DALLAS, Jan. 15, 2015 /PRNewswire/ -- Shawn Bartholomae, CEO of Prodigy Exploration Inc., says that the sudden and sharp drop in crude prices may sting at first, but it won't last long. In the very near future the price to drill will become more efficient resulting in higher profit margins over time. This scenario will hold true for Silver Tusk Oil, a sister company to PEI, more so than most.
Profit margins and break-even points are relative not only to the price of oil but also to the cost of conducting business. As oil prices drop, producers will renegotiate their inflated oil service contracts, forcing the drilling companies to slash workforce wages and cut perks to bring their costs in-line with depressed crude prices. The growing demand for oil remains strong, which will provide a "floor" preventing prices from going so low that profit margins cannot return to a profitable state. But, you ask, what is the floor and is it the same for everyone? Apparently not, and I'll explain below.
How oil prices dropped to $46 a barrel isn't a complete mystery as most claim. Will prices climb over $100 a barrel again in the near future? The answer is unquestionably, YES! Historical patterns tell us they will and there are many reasons for oil prices to reach triple digits once more. With that being said, our focus should not be so much on the price of oil as it should be on profit margins associated with the price at hand.
So, how do we handle the 55% drop in oil prices we've seen over the past several months? This has been shocking for most investors, but not entirely for oil bears and bulls alike. How on earth did it fall so hard, so fast? There's plenty of speculation ranging from the Saudi's desire to crush the U.S. shale industry to the U.S. conspiring with the Saudis to flood the market in order to bankrupt an aggressive Russia and an obstinate Iran.
All theories aside, the fact remains that the collapse of oil prices are a reality regardless of the reasons. However, let's not make the fatal mistake of failing to recognize that it is also the very prelude for the industry's next Bull Run. This drop in price may very well be just what the industry needs and we are about to experience the longest Bull Run in history. Is this a practical outlook? Yes! Shawn Bartholomae, CEO of Prodigy Exploration and Sr. Partner at Silver Tusk Oil Co., says the timing is impeccable as we are on the outset of a political setting that benefits our industry. As you will recall, Republicans took control of Congress in the 2014 midterm election which transformed the political dynamic in Washington and gave the GOP new power over the President's final two years in office. Additionally, Republicans won Senate seats allowing them to assemble a majority of more than 52 seats expanding their margin in the House to levels not seen in decades. Further, they have won key governor races also supporting the oil industry, particularly in Texas! The sweep left Democrats without a majority in either chamber for the first time since 2006. Our country is making a statement and it would be reasonable to assume that our next President will also be Republican!
A Republican influence will undoubtedly support the industry overall and particularly bolster returns to oil and gas investors alike.
But what happens if oil prices remain low for longer than expected? It's not all bad; in fact, it may be even better for smaller developers than if prices had never dropped at all. This is particularly true for Silver Tusk and partners, and I'll explain why. But first, let me say don't panic over "the sky is falling" premise! These types of analysts and journalists are claiming that the price of oil will remain low with devastating repercussions to the industry, the economy, and investors, especially those in oil and gas. Quite frankly nothing could be further from the truth! Why do they do this? That's an unknown; however, this is what they've done every time prices have dropped in the past and then inevitably prices return to an all-time high or at least to a price that has profit margins back at a level where every facet of the industry is prospering again. You would think their reactions would differ from the past as these price cuts provide the most enlightening facts as to why energy prices will not remain low for an extended period of time. So how long will prices remain low? The answer is simply "not long" as in just a few months.
How do I know? I know because oil and gas price patterns historically repeat themselves. Oil prices drop and in return development costs decrease, which re-inflates profit margins making it profitable for developers once again, even while oil prices are down. This too will foster the industry's next Bull Run! Without mixing words, NOW is the time to start drilling as many wells as possible particularly those likely to produce both oil "and" gas, which is precisely what Silver Tusk Oil Co. is doing.
All this sounds encouraging but what about our economy and the impact of plummeting oil prices? Overall, it seems most investors are concerned, which is a normal reaction. After all, the oil industry is a major producer of jobs and wealth for the U.S. contributing approximately $1.2 trillion to U.S. GDP and over 9.3 million permanent jobs, according to a study from The Perryman Group. The oil industry does not generate all those funds and/or jobs. Instead, they are derived from the multiplier effect the industry has on local economies. Given this, it's clear why a 55% drop in oil prices is cause for concern by some, but not for all!
