A Fracking Revolution

09/30/2013 10:00 am EST


There's nothing quite like oil, says Robert Rapier, editor of the Energy Strategist. However, Robert feels one thing has changed the rules of the energy game just recently, despite the fact that it's been around for quite some time.

Steve Halpern: We are here today with Robert Rapier, editor of the Energy Strategist. How are you doing, Robert?

Robert Rapier: I'm okay, how are you?

Steve Halpern: Very good. You recently became a member of The Wall Street Journal's Ask the Expert energy panel. Congratulations on that.

Robert Rapier: Thank you very much.

Steve Halpern: Given this expertise in the energy sector, can you highlight the prospects for oil and oil related stocks?

Robert Rapier: Sure, over the long term, I mean for the past ten years, I've been very bullish on oil, because I felt like there's really nothing in the world like oil, nothing that can replace oil, and so you can see this even in developing countries, as oil prices went to $100 a barrel.

Demand continued to increase across all developing nations. That has put incredible pressure on oil prices and I felt like longer-term, the trend is up, up, up.

Now, in the short-term, there aren't any catalysts, so we've been warning people, about a month now, there aren't any catalysts to push oil prices up at the moment that are in sight.

That could change overnight, but at the moment, I think they're going to drift down a little bit. For the long-term, there are lots and lots of oil companies that are very good bets.

One of our favorites is Oasis Petroleum (OAS) which is a pure play on the Bakken formation in North Dakota. They're up 71% over the past year; that's been one of our big winners.

But a lot of companies that are pure oil producers in some of these shale plays in the US have performed extremely well and will likely continue to do so over the longer-term.

Steve Halpern: So, even if there's a temporary setback in oil prices, that would not hinder your long-term bullishness, you would have investors take positions now?

Robert Rapier: Well, at this quarter, you're liable to see some softness, so you may see a little bit of a pullback on some of these. I think over four quarters that are probably drifting down now from guidance; oil prices are off maybe 10% over the past month and so you'll see a little bit of softness.

But over the longer-term, their production is still growing, a lot of these players in these shale plays, and so the long-term, I think, is still very good. You might get a little cheaper entry points over this quarter into the fourth quarter.

Steve Halpern: What's your outlook for the oil refiners?

Robert Rapier: The oil refiners, that's an interesting story. You really have to stay on top of oil refiners and that is not a sector that I recommend for a buy and hold investor. When I joined the Energy Strategist a year ago, that's one of the first recommendations I made, was buy the oil refiners, Valero (VLO), Tesoro (TSO).

And they had a very solid run between then and the end of the year, and we started to see some signs that things were starting to turn south, and so we advised investors to pull back, hold them, or sell them if you're a conservative investor.

Right now, at the moment, the problem is, the fracking revolution of the US has depressed domestic prices and that's created a very large differential between West Texas Intermediate crude—and the US crudes are based off West Texas Intermediate—and Coastal crudes, like globally traded crudes—and finished products are set off of those crudes. What happened was, refiners in the US could buy very cheap US crudes and sell them at prices that were reflective of more expensive international crudes.

Well, this year, and this is something else we predicted, that this year that differential would vanish, and it has. The differential has vanished. A year ago there was nearly $20 difference between West Texas Intermediate and Brent Crude and today it's $5.

That comes right out of the refiner's bottom line, so a year ago refiners looked great; at the moment they look pretty bad. They'll come out of this. If you're a patient person, this might be a good entry point, but you're liable to not see a turnaround for another quarter or two.

Steve Halpern: Your recent research suggested the biofuel sector has been a failure and that that plays into your bullishness on the overall oil sector. Could you expand on that?

Robert Rapier: Yes, correct. I have warned people away from the advanced biofuel sector for a number of years, and the main reason is, if you think about what oil is, oil is ancient biomass that Mother Nature harvested, processed, added the heat, added the pressure, and converted into oil.

Biofuels are trying to do all that with human inputs and that makes it extremely difficult to compete. If you're going out and you're going and harvesting biomass and converting it into an oil, it's very, very difficult to compete with that.

Over the years, I've seen a lot of companies making various claims that I knew couldn't possibly be true. They could not sell biofuels for $1 a gallon, $2 a gallon. I had warned people that they're making claims that are incredible.

I had specifically warned away from a number of advanced biofuel companies, some of which are bankrupt today. The sector, as a whole, I think 90% of the companies I've said before will ultimately be bankrupt, and therefore, the one gem out of the 90, I just tend to avoid that sector completely.

There's a company called Solazyme (SZYM) who actually makes fuel out of algae; but they couldn't make it very economically so they shifted into neutroceuticals and pharmaceuticals and making oils for cosmetics and things like that.

Now, they'll probably be around for the long haul, but they won't be a fuel producer. That's what they organized to do, was to produce fuel. They haven't been able to compete in that market.

Steve Halpern: Now earlier you mentioned the fracking revolution. Could you explain what that is and perhaps highlight a few companies that are well positioned to benefit from fracking?

Robert Rapier: Sure, so what fracking is, and fracking has been around since the 1940s. It was invented in the Midwest; it was used across Oklahoma, Texas, Kansas.

It means drilling down into an oil formation and pumping water, sand, chemicals under high pressure and basically cracking open the rock, the source rock where the oil is. The sand is in there to hold those cracks open and then it allows the oil to flow into the well board.

Over the past decade, the technology of horizontal drilling, so drilling down and then curving the drill bit horizontal to the formation has been married to fracking, and those two techniques combined, have created the fracking revolution. It has. made a tremendous number of oil resources in the US economical to produce.

The difference in an oil resource and a proved reserve is, if you can economically produce it it's a proved reserve. We've know about the Bakken formation in North Dakota for many, many years, but it was never economical to produce. Today it is because of the fracking revolution.

There are some environmental concerns about fracking. Like I said, it's been around Texas and Oklahoma for many, many, many years.

But the more people that go in and do something like this, the more chance there will be to screw something up, so it's not like there's no environmental concern at all, there is some; things have to be done correctly, but correctly done fracking should pose no risk to water and so forth.

The fracking revolution has opened up North Dakota as one of the fastest growing oil-producing states in the country.

Many people don't know that Texas has had resurgence that actually is much greater even than North Dakota and so the Eagle Ford in Texas; the largest player there is EOG Resources, which was actually spun out of Enron many years ago.

EOG Resources (EOG) is the largest producer in the Eagle Ford. That's been one of our big winners; it's up 56% over the past year. We still recommend it, although it is getting up around the buy target that we set for it.

Again, Oasis Petroleum, they're the pure player in the Bakken and they've done remarkably.

Chesapeake Energy (CHK) is a natural gas producer who is shifting more and more into liquids production and they're in some of these plays. We recommended them back in May; they're up 30% since we made that recommendation.

Chesapeake has had some free spending ways over the years, but they've got a new CEO in there who's really looking at the bottom line and they're shift into liquids production, I think, will benefit them well and the stock has had quite a turnaround, especially as natural gas prices have bounced back off their bottom from last year.

Steve Halpern: Well, thank you for joining us; we appreciate your insights.

Robert Rapier: Thank you very much.

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