Oil goes up. Oil goes down.
The average person sees it in their gas mileage. The average investor sees it in their upstream, midstream, and downstream stocks.
It’s a cycle older than the hills, and it will go on forever…
Or, well, we’d like to think so anyway.
The truth of the matter is that oil is not a renewable resource. Once we’re out, that’s it. No more.
But that’s the easy part of the argument. The real work comes in when trying to figure out exactly when it will happen.
Time is of the essence. Oil’s final decline has already begun.
Oil Peaks: When Did That Happen?
There’s a debate going on in the energy field, and it hinges on a few key questions:
- When will oil discoveries, production, and consumption peak?
- Have they already?
- Is peak oil even a thing?
To that last one, the answer is a resounding, “YES” simply because we know that oil is a finite resource. Eventually, the world is going to run out of it, which means production will definitely peak.
Moreover, with the ever-changing landscape of the energy markets, there’s a good chance oil consumption will peak even before we run out. In fact, it would be better if it did so that we’re not left hanging while we find a replacement energy source!
Now the challenge is finding out exactly how much time we have to worry about this…
Some estimates say that peak oil has already happened.
M. King Hubbert is credited with the original “peak oil” theory, and his assertion was that the U.S. hit peak oil back in 1970. At the time, U.S. oil production had hit 9.6 million barrels per day and then went into decline.
Short of only applying to the U.S., this theory was officially proved wrong in April of 2015, when top production reached nearly 9.7 million barrels per day.
This is just the pessimistic view of the situation anyway.
The optimistic view gives us until 2020!
At that point, we’ll start heading towards to one of two conclusions: we run out of oil, or we simply stop using it.
That second choice may have more clout than you think. Estimates published by Bloomberg New Energy Finance, using data from the International Energy Agency, say that the world will reach peak oil demand sometime around 2030.
As you can see, oil’s prospects have not been improving over the years.
The most recent estimate was based largely on the landmark agreement made at the 2015 Conference of the Powers (COP-21), during which 197 countries from around the world signed on to reduce carbon emissions to stave off climate change.
This, of course, means that countries are working to use less fossil fuels, including coal, natural gas, and oil.
There are other factors working against oil too.
Not the least of these is lithium, which has been dubbed “metal oil” for its role in the fast-growing electric vehicle market.
Over the past decade, Tesla (previously Tesla Motors) has begun a revolution that has every major car company in the world working to make a competitive electric vehicle. Demand for these EVs is expected to keep climbing, and EV sales could account for as much as 35% of new car sales by 2040.
Since oil’s biggest use by a wide margin is in transportation, that’s going to cut a chunk out of its energy market share.
And that’s not even the most worrisome issue facing our favorite fossil fuel...
A Real Sign of the Times
The biggest sign of the beginning of the end is one that many investors don’t think about — but they should.
More important even than oil production or demand is oil field discoveries.
Oil companies have an obligation to not only continue producing, but to regularly replace the reserves they’ve produced from.
If a company hits a new high and produces 500,000 barrels of oil per day, investors should then wonder where it will find a new 500,000 barrels per day in reserves.
This is called the reserve-replacement ratio, and companies want to keep it as high as possible.
This issue has become a little more muddied in the past few years…
You see, since 1960, oil discoveries had been going nowhere but down. Production may have increased, but the exploration and development of new oil resources had fallen to the wayside.
Enter: American shale drillers.
At the height of the market in 2014, more than 1,500 oil and gas rigs were drilling for new supply in the shale formations of the U.S. And what made those supplies so viable?
Hydraulic fracturing. Also known as fracking, the process shoots thousands of gallons of water, sand, and chemicals into the brittle shale formations under the ground. This loosens more of the oil and allows it to be more easily pumped back up.
This amazing development made re-completion of older wells viable, and made drilling new wells millions of dollars cheaper.
This alone made existing resources more viable. The difference between probable and proven reserves is how much can actually be produced economically. If a company has found 5 billion barrels of oil in the ground, but can only viably get to 2 billion of them, then that 2 billion is what counts.
In late 2016, oil prices began to rise out of historic lows, making exploration and development a worthwhile endeavor again. Almost immediately, North American drilling rig counts began climbing.
Yet just a year prior, oil discoveries had hit a 70-year low.
Worldwide, only 12.1 billion barrels of oil were discovered in 2015. If that sounds like a lot to you, consider that just five years earlier, in 2010, discoveries reached more than 40 billion barrels.
2010 was also the last year discoveries outpaced production.
According to data from Rystad Energy and Morgan Stanley, oil discoveries hit their peak in 1964. Even as production and consumption kept climbing, discoveries have been riding a slippery slope downward.
2016 did see a glimmer of hope when American driller Apache Corporation made the largest discovery all year: in an area of Texas’ Permian Basin which the company dubbed Alpine High, Apache found an estimated 3 billion barrels of oil, plus around 75 trillion cubic feet of natural gas.
Now, keep in mind that probable-proven reserve difference. IHS Markit noted early on that these resources were only economically viable if oil stays between $55 and $65.
Meanwhile, global discoveries continue to decline…
The reality of the situation is that we’re not likely to run out of oil any time soon. There are still discoveries to be made, and improvements in technology will make even more resources viable as time goes on.
Moreover, we may yet find a way to peacefully cut off our oil usage.
But make no mistake: there is an end to the oil market, and we’re approaching it as you read this.
The companies that will continue to make money while oil still dominates the energy market are those in a position to keep making the big discoveries.
Apache Corp (NYSE: APA)
This one is an obvious choice since it’s just recently found a new resource and is working to optimize it starting this year.
Apache is planning to operate between four and six rigs on the company’s acreage throughout 2017.
It’s also building a pipeline system to transport the product out of the area, most likely south to the nearby Gulf of Mexico.
This isn’t even the last of Apache’s exploration initiative. The company is also drilling in the North Sea of the UK, an area which has historically been left by the wayside but is picking business back up at a clip!
The company has begun drilling in newly-mapped sections of the Forties field, and expects to have its satellite field in the Beryl play online in the summer of 2017.
Whiting Petroleum (NYSE: WLL)
The Permian isn’t the only major shale play in the U.S. It’s the Bakken play in North Dakota that’s credited with really kicking off the shale boom.
Whiting is one of the top producers in the area, as well as one of the biggest developers of the Niobara shale play in Colorado. As of September 2016, the company even had the highest 90-day initial production average in the area at about 1,080 barrels per day.
The company reports at 92% of its potential drilling locations in the Bakken and Three Forks areas are in core positions, meaning it's got an advantage on reserves and production.
Even though the Permian seems to be where all the action is happening, the Bakken is still one of the biggest U.S. resources to date. And Whiting’s position at the top here gives it a huge advantage over other drillers up north.
Eni S.p.A. (NYSE: E)
Taking a step away from North American shale, Eni S.p.A. is an Italian Oil Major with operations all over the world.
As of early 2016, the company has about 1.6 billion barrels of oil equivalent in exploration resources worldwide. Between 2015 and 2019, Eni expects to see more than 3% compound annual growth in its production rates.
Since 2008, the company has discovered nearly 12 billion barrels of oil equivalent. That’s more than three times the resource discovery of peers like ExxonMobil, BP, and Total in the same time.
This also gives Eni the highest reserve-replacement ratio at 2.4x; only one other peer had a ratio of one, meaning very few of today’s major oil companies are breaking even on their reserve-replacement rates.
Eni’s latest exploration into the Adriatic and Ionian Seas of Italy have been noted has having a high probability of discovery in coming years. The company certainly has the reach, plus the assets to grow those reserves!
All of these companies have two major things in common: they’ve got great supplies now, and the means to explore and expand to replace those supplies later.