Energy Alerts, May 6, 2015

Oil prices have rebounded from their winter lows. But the oil industry isn’t out of the woods yet.

Since St. Patrick’s Day, when West Texas Intermediate — the U.S. crude oil benchmark — bottomed out at $43.46 per barrel, oil has been on a tear. At today’s price of $60 per barrel, WTI has rebounded by more than 30%.

A few key factors have fueled that rise. First, the amount of crude held in storage is no longer soaring the way it was this past winter, when investors fretted that storage depots would run out of physical space to hold all of the oil coming out of shale fields from Texas to North Dakota. In recent weeks, the Department of Energy’s weekly data has shown only small increases in stockpiles.

Oil is no longer piling up in storage so quickly because refineries are buying more and turning it into motor fuel. Demand for gasoline has been strong this spring, thanks to continued modest hiring gains that are putting more folks behind the wheel as they commute to new jobs. Plus, cheaper gasoline is likely spurring more travel. As a result, the Department of Transportation reports that Americans are driving more miles than ever before. (See page 2 of the DOT report for historical data.)

And, finally, U.S. oil output has hit a plateau. After growing sharply last year and during the early months of 2015, daily output is now holding fairly steady at a bit less than 9.4 million barrels. Chalk it up to the huge reduction in drilling activity prompted by the sharp drop in oil prices that started last year. The number of rigs actively drilling for oil is down more than half from last autumn, and will likely keep falling. That, in turn, means U.S. oil output might start falling fairly soon.

All of that is bullish for prices. But nobody in the oil industry is breathing a sigh of relief yet.

First of all, another price drop can’t be ruled out. Stephen Schork, editor of the Schork Report, a daily publication that analyzes the fundamentals of energy markets for professional traders, thinks the recent price rebound in oil is overdone. Refineries are buying lots of crude now to take advantage of large profit margins on refined fuel, a buying spree that he believes won’t continue. That could spell another “leg down” for crude prices sometime before summer arrives.

Companies in the oil patch are all too aware of that possibility, and they are investing accordingly, paring drilling budgets and looking everywhere for cost savings. One Texas-based energy consultant, who requested anonymity so he could speak freely, says that “caution is the MO” right now as drillers focus on their most promising oil fields and cut spending everywhere else.

That means targeting areas with lower drilling costs, such as the Eagle Ford Shale in Texas, and avoiding higher-cost plays such as North Dakota’s Bakken Shale. (Bakken producers are also handicapped by the lack of pipeline capacity there, which causes North Dakota crude to trade at a significant discount to WTI.)

But even Texas is seeing reduced drilling investment. The Railroad Commission of Texas, which regulates state oil and gas production, reports that it granted fewer than half as many oil drilling permits in the first three months of 2015 than it did during the same period last year. The same story is playing out just about everywhere in oil country. In Louisiana, for instance, drilling activity has fallen to 1970s levels, says Ragan Dickens, director of communications for the Louisiana Oil & Gas Association. The downturn has been especially bad for the many oilfield services companies based in Louisiana that do business in other oil states, he says.

The Upshot for Investors

We look for oil prices to gradually grind higher, with WTI ranging from $60 to $65 per barrel by August and a tad higher in September. But even if that pans out, markets figure to stay volatile, and many firms in the oil industry will remain under pressure.

So where does that leave investors who are trying to size up the oil industry? In the short term, it seems clear that companies that refine or transport crude and petroleum products are in better shape than companies that pump oil out of the ground. Energy expert Schork favors refiners, which are benefiting from relatively affordable oil and the recent run-up in gasoline prices. That makes refiner Phillips 66 a more profitable bet than Conoco, its former parent, he says. If you’re interested in energy master limited partnerships, “you’ve got to stay away” from those that produce oil.

Firms that provide services to oil drillers appear to be especially risky bets in the near term, too. The anonymous Texas energy consultant says he knows of service providers that are slashing their rates below cost, simply to hang on to clients that are demanding big discounts. By contrast, the integrated oil majors that both produce and refine oil are more insulated from such pressures. Firms such as Exxon, Shell and BP are making less on the oil they’re pumping, but their huge refining operations help offset those losses.

Tesla Powers Up the Battery Market

A few weeks ago, we wrote about the growth prospects for the energy storage business. Right on cue, electric car maker Tesla has announced a new line of lithium-ion batteries that it will begin selling to homeowners, commercial customers and utilities this summer.

We’ll reserve judgment on the quality of Tesla’s batteries until customers start testing them, but there’s no question that this is a sign of the energy storage industry’s future. At $3,500 plus installation, Tesla’s battery should be a compelling option for both homeowners and businesses looking to guard against blackouts or store energy generated during the day by rooftop solar panels.

Electricity customers whose utilities charge “time of use” rates that vary during the day could especially benefit from the growing supply of large batteries. Such plans charge higher rates during times of peak demand and lower rates at night or during mild weather. Customers who can charge a large battery when prices are low and then run their homes or businesses with that stored energy during the day when rates are high will be able to shave their electric bills, perhaps substantially.

According to the Department of Energy, in 2013 (the most recent data available) more than 4 million residential customers were covered by time-of-use pricing plans. It’s a near certainty that such pricing will expand in the years ahead as utilities look to manage peak demand for power without building expensive new power plants.