Thursday, November 14, 2013 12:54 PM
Harley Davidson, that icon of discretionary expenditures, is HOG wild again, reporting record sales. The XES energy service ETF just hit a new high. Corpus Christi is booming with foreign investment taking advantage of the surplus of crude and natural gas. The stock markets hit new highs. What could go wrong?
That’s what we worry about here each and every week. We have noted that the social mood in the Basin and Eagle Ford is very much like what we had in 1981. That worries rather than encourages me. So, let’s examine the recent oil price action.
Then we look at some fundamental reasons for, gulp, the recent pull back in oil prices.
The energy complex made its last significant lows in the summer of 2012. Crude bottomed at $80 and the XES at $28. Crude topped in August 2013 at $110. The XES peaked at $45 this past week. Since then crude has tumbled to $96.50, as I write today—Wednesday, October 23.
For perspective, the 200-week moving average (MA) comes in at $91.54. Price overshot that MA in the summer of 2012 and then took off for $110. The XES has dropped 2.5 percent just today, to $43.40.
The XES is a blend of all the major oil service firms including Halliburton, Baker Hughes and such. That makes it a great proxy for the energy service-driven Permian Basin economy. In the same 15-month period, Halliburton has risen from $27 to $52, about doubling in price.
Indeed, Halliburton’s third quarter earnings rose 17 percent to $706 million. But most of that increase came from overseas work.
Now we get to the ‘this bears watching part of the story.’ Halliburton (HAL) is the largest provider of hydraulic fracturing operations in North America. The increase in business has brought more competitors to the game. Earlier this year HAL talked of becoming ‘more efficient.’ HAL assumed more demand for natural gas drilling, which has not materialized. HAL took a $38 million charge for severance (read layoffs) and retiring equipment related to two efficiency drives.
In analyzing potential early warning indicators at the top of the boom in 1981, I reached this conclusion. Oil topped in price at $36 in 1981, and then began falling. However the rig count continued to soar. So more equipment was employed chasing lower and lower prices, a formula for tragedy if there ever was one.
Now the energy service sector is becoming a victim of its own technology success. Prices for fracturing are down. Improved technology has produced more natural gas than is demanded. Hence, drilling programs have scaled back, even as oil field service companies lay off workers and cut prices. Statistics bear out this trend. The number of rigs drilling Eagle Ford has declined 5 percent from a year ago. But the oil and gas output from these wells is 28 percent higher than just a year ago. So we have less equipment producing ever more product.
Jeff Miller, HAL CEO, commented Monday that everyone is very, very focused on continuing to drive efficiencies in the marketplace.
There’s that word again—efficiencies. I recall firms in the post-1986 bust engaging in what was called ‘right sizing.’ This was corporate speak for massive layoffs.
Regular readers are aware that I have been asking this question on these pages. With more and more oil and gas produced, why are prices so high? Indeed, now prices of oil and the stock prices of service companies are coming off recent highs. But this is occurring as the entire sector has geared up, built up, and assumed there would be an inelastic demand for their services. From the 52-story office building in Midland (groundbreaking in January 2014) to HAL’ largest-ever North American facility south of San Antonio, hubris and confidence are on display all around.
Oil was the last market to top in 2008. We are just about where we were in January of 2008, i.e., stock and oil price highs. Indeed, this next month will be the five-year anniversary of November 2008 stock market lows.
If oil prices peak in the period between now and the groundbreaking in Midland, we will have the perfect 34-year Fibonacci anniversary of the topping out of the ten stories added to the First National Bank of Midland in 1979.
Meanwhile I suggest watching that 200-week Moving Average for oil at $91.54. Readers can follow our updates at the weblog address below.
Dennis Elam PhD CPA Texas A&M University-San Antonio blogs at www.themarketperspective.com and writes on the energy industry.
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