Dear readers,

I am writing this week from the Permian Basin in Texas and New Mexico. My day job brings me to the area, and has put me in touch with the men and women working the most important oil-producing basin in the country.

People are hurting here and business is down. I had dinner with an oilfield services business owner last night, and he told me that he is lucky because his business is only down 60%. Such is the case across the region, but there is a reason that the Permian is still producing oil nearly 100 years after the first well was drilled here. This region has seen the booms and busts before, and it knows how to survive them.

I mention often that the entire oil industry has always swung from booms to busts and back again. In good times (e.g., with crude fetching $100 a barrel) the industry over-invests, and in the bust cycles (e.g., $30/bbl oil), it resorts to deep spending cuts — which sow the seeds of the next boom.

As an investor, you want to buy low and sell high. To do so, you have to recognize what’s high and what’s low. I base those extremes on my expectations for commodity prices over the next three to five years. Right now, I am betting on higher prices during that span. So I think I could buy low right now.

There are many mixed messages right now from pundits, with some suggesting oil could get down to $10/bbl, or that we could see current prices for many years to come. This is where you, as an investor, have to do your due diligence. Listen to the competing messages, and weigh them for credibility. What are the supply and demand forecasts? What is the inventory picture? What is the competition?  

Last week the price for the front month contract (February 2016) of West Texas Intermediate crude (WTI) dropped all the way down to $26.55/bbl, the lowest in nearly 13 years. But the latter part of the week saw a surge in the price of WTI and the front month rollover to March, so the benchmark ended the week at $32.25/bbl.

That 21% rebound in the price of crude lifted many of the beleaguered oil and gas stocks, with some of the most beaten-down names gaining 20-30%. It was inevitable that at some point crude would bounce hard, but if you are kicking yourself for missing out on last week’s rally — don’t. Just be patient and execute your strategy. Excessive greed can wipe you out. Try to look at the market objectively, weigh your investment style, and if you believe — as I do — that the current price of oil is unlikely to persist, then it’s time to start shifting money into the companies that will survive long enough to take advantage of the recovery.

I always stress that everyone has a different investment style. Some people are short-term traders. Some are more patient buy and hold investors. Personally, I don’t attempt short-term trades for a very simple reason. Doing so requires one to consistently and accurately predict investor psychology. I prefer to shift money into the market in stages when I feel it’s undervalued for fundamental reasons, and to lighten up when I feel that it is overvalued.

Fundamentally, crude is deeply undervalued, because oil prices are too low to justify the investments that will ensure that global crude supplies will meet global demand for crude oil over the long term. The key phrase here, however, is “long term.” Prices can veer far from sustainable price levels for a long time for various reasons. That’s not a problem for patient investors.

While I can’t promise the short-term trader that we won’t visit the $20/bbl level before a recovery, I am much more confident that oil will be significantly higher than the current price in a year or two. Thus, this is the time to accumulate. Buy when others are fearful.

That’s this week’s message as I drive around the Permian Basin. History rarely affords the opportunity to shift money into the oil market as such deeply discounted prices, but when it does, that opportunity typically doesn’t last for long.

Sincerely,

Robert Rapier from Midland, Texas

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