Cash In on Changing Tides for THIS Sector

Eric Fry By Eric Fry
Macro Strategist

Oil & Gas

“Who wants to be a billionaire?”

That was the question I posed to attendees at last month’s Private Wealth Seminar in beautiful Whistler, British Columbia.

No one raised a hand. Perhaps they were all billionaires already… or perhaps they were too shy to admit publicly that they were not yet billionaires.

Whatever the case, I showed them precisely how to become a billionaire.

And I’m going to share the same wisdom with you today, so pay attention.

Here’s the secret: Invest all your money in one stock that…

  • Produces an annual loss a quarter of the time
  • Produces a three-year loss 8% of the time
  • Produces a decade-long loss once every 30 years.

Skeptical?

You shouldn’t be. The stock I described is Berkshire Hathaway – the stock that made a multibillionaire out of Warren Buffett and made multimillionaires out of scores of other investors.

The point I was trying to make was that grand investment successes almost never result from a serene chairlift ride atop upwardly sloping annual returns. They result from a harrowing roller-coaster ride of exhilarating gains and gut-wrenching losses.

Even the greatest of stocks will subject investors to recurring – and sometimes lengthy – periods of negative returns.

What distinguishes a great stock like Berkshire Hathaway is not its lack of volatility, but rather how that volatility manifests over time.

Simply stated, the greatest stocks produce bigger ups and smaller downs than the average stock. But the ups and downs still happen.

Buffett was a savvy buyer when most folks were panicky sellers. He invested during the moments when good stocks were selling on the cheap.

In today’s high-priced market, very few U.S. stocks are selling on the cheap. But one portion of one particular sector is conspicuously cheap. That’s because it is distinctly out of favor.

In fact, this sector seems as useless to most investors as a rotary phone does to a teenager. And it has the potential to make billionaires out of all of us.

The Services Slum

Energy stocks in general have not been very popular with investors for the last several months. But energy services stocks have been especially unpopular…

Within the energy services sector, the companies that focus on the Permian Basin in Texas have been some of the worst performers. But there’s a reason for that poor performance…

Production growth in the Permian is booming. From less than 1 million barrels per day (bpd) seven years ago, the Permian now produces nearly 3.5 million bpd, according to the U.S. Energy Information Administration.

This rapid growth rate, combined with the rising price of crude, should be great news for oil services companies that operate in the region. And it is… sort of.

Production has been growing at such a breakneck pace that it now exceeds pipeline capacity. As a result, some of the Permian oil can’t make its way to refineries on the Gulf Coast unless it travels by truck or train. That’s an expensive option.

In fact, it is so expensive to transport this oil that the price of Permian crude, known as WTI Midland, has dropped to a steep discount relative to the benchmark West Texas Intermediate (WTI) crude.

The severe pricing penalty for “trapped” Permian crude has created a big scary narrative that is spooking investors.

It goes something like this: Pipeline capacity is so maxed out in the Permian that many oil companies in the basin will halt most or all of their drilling activity. As a result, demand for oil services will dry up and revenues of oil services companies will slump.

This narrative certainly contains a few grains of truth. But the biggest part of the Permian story is not the temporary slowdown that might occur during the next few months; it is the spectacular growth that is all but certain to occur over the next several years.

In other words, the recent weakness of many oil services stocks seems to be an outstanding long-term buying opportunity.

[Don’t] Mind the Gap

While it is true that pipeline capacity in the Permian is maxed out, it is also true that a number of new pipelines and/or capacity expansions will be coming online next year.

By the second half of next year, pipeline capacity should catch up to production once again… and then continue to expand thereafter. This likelihood shows up in the pricing of WTI Midland crude futures contracts versus that of WTI futures contracts.

As you can see, based on futures prices, the discount between WTI Midland and WTI narrows from about $16 on the September 2018 contract to less than $2 on the December 2019 contract.

In other words, today’s suboptimal pricing in the Permian will fly past us like a billboard on Route 66. Before long, we’ll be seeing it in the rearview mirror.

The heavily discounted pricing of Permian crude is certainly a near-term challenge, but it does not dim the long-term investment appeal of services companies that operate in that basin.

According to IHS Markit, oil production in the Permian Basin will soar to 5.4 million bpd in 2023. This assumes a whopping 41,000 new wells and more than $300 billion in spending.

That’s a billionaire-making opportunity. Don’t let it pass you by.

Good investing,

Eric