Don, we feel like a lot of very good companies have traded down in sympathy, but some don’t really have a good reason. For example, natural gas prices have been firm all year, and higher than they were a year ago. Yet natural gas producers have also sold off sharply. Likewise, some of the midstream MLPs have sold off more than they should have. We believe there have been a lot of bargains created as a result of the sell off, some of which should not be all the risky.

Right now Oasis is a really high risk, high reward play. If oil prices rise from here — and I think the average price for next year is going to be above where it is now — then Oasis should soar. However, at current prices Oasis is almost definitely gone to cut spending, and they will likely have to write down some reserves at year end. But most of this is priced in at this point.

At the end of last year, their PV10 was $5.2 billion, and their EV was $4.1 billion. That PV10 will almost certainly fall this year as a result of low oil prices. They also have a lot of debt. Nevertheless, I feel like the upside at this point is greater than the downside — assuming you have the risk tolerance. I was a bit concerned about Oasis earlier in the year because of my belief that oil prices would fall. But I really think it’s overs shot to the downside. I am a buyer right now.

As far as their cost of production, it varies depending on the location within the Bakken. Some of their acreage isn’t going to be economical at sub-$70/bbl WTI prices. However, they have hedged about half of their 2015 production at a floor of $87.77/bbl. Unless oil prices remain at these levels and it starts costing them much more to hedge going forward, I think they will come out of this all OK. And they have to be attracting the attention of some of the larger players who want more exposure to the Bakken.

Don, it’s always hard to predict these movements short term, but right now my feeling is that the upside is greater than the downside. If someone told me that in six months oil would be trading at $10/bbl from the current price, I would guess that it would be higher. There’s just too much marginal oil production that isn’t profitable at current prices.

Mark, there are many different ways to rework existing wells. I would think refracking them could be economically worthwhile given the lower costs. I just don’t know if there is enough data on how quickly they deplete the second time around. That will ultimately determine how economical they are. Fracked wells deplete very quickly in the beginning, but produce a lot of oil and gas. If the refracked wells also deplete quickly but don’t have that initial surge, it could be a problem. But I haven’t seen data either way.

Hi Arthur,

First of all, I am sorry for the losses you sustained. Emerald’s balance sheet still looks attractive at higher oil prices than we are seeing today, but there are two things at this point that are problematic from our standpoint (besides just the decline in share price, which can be irrational in some circumstances).

The overall decline in oil prices has hit small producers especially hard. Of course those are also the ones that will have the largest bounce to the upside as oil prices strengthen. So were it not for the next factor, I would still be comfortable with a Buy on Emerald, with the appropriate warnings that it’s for investors with aggressive appetites.

So my philosophy is if the underlying story remains intact, and the declines are understandable — which they are in the case of plummeting oil prices — I will hang onto a company if I feel oil prices will recover in the short to mid-term. However, if management makes a move that is blatantly shareholder unfriendly, my philosophy on the company changes. That has happened in the past for me with Petrobras, Westport Innovations, and Eagle Rock Energy Partners — to name a few. I liked the underlying story, but then management made a move in their own self-interest — or they otherwise gave poor guidance — and that changed the picture. That’s what happened with EOX here, and is the reason behind our change in outlook for the company.

We were certainly not the only ones caught off guard by their move. There were many brokerage houses that rated the company highly, and then suddenly issued Sell ratings. Our independent analysis suggested that the company was in a very good position for generating positive cash flow with oil in the $70 to $80/bbl range (which is where I think it will return within 12 months).

I always try to caution investors not to concentrate too much into a particular company, as it is a high-risk move. I also remind investors to protect their downside, and know their risk tolerance. The first piece keeps your portfolio from taking a substantial hit from a position that turns south, and the second allows you to prevent things from going too far south, depending on your risk tolerance. (Although people with moderate to conservative investing styles should never invest in a company like EOX in the first place).

We will survive this downturn, and I believe we will continue to pick more winners than losers as we have for the past two years. But make no mistake, EOX is a bitter pill to swallow for all of us.

There are several reasons for the decline, one of which is the overall downturn in the energy markets. If the spread is only $4, these projects will be really marginal. I have been more concerned about the prospects for natural gas prices creeping higher due to greater demand, which would also eat into the spread (but would be good for natural gas producers). But I think LNG prices will recover over the next six months, as I believe energy prices in general will strengthen after potentially remaining soft in the first half of 2015.

I think 2008-09 can be very instructive considering the current plunge. I have gone back and looked at that time period many times, noting what got hit the hardest and which companies came through in good shape. I think the midstream MLPs you mentioned should all be in decent shape. As you say most of their income comes from pretty secure fixed contracts. They are likely the safest harbors in the storm. Their unit prices are dropping along with the overall energy sector, but I don’t think you are going to see a sharp drop in profits like you will with the upstream guys.

I would say it depends on whether you have gains that need to be offset. There is a lot of tax-related selling going on right now on top of the selling due to the drop in the price of oil — which has battered oil producers across the board. Unless oil prices continue to fall — and I don’t believe that’s likely — I would expect we are pretty close to a bottom. I think Whiting is pretty well-positioned to return to growth as oil prices recover, but it’s not likely to do much until it is very clear that prices are starting to recover. If you are patient and don’t need the loss to offset the tax gain, I would sit tight.

So many of these companies were so oversold that it was just a matter of time. You can look at the fundamentals and what they warrant all day long, but panicked investors can turn those fundamentals upside down.

I have maintained that companies like EOG will come out of this looking pretty good, and I actually said on a radio interview last month that I would load up on EOG should it drop to $90. It was $98 at the time, and did drop to $90, but today’s energy rally has EOG currently up 6.5%.

WLL is in pretty good shape, as they aren’t too leveraged. They will survive the current fall, and when prices bounce back to $70 — which I think will happen in the 2nd half of next year — they will shine. But EOG is really well-positioned to sustain the current prices. Among the larger companies, I think ConocoPhillips is well-poised to withstand this weakness. Let’s just hope that this rally that started yesterday is a sign that we have seen the bottom.

Harold,

You are correct. There will be some write-offs of reserves this year for oil companies. I have never looked at it closely, but my guess is that companies that are expected to write off reserves sell off prior to that write-off just as we have seen the oil companies sell off. So it isn’t a huge surprise. It’s the big surprise like when Shell did it a few years ago that there can be a big haircut.

One thing I am working on is putting together a large database of the value of the proved reserves of oil and gas companies as they come in. But as you say, it will probably be April before we see them.

If you look at the history of oil prices and where USO has traded, I think it’s unlikely that it gets back into the $35 range in the near future. But I do think you will see it stabilize at a bit higher than where it is now. I would probably try to capture back a little more before selling though.

Joe,

You probably know that we got people out of Linn a while back. I don’t think there are any catalysts in the short term to drive the price higher, but I also don’t think there is a lot of downside from this point. I think a distribution cut is already being priced in, so when/if that happens I don’t think you will see a huge drop. If the cut isn’t huge, it could rally some, but I don’t think it gets back to $20 in 2015 unless oil prices skyrocket.

Hi Peter,

Oil consumption has grown for the past 4 years, and I expect it will show growth again this year. In developed countries oil demand has declined, but growing demand in developing countries has more than offset the declines. So it depends on how the question is phrased. Has global oil demand gone down? I have seen no evidence of that. Has demand growth slowed. Perhaps. Has it declined in the West? Yes.