarters' cash flow. It's a predictable, dividend increase/decrease, or just no dividend at all. It's prudent, which I appreciate.
O'Reilly: They're not committing themselves to pay a dividend when they, theoretically, can't pay.
Muckerman: Yes.
O'Reilly: OK. Got it. Cool.
Muckerman: With their production in record gold sales, which is something that, it still is a small portion of their business in terms of production, not production, but in terms of sales. It's something that they're focusing on more intently, is gold. They had a nice rally with the prices and record sales and solid production from the miners that they're working with.
O'Reilly: Speaking of enthusiasm for gold, we're going to take a pivot a little bit here and dip our toes, ever so lightly, into the world of politics.
We're going to take a look at Trump's energy platform. We're going to ignore candidate preferences and we'll just be talking about the pros and cons of their stated energy policies, as found on their websites, I guess, or speeches. We'll be giving, for our listeners here, who are curious, Hillary's plan a closer look next week on the episode Energy. If you'd be so kind, Mr. Muckerman, run us down what Trump thinks America should do with its energy policy.
Muckerman: It's to cut regulations massively. That's his word, "massively," twice. Also, basically forgoing renewable energy in favor of fossil fuels, calling it the policy of the future. Which makes me scratch my head when you talk about fossil fuels and coal, in favor of renewable energy. I think renewable energy is going to have a much longer future than, say, coal or oil.
O'Reilly: You're not being mean to any of our listeners that work in coal country, or in the oil industry, or whatever, but the planet Earth has, like, 30, 40, 50 years of oil left, for all our needs and everything. Then what do we do? Is that ...
Muckerman: You can continue to get more efficient.
O'Reilly: Technological advances. Yes, but ...
Muckerman: You can continue to extract more oil and natural gas and coal out of the ground. When you talk about coal losing jobs, coal losing demand, it's not an American problem, it's a global problem. I don't know if it's, you call it a problem if you're in the industry. Everyone else, I think, looks at it as progress. It's not just because regulation is cutting coal jobs. If you look at it, miners are becoming much more efficient. Go back to, let's say, let's pick a date, 1975, annual production per miner was ...
O'Reilly: Couple of tons, what?
Muckerman: It's a quarter of what it is now. Mining has got that much more efficient. Naturally, jobs are going to decline if you're upping your production per unit. You're looking at peak U.S. coal production, basically, in 2006. It's been declining ever since then. Miners have been getting more efficient. In terms of employment, basically seeing peak coal employment in the '80s. You've been losing jobs for the last 30 some-odd years. It's not just regulation.
O'Reilly: Now they're losing stuff on the demand side, because you've got China literally shuttering all their coal, electricity plants. They're trying to ...
Muckerman: Europe is waning on terms of coal demand. United States is waning in terms of coal demand. It's, sometimes Trump, Donald Trump, tries to put things into a basket of just America. It's America's problem. Coal and oil are globally traded. Yes, you might be able to help boost some jobs. I don't think you're ever, ever, ever going to re-create the jobs that were once in the coal industry. It's just not going to happen.
O'Reilly: Right. Is there anything else that he talked about with his plan?
Muckerman: Basically, just cutting regulations.
O'Reilly: Is that literally closing the EPA? What does that mean?
Muckerman: I think it would be on the table. I don't know. At least in terms of anybody trying to crack down on oil and gas and coal. I don't think he's ever outright said that. Just in terms of his focus on cutting regulation, that would have to be, you might gain some coal jobs, but you might lose some EPA jobs.
O'Reilly: Right. Got it. Or some natural gas jobs.
Muckerman: Yes, or some natural gas jobs. Then, if you look at the growth in renewable jobs, if you try to put a bottleneck on that, I don't know if you're even going to net out to positive job growth from his energy plan. The industry itself, in coal, just isn't going to support it, whereas, if you focus more on renewable energy, you're going to have all those engineers from that industry that could possibly go work in the renewable-energy industry. It might not be a seamless transition, but those jobs are going to be available.
O'Reilly: What about something that we currently still definitely need, which is oil. Do you think the oil industry would love all this stuff?
Muckerman: You know, maybe if he cuts down on the measures that require you on omissions or things like that while you're drilling. Flaring, for instance. Excess gas that you're producing at the well site. A president's only around for four years, generally. Yes, he could go for eight. These energy companies, I don't, they've already been focusing so intently on cutting emissions and becoming more efficient, that I don't think one president's going to cause them to completely reverse course because things could change in a second.
O'Reilly: Got it. OK. Cool. All right. Thanks for your thoughts, Taylor.
Muckerman: Yes. Thank you.
O'Reilly: Have a good one.
Muckerman: You, too.
O'Reilly: That is it for us, folks. If you're a loyal listener and have questions or comments, we would love to hear from you. Just email us at industryfocus@fool.com. Once again, that's industryfocus@fool.com. As always, people in this program may have interest in the stocks that they talk about. The Motley Fool may have formal recommendations for or against those stocks. Don't buy or sell anything based solely on what you hear in this program. For Taylor Muckerman, I'm Sean O'Reilly. Thanks for listening, and Fool on!
Sean O'Reilly has no position in any stocks mentioned. Taylor Muckerman has no position in any stocks mentioned. The Motley Fool owns shares of Companhia Vale, EOG Resources, and Silver Wheaton. 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.