Oil stocks are plunging… and there may be even more trouble ahead.
As regular readers know, the price of oil has tumbled over the past few months. The benchmark West Texas Intermediate (WTI) crude oil price is down around 40% since July 1. And the decline in oil prices has destroyed oil stocks.
For example, Bakken shale-oil powerhouse Continental Resources (CLR) has fallen around 58% in just over two months. Williston Basin leader Oasis Petroleum is down 77% in five months. And these oil producers could fall even lower next year.
[ad#Google Adsense 336×280-IA]Here’s why…
In the first quarter next year, U.S. oil producers will report their 2014 year-end proven oil reserves.
A company’s proven oil reserves are the amount of oil a producer can extract economically.
In short, while there may be plenty of oil in the ground – a company’s proven reserves are the amount of this oil it can produce for a profit.
The Securities and Exchange Commission requires companies to calculate their oil and gas reserves based on the 12-month average oil price.
An increasing oil price makes more oil profitable… and allows producers to grow their proven reserves.
From 2010 to 2013, the average oil price increased every year (except for 2012 when it was about flat). That allowed oil producers to increase their proven reserves. The table below shows the oil producers who increased their proven reserves the fastest during that time.
Investors tend to favor companies growing their reserves, so the share prices of these companies rocketed. For example, Oasis Petroleum shares soared more than 200% from 2010 to 2013. And PDC Energy shares increased more than 190%.
But the opposite also holds true. Investors may “run for the exits” when oil producers report decreasing proven oil reserves.
For example, leading shale producer Pioneer Natural Resources (PXD) reported a drop in its 2013 proven oil reserves on February 10. The company’s share price fell 3% on the news, despite the fact oil producers were rising at the time.
And with oil prices so low today, we’re about to see many oil producers report decreasing proven reserves.
If the oil price remains at its current level for the rest of the year (around $63 per barrel, as of Monday), the average oil price will decrease this year to $92.77 per barrel. That’s the lowest average oil price we’ve seen since 2010… and a 5% decline from 2013’s average oil price.
Lower average oil prices will make more oil production uneconomic… cause oil producers’ proven reserves to decline… and share prices to fall.
Unless oil prices move a lot higher before the end of the year, I recommend waiting to buy U.S. oil producers right now. We may see another selloff in these names in early 2015.
Good investing,
Brian Weepie
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Source: Growth Stock Wire