Option Investor

Go Home, We Will Call You

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That is what drillers all over the U.S. are being told this week as the fallout from lower gas and oil prices. With nat-gas prices hitting $5.50 last week Whiting Petroleum (WLL) called it quits on capex spending.

One of my sons is a driller for a Whiting contractor and they literally told them to go home. The contract drilling firm that he works for told them Whiting cancelled the contract and told them to plug any unfinished holes and pack it up.

This story is being repeated all across the U.S. and around the world as hundreds of projects are cancelled for lack of funding. Whiting is just one of hundreds of firms that have to face the cold hard facts. Whiting spent $850 million for capex in 2008 and said spending for 2009 will be substantially less. They said they would only be drilling within their own excess cash flow and would not take on any more debt EVEN if it came available. That comment is telling. It means they lost access to their capex credit lines just like hundreds of other exploration and production firms. When oil was over $100 bankers and investors were eager to put their money on the line because payback was guaranteed. With a $100 drop in crude prices to the mid $40s it is no longer guaranteed and bankers are running scared.

Goldman Sachs hit the sector hard on Friday saying they could see prices in the $30 in 2009 and their target price for all of 2009 was $45. There are literally thousands of projects that won't get funded, started or completed if oil prices remain in the 40s.

We could see another blowout of labor and equipment like we saw in 1998 that nearly ruined the industry. Merrill Lynch said there were 1400 working gas rigs in the U.S. and they expect many of them to be laid down. When rigs are mothballed they are laid out flat on the ground to avoid accidents and damage. Many times parts are cannibalized to keep other rigs running rather than buy new parts while the others lay rusting.

Encana announced it had postponed indefinitely its plans to split into two separate companies because of the financial crisis. Encana typically announces its next year's budget in December but so far their announcement has been to "proceed in a conservative and prudent manner."

These companies are refocusing their efforts to areas where wells are cheap and gas is easy to produce. At $5.50 and falling there are quite a few areas where it is no longer cost effective to drill.

This same problem is occurring in the oil patch and work is being halted everywhere until oil prices rebound. Oilfield workers are paid hourly. If they are not working they are not being paid and most cannot last more than a couple paychecks before they have to find another line of work. It months pass before oil prices rebound then all those workers will have moved on to a new job. Restarting the recent pace of drilling will be nearly impossible for several years.

New workers will have to be hired and trained. Rigs renovated and missing parts ordered with unknown backlogs. Pipe orders will have to be put in process with the potential for being backordered for a year or more. Make no mistake. Halting drilling today is going to be a serious problem when the recession passes and demand spikes suddenly.

With the drop in oil prices the oil sands developments have turned into quicksand for many firms. These are very expensive, very labor intensive projects that need oil prices over $60-$65 to be commercially viable. Suncor Energy (SU) and Canadian Natural Resources (CNQ) have two projects in advanced stages and relatively low cost but both have slowed development significantly. StaatoilHydro scrapped its multi-billion dollar Edmonton upgrader because of falling prices. Out of seven major oil sands projects only one, an expansion by Shell (RDS) remains in play. Shell already backed off on two other projects. Petro-Canada ran out of money in September when it was unable to attract project financing on falling oil prices. Nexen announced it was delaying its Long Lake expansion until prices recovered. This same story is playing out all around the world and the impact to future production volumes in 2010-2011 is going to be drastic.

OPEC meets again on Wednesday and it is almost a sure bet that they will cut another 1.5 million barrels of production. I am betting that we see a sell the news event because of last week's rally in advance of the meeting. First, depending on the success they have had in getting members to adhere to the November cut, investors will be taking odds on getting a December cut to stick. OPEC countries are hurting and they can't afford to cut production but they also can't afford not to cut production. If they just keep pumping as fast as they can we could see prices in the $30s and that would create untold devastation in the oil patch. They need to suck it up and bite the bullet and stand tough on production until prices return to the mid $60s or higher. They have the power but they are too weak to use it. Let's hope they find some backbone.

January crude futures expire next Friday.

The results of the reader poll last week on continuing to include low priced stocks in the recommendations was 100% yes. I received dozens of emails all strongly in favor of profiling those stocks. Since they make such a good addition to an IRA I was not surprised and glad to see such a strong response. I am adding two more solar stocks this week that I believe have a bright future. It is not my intention to load up the portfolio with solar stocks but they have been beaten pretty severely and I believe these are good candidates.

Check out the end of year renewal special we are advertising this weekend. There is another crude oil video and two special reports on energy.

Click here for the full package description

Jim Brown

January Crude Futures Chart - Daily
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Natural Gas Futures Chart - Daily
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January Gasoline Chart - Daily

Gasoline chart unavailable this weekend. Thank you Qcharts!

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