Falling Oil Prices Continue to Burn Producers

On the heels of crude oil’s fourth month of declines, energy producers are continuing to experience significant stress ever since the price of crude oil peaked in late June at $104 a barrel. With oil prices currently at $80 a barrel, domestic exploration and production companies have experienced the largest declines. This is mainly due to the fact that domestic oil production, which is mainly unconventional (ie shale production) is significantly more expensive on a per barrel basis than more traditional extraction methods such as deep water drilling.

This spread is apparent when comparing more traditional producers such as Exxon Mobil (XOM) to unconventional producers such as Cabot Oil & Gas (COG). From oil’s peak in late June Exon is down roughly 5% while Cabot is down nearly 25% in the same time period. The benefits of higher margin production are made clear when examining the current spread between traditional producers and unconventional producers. When looking at a longer timeframe, however, the reverse is true; over the past 5 years Exxon is up only 35% while Cabot is up 220%. When juxtaposing current energy prices with historical energy prices, this short term spread appears to be cyclical and should revert back as energy prices eventually rise. When energy prices do reverse directions, the reverse spread trade (short traditional produces and long unconventional producers) should generate significant returns. The performance of all oil producers are directly correlated to energy prices and if energy prices continue to fall, all oil producers will continue to experience financial stress.

-- Radi Sultan