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Why Are Shale Drillers Spending $25 Billion at the Mere Hint of an Oil-Price Increase?

Oil has recovered from the abysmal per-barrel prices we saw in 2016, but many investors and analysts are still maintaining a cautious view.

On this episode of Industry Focus: Energy, Motley Fool analysts Taylor Muckerman and Sean O'Reilly explain why demand seems to be a bit weak for the amount of oil that the U.S. is producing, and why that's so important. Tune in to find out a few companies that investors will want to take a look at given the potential oil glut, when we might actually have a bit of an oil shortage in the next decade (and why), and more.

A full transcript follows the video.

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This podcast was recorded on March 23, 2017.

Sean O'Reilly: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. Today is Thursday, March 23, 2017, so we're talking about energy, materials, and industrials. I'm your host, Sean O'Reilly, and joining me today in studio is Motley Fool premium analyst and part-time crooner, Mr. Taylor Muckerman. How's it going, sir?

Taylor Muckerman: Hey, hey hey.

O'Reilly: So, the dynamic duo is back. I missed you.

Muckerman: Yeah, it's been three or four weeks.

O'Reilly: What have you been up to?

Muckerman: I did some skiing in Colorado, I was in Las Vegas last weekend.

O'Reilly: Did your skiing get disrupted by the Trump sons? I heard they were in Aspen and it messed up some vacations.

Muckerman: No, I wasn't that deep into Colorado. I was in Breckenridge and Keystone, Summit County.

O'Reilly: I think they were in Aspen, yeah. That would have been fun though, huh? To ski with the Trump boys? [laughs] 

Muckerman: I guess. Could be doing some hobnobbing.

O'Reilly: Secret service? So, oil has been weird while you were gone. Did you listen to all the shows?

Muckerman: I listened to a couple. You had Tyler Crowe from Africa, long distance in the heart of African oil land.

O'Reilly: Tyler was back!

Muckerman: I miss that guy.

O'Reilly: We had to do it at a certain time because when everybody gets off work there, they go on their cellphones to go on Facebook and stuff and it jams up all the cell towers. And that's his internet connection.

Muckerman: Where are these Google blimps with internet, and Facebook satellites with internet? Come on, guys.

O'Reilly: Yeah. What, Zuckerberg wants to have the drones flying around the planet to provide internet?

Muckerman: Yeah. Well, when the company is based on access to the internet, might as well provide it.

O'Reilly: Wouldn't that be nice?

Muckerman: But this isn't a tech show.

O'Reilly: It's not. Darn you, tech. That's tomorrow. No, we're going to talk about oil, that oil there in the ground. Couple months ago, OPEC cut production, and everybody was like, "Oh, it's $50, it's coming back, maybe $70 this year." You, very wisely, have been a little less euphoric, enthusiastic.

Muckerman: Yeah. I feel like we've talked about what's happening months ago, before it actually happened.

O'Reilly: But we have to do it again.

Muckerman: Yeah. OPEC cut, U.S. said, "We're not going to, we're going to ramp it up."

O'Reilly: Fuel Fix, you sent me a very interesting blog, I was very happy to read this, because it gives some hard numbers for what we're talking about. The headline reads, "Is The Boom Back? Drillers To Spend $25 Billion More In 2017," by David Hunn, it ran on March 16th. That's a lot of money. And also, when I read this, it popped into my mind that Exxon[Mobil] (NYSE: XOM) made that $6.5 billion purchase from the Bass family down there in Texas of shale property. So now, you have the biggest domestic energy company out there getting in on the game. It's like, "Ugh, we're going to do this again?"

Muckerman: Reminds me of their XTO purchase way back when.

O'Reilly: Oh, gosh, what year would that have been?

Muckerman: That was 2010 or 2011.

O'Reilly: How big was it? Why did you say that reminded you of this?

Muckerman: Because they were trying to get into the shale gas game when prices were sky high, then they fell off. At least now, maybe they're buying at low prices. Could be. Maybe $50 is the new $100. The U.S., like you said, spending is up globally throughout the rest of this year, predominantly in the U.S.

O'Reilly: They're getting so efficient. Yeah