While Texas is known as the US capital for oil and gas development, does this mean the State could suffer economically from oil prices nose diving? The answer is absolutely not. Regardless of what you may read elsewhere, the falling price of crude hasn't had a negative impact on the state's economy and it likely never will.
A more pertinent question is how does $46 oil affect other large developers with enormous blocks of Bakken shale acreage in North Dakota? They are saying West Texas Intermediate (WTI) crude needs to remain above $60 a barrel for their companies to stay in the black, that is; of course, if the contractors and other oil field service costs remain inflated, which is not the case. On the other hand, the larger developers holding shale acreage in south Texas say their companies can remain profitable with oil as low as $45 a barrel as they strategically drive oil service contracts down. The minimum price to maintain profit is forever changing. As development prices decrease, so does the minimum price needed to maintain profits. How does this occur? The larger developers are left with the task of lowering the cost of doing business by ceasing exploration and slowing infield development which translates to a decrease in rig activity but not necessarily production. Larger developers typically have dozens of rigs running so price cuts must trail the decline of oil prices to once again make it economical to drill. If not rigs get parked placing tremendous pressure on drilling companies to lower costs.
These price cuts spill over to the smaller companies as well. Again, this is the optimal time to drill in an attempt to establish as much production as possible preceding the industry's next Bull Run. Question is, is this happening, are the rigs being parked resulting in a significant price cut? YES!
In just the last few weeks, rig counts have dropped quite rapidly. The latest Baker Hughes rig count reflected the total number of US rigs in operation (including both oil and gas) fell again last week to 1,750 as of Jan 9th 2015, down another 61 rigs from 1,811, which is down from 1,842 the previous week. This is down from 1,920 for the week ending December 5.
Oil rigs in use fell by 37 the week before last, while gas rigs increased by two. For the week ending December 12, the number of oil rigs in use fell by 27, which at that time was the single largest weekly decline in two years. The following week, the number of rigs in use fell by 18. These reports are released each week.
The drop in oil rigs is already lowering the cost of development! The price of West Texas Intermediate touched down as low as $48 a barrel for the first time since June 2004. But this is no reason to panic and here's why! Take a look at history once again. Back in December 2001, WTI crude was priced around $25 a barrel and steadily climbed to $82 per barrel by 2006. Shortly thereafter prices dropped to $68 a barrel before skyrocketing to an all-time high of $143 a barrel in July of 2008, just two years later. Then, within six months it spiraled to $43 a barrel in 2009, even lower than it is now! And then what happened? By April of 2011, prices steadily increased to $115 a barrel, again just two years later. The cycle is starting again and we know that the best time to invest in oil and gas is when development costs are down and profit margins have re-inflated as they always do thereby allowing for maximum gain during the next Bull Run.
Nevertheless, the Fed Beige book says the outlook for North Dakota remains optimistic and that they expect oil production to continue to increase over the next two years. What are they thinking? Don't they worry about the break-even price of oil? Secondarily yes, but this is the best time to prepare for the industry's next Bull Run which is expected to be the longest in history. These very same developers recall drilling for oil when it traded in the upper teens. Even then profit margins came back into perspective and not long afterward prices started flourishing once again expanding profit margins at a rate otherwise not possible.
This would not have been the case had they not continued to drill while crude prices were down. Shawn Bartholomae makes it simple, history is our strongest future indicator! We don't need a crystal ball or some oracle to tell us what history is already making abundantly clear!
Drilling for oil in the last several years has become easier and more efficient but production costs have gone through the roof. Why? There are a few reasons for this but the primary reason is high oil prices. When oil service firms like Halliburton and Schlumberger negotiate contracts with developers they take the oil price and demand into consideration. The higher the oil price, the higher the demand, the higher cost for their services which equates to higher costs for everything associated with the industry, such as labor, pipe, equipment, administrative costs, engineers, geologists, and drilling costs. Furthermore, when prices drop development costs do as well which brings the "break-even" price down with it as I mentioned previously. The larger developers know how to accomplish this task. They simply don't engage new drilling contracts unless it is economical which has a rippling effect on other oil field services. What happens next is simple. Drilling companies drop their rates to keep their rigs active. As this occurs the drop in drilling costs becomes highly competitive dropping rates even further and profit margins come back into focus even if the price of oil falls to an unimaginable $30 a barrel.
Typically this doesn't occur all at once but cutting costs is not far behind the dwindling price bringing the profit margins back into full perspective quite rapidly. Even if oil prices remain low for a lengthy period, profit margins will remain intact! For Silver Tusk and our partners the timing couldn't be better. Why? First, we are at the very early stages of our newest development, which means we will drill the majority of our wells while development costs remain low. As oil prices make their comeback as they historically have, our profit margins will expand at an accelerated rate. This reduplicating pattern seems unbreakable, like an echoing cycle repeating itself one scale up from the last.
Shawn Bartholomae says if we had been at the later stages of this development with numerous wells already drilled at higher costs, the opportunity would not have the same benefits. Secondly, I don't think anyone expected oil prices to drop so suddenly or sharply but Silver Tusk is prepared. How? It's in our strategic development. We are developing in a region which typically yields a high percentage of gas compared to oil. Pursuing this production balance is vital in maintaining a steady revenue stream. Silver Tusk Oil planned a portion of our development in a specific region where the natural gas being produced is more likely to have a much higher BTU rating which, in turn, will yield a much higher price than spot market. This strategy is already working. A prime example is the recent success of the Margie Sanders #1. The gas from this well is very potent generating a bonus of $1.50 extra per MCF. In other words, if NYMEX Natural Gas is $3 per MCF, we will be getting roughly $4.50/MCF from the gas produced by this well, and similarly from another well not far off the JD Kilcrease #1! Additionally, it appears our geological analysis is correct now that we have encountered the same formation in a 3rd well, the Kilcrease Bowles #1, which will be tested this week. Silver Tusk Oil is taking full advantage of this situation by establishing as much production as possible as we approach the next Bull Run!
So where is the floor? How far can oil prices fall before they're completely uneconomic or so low that profit margins could never recover? Once again, Shawn Bartholomae says to look back to look ahead, history gives us the answer!
Consider this—fracking boomed in the U.S. back in the mid-1980s when a barrel of oil fetched around $23. When adjusted for inflation, this equates to $50 a barrel at today's prices. That boom went bust after prices fell to around $8 a barrel, which is worth around $18 in today's money. It seems that $20 a barrel would be a bust at least for the time! And we are presently at $48 a barrel. Are prices going any lower than $48 a barrel? Maybe, but not by much. Why not? The growing demand won't allow it! We are currently at $48 a barrel and profit margins will re-inflate at this price and, perhaps, even lower. Even a $30/barrel price could swing profit margins back to a range allowing developers to continue in the black. But at the end of the day it doesn't appear the price of oil will continue to fall much lower, nor will it stay down. If you take a look at previous price drops, they are short lived compared to price increases which typically have lengthy runs. The fact is prior to 1998 the average price has steadily increased. See Exhibit B.
An upward march in energy prices should take place over the next year; but, keep in mind we don't necessarily want the price of oil to increase as rapidly as it dropped defeating the purpose of adjusting profit margins that are needed for the industry's next Bull Run. Now is the time to gain as much momentum as possible. The irony in all this is simple, as long as we are successful in finding and producing oil and gas while development cost are down we are setting the stage for much higher returns than if development cost remained high while prices stayed up around $100 a barrel. Overall, we benefit from the drop in oil prices. It may be unpleasant at first as we experience a drop in revenue from existing production but that's minor given the fact that we are at the early stage of our development. Shawn Bartholomae, CEO of Prodigy Exploration Inc. and Sr Partner for Silver Tusk Oil Co., says the long term benefits are superb if we continue drilling to establish as much production as possible. And, as a small company, we are perfectly positioned to do just that!
I trust this practical viewpoint alleviates any concerns one might have regarding the recent market changes and clarifies the development opportunities at hand giving investors a reason to look forward to a prosperous future in oil and gas. In the very near future, Silver Tusk Oil Co. will embark on another new development proposing the drilling of several vertical gas wells on acreage strategically close in proximity to their most recent successes! Shawn Bartholomae says this may be the best time to invest in oil and gas, both markets look very strong going forward! The fact remains that Silver Tusk Oil Co. and Partners are in a development to establish as much oil and gas production as possible while development cost are down thus preparing for the industries next Bull Run!
SOURCE Prodigy Exploration Inc.