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Fracking vs Conventional Oil Drilling: An Investor's Guide

Ever since the oil crisis of 1973, the idea of peak oil has fluttered in and out of the consciousness of consumers and investors all over the world.

Around that time, U.S. oil production peaked at a little more than 10 million barrels per day, and every president and politician since then has been forced to deal with our growing addiction to foreign oil sources.

These days, however, the idea of peak oil doesn’t make the kinds of headlines it used to. Perhaps it shouldn’t, either. After all, the shale and tight oil boom in the Lower 48 was solely responsible for production reaching about 9.5 million barrels per day in 2015.

But there’s one serious catch in this story…

What the shale boom effectively accomplished was to mask the continued decline in conventional oil production.

Hydraulic Fracturing: Do or Die for U.S. Oil

Since the mid-1800s, the world has consumed more than a trillion barrels of crude oil.

And the truth is that nearly all of this was supplied through conventional drilling.

It’s a simple process, really. A vertical well is drilled into the ground and into an oil-bearing reservoir. The crude is then pumped to the surface, and it looks something like this:

Drilling

The above shows the various components of an onshore, conventional drilling rig that, although improved upon over the years, has been the blueprint for harvesting oil pooled deep underground for over a century.

Although it looks complex, the process is far less complicated (and less expensive) than drilling in the shale and tight oil plays here in the United States.

And even though there are billions of barrels of untapped unconventional oil resources in the U.S., it was only up until 2008 that we were really able to extract them.

The reason for that is two-fold: economics and technology.

We Have the Technology

Ever since James “Paraffin” Young first discovered oil oozing from recently excavated shale rocks at the edges of the North Sea in the mid-19th century, we have known that certain shale formations hold a lot of oil.

And global estimates confirm that the amount of oil locked away in shale is about three times that of all the oil consumed since Young's great discovery.

However, the problem with shale oil and other unconventional oil (such as oil sands) has always been a lack of technology.

Granted, there were several pioneers (including George Mitchell) who have been combining horizontal drilling techniques with hydraulic fracturing since the early 1980s, but it wasn’t until 2008 that the tight oil boom really took off.

The technology was used in the Bakken, Marcellus, Eagle Ford, Permian Basin, and a few other shale formations throughout the United States.

Of course, it directly led to North Dakota’s oil output growing at an astounding rate:

nd oil production

Today, more than half of our oil supply comes from just three tight oil plays: the Bakken, the Eagle Ford, and the Permian Basin.

And although Texas has a sizable amount of conventional oil still to be extracted, virtually all of its production growth is from unconventional areas such as the Barnett, Permian, and Eagle Ford.

OPEC vs. U.S.

Another thing fracking has changed? It's gotten the U.S. out of OPEC's chokehold. 

“If energy is going to be used as a weapon, we need to have the largest arsenal.”

Former Texas governor Rick Perry said this at a conference in Houston in 2015.

He was referencing the clout of OPEC within the global oil trade and the fact that the U.S. was beholden to the whims of the group.

The U.S. was caught in OPEC's net and there wasn’t much light at the end of the tunnel…

Two years ago, we wrote about the (tiny) hope that the U.S. would lift the ban on crude oil exports…

Many thought it was a fool’s hope.

But in December of 2015 the ban was lifted…

And U.S. shale producers jumped in feet first, suddenly, with the advent of fracking technology they were able to produce more (and cheaper) than ever before. 

Since then oil has been on a rollercoaster of ups and downs.

In early July, crude prices reached a seven-month low, currently sitting just above $44 a barrel. For months, we’ve seen oil trade around $50 per barrel, desperate for support.

The question is, who can afford to produce under such low prices?

OPEC can’t.

But the U.S.? That’s another story.

The U.S. actually increased rig counts last week, to 952 active oil and gas rigs (up more than 500 from this time last year), while boosting production to more than 9.33 million barrels of oil a day.

The cost to build and operate wells in the oil-rich U.S. shale basins has decreased (due to fracking) by millions over the past few years.

This means that certain U.S. shale producers can make a profit when crude prices are trading between $40-50 per barrel.

The U.S. has nearly doubled oil production in the past nine years and is producing more than any other country. 

The U.S. isn't the only one making use of fracking technology. The U.K., where fracking has been a controversial topic, has just allowed a local company to drill a set of wells for the first time since the company created a small earth tremor after drilling in 2011. This will set the path for other companies to use fracking technology in the U.K., possibly creating a shale boom similar to the one in the U.S.  

Now we know, oil prices aren't doing very well lately, hovering between $40-50 a barrel... Which is why now is the time to buy in. Once oil recovers (and it always does) you'll be in the ideal spot to profit. 

More importantly, you can always search for those hidden gems that are poised for strong growth in the coming quarters as the oil recovery continues.

Here are three oil stocks to help you get started:

ExxonMobil Corp. (NYSE: XOM):

Exxon is the largest oil and gas company in the world, with a market cap of over $300 billion. It increased its dividend payments to 3.8%, which jumps them by 2.7%. The company has a history of increasing its dividends annually and has operations in every part of oil and gas development, with over 35,000 gross operated wells. Exxon has stayed strong even through the ups and downs of oil and gas prices. It was founded in 1870 and is headquartered in Irving, Texas.

Chevron Corporation (NYSE: CVX):

Chevron is the second largest oil and gas company behind Exxon, with a market cap of $196.51 billion. One of the best things about Chevron is that it has one of the best histories of dividend payments, increasing them continually over the past 27 years, even through many boom and bust oil cycles. Chevron’s diversity has helped it stay afloat through many years, and has a dividend yield of 4.19%. It was founded in 1879 and is headquartered in San Ramon, California.

ConocoPhillips Co (NYSE: COP):

COP explores for, produces, transports, and markets crude oil and natural gases worldwide. It has maintained or increased dividend payments since 2002. Even when oil prices dropped along with COP’s value (causing the company to make cutbacks), it still made dividend payments its top priority and actually increased the payments in 2014 and 2015. Its dividend yield is currently 2.44%. COP has a market cap of $53.21 billion and obviously puts dividends high on its priority list, which means it cares about its investors. It was founded in 1917 and is headquartered in Houston, Texas.

Oil is on the road to recovery, and these companies have consistently showed that they can outlive oil slumps, which means they’re perfectly placed for oil’s comeback.


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