Oil is Cheap and May Get Cheaper

This article published with permission from InvestmentU.com.

Thanks to hydraulic fracking, America is now awash in cheap oil. And that’s great news for everyone … except oil companies and their investors. For them, low oil prices are a real problem. And prices may go lower yet.

But there are winners in the oil patch regardless of the price of oil.

Here’s what will happen — and what you should do — if oil stays cheap or gets cheaper.

First, the background: The United States is now producing more oil domestically (more than 7.6 million barrels per day) than it’s importing. We’re a net exporter of oil for the first time in 50 years. The International Energy Agency (IEA) expects U.S. production to surpass Russia and Saudi Arabia by 2017.

As our supply continues to go up, prices go down. West Texas Intermediate (WTI) light sweet crude, the benchmark for U.S. oil prices, is trading below $95 a barrel, down 11% in just six weeks.

Prices are nearing the point where they won’t support more drilling. If they go much lower, you could see producers shutting down oil rigs amid a wave of consolidation.

Permian problem

The Permian Basin of Texas is estimated to contain 50 billion barrels of oil, second only to Saudi Arabia’s Ghawar field. But the varied geology of the region, with as many as eight distinct layers of shale stacked atop each other, makes parts of the Permian expensive to drill.

Exploration and production companies need an average oil price of $96 a barrel just to break even on wells drilled in the Cline Shale and the Northern Mississippian Lime portions of the Permian.

Compare that to a $78-a-barrel break-even price for Eagle Ford Shale wells and $84 for wells drilled in the Bakken in North Dakota.

If WTI crude drops to $80 a barrel, some producers will begin to shut down drill rigs in the Permian. Some consolidation among smaller E&P companies is also likely.

Larger drillers will simply slow production. Some might “shut in” wells, meaning they’ll drill the wells but wait until prices rebound before producing from them.

What should investors do?

Right now, infrastructure to handle America’s exploding crude supply is building out at a record pace. Additional pipelines and railroad tank cars are going into service to move oil to the refineries.

The refineries are making modifications to handle the light, sweet crude that comes from the shale plays. Record gasoline and diesel exports are keeping a floor under prices.

Pipeline companies will come out winners in the oil boom regardless of oil’s price because they make money based on the amount of oil flowing through them. Many pipeline companies, set up as master limited partnerships (MLPs), pay healthy dividends.

Rather than buying individual energy MLPs, investors should consider the Alerian MLP ETF (NYSE: AMLP). Alerian is an exchange-traded fund that seeks to match the price and yield performance of the Alerian MLP infrastructure index.

Twenty-five energy infrastructure MLPs make up the index. Over the last year, the Alerian ETF has increased 7.7%. It also pays a healthy 5.87% yield.

With 25 companies in the ETF, investor exposure is limited as well. It’s a great way to invest in America’s growing energy infrastructure sector.

Dave Fessler is a senior analyst at InvestmentU.com. See more articles by Dave here.

The information contained in this article should not be construed as investment advice or as a solicitation to buy or sell any stock. Nothing published by Physician’s Money Digest should be considered personalized investment advice. Physician’s Money Digest, its writers and editors, and Intellisphere LLC and its employees are not responsible for errors and/or omissions.