Think Twice Before Bottom-Fishing for Oil Stocks

The days of triple-digit oil prices may be over. In fact, oil prices may have a difficult time breaking $75 a barrel over the next few years. That’s because producers will keep flooding the market with oil. Saudi Arabia is doing its part. The OPEC leader is producing oil at a near-record pace. The U.S. has not slowed production, either. Despite a 50% decline in prices, production remains near record highs. These trends will not reverse anytime soon. That means oil prices will stay depressed much longer than most people expect.This is something investors should think about before bottom-fishing for oil stocks.Last month, oil services company Baker Hughes (BHI) said the U.S. oil rig count fell to a 12-year low. Oil companies have announced tons of lay-offs. They’ve also cut spending (capex) since many projects cannot generate profits with oil under $75. (Oil prices are trading at $55 a barrel today.)These cuts are supposed to result in fewer barrels produced. With less oil (supply) on the market, oil prices are expected to stabilize and eventually move higher.However, U.S. production is near its highest levels since 1973.Most of this production can be blamed on shale oil companies. Production costs for the industry have fallen by 25% over the past year. This amounts to roughly $55 a barrel (from $75 a barrel). In short, these companies can keep ramping-up production at much lower prices. That’s why U.S. oil production has not gone down much despite the huge drop in rig counts. More important, most shale companies are likely to produce as much oil as possible with prices over $55. That’s because they have massive debt loads.According to Bloomberg, shale oil drillers are carrying over $230 billion in debt on their balance sheets. Most of this debt was issued when oil prices traded above $80 a barrel. And nearly half of North American shale drillers are spending more than 10% on interest payments alone. Based on this factor, shale companies need to produce as much oil as possible (as long as oil prices trade above $55 a barrel) to pay off their debt.This could keep U.S. oil production near record levels for a few years. It’s also likely to keep oil prices depressed for just as long. While U.S. rig counts are at a 12-year low, the Saudis are drilling oil at a record pace. Their oil rig count is at a 20-year high.The Saudis are using this strategy to keep oil prices low. This will help the country maintain market share — something that was lost as the U.S. used higher oil prices to produce massive amounts of oil. The Saudis are expected to keep the pedal to the metal. Oil production is projected to hit 11 million barrels a day by year-end. That would mark a 30-year high for the country. And U.S shale companies need to produce as much oil as possible to pay down debt. These factors are likely to keep oil prices depressed (under $75) for at least the next few years. This is something investors need to consider before buying oil stocks at current levels. My advice is to stay clear of companies that are dependent on higher oil prices. This includes:

•  Deepwater drillers like Transocean (RIG) and Noble Corp. (NE) … •  Oil sands plays like Canadian Natural Resources Ltd. (CNQ) and Suncor Energy (SU) … and •  Seismic data companies like ION Geophysical (ION) and CGG (CGG).

Most are trading at 52-week lows and will likely fall further in the months and years ahead. The best-positioned plays are oil services companies with onshore exposure. Names like C&J Energy Services (CJES), Nabors Industries (NBR) and Helmerich & Payne (HP) could continue to see strong business from shale oil companies that need to drill for oil.

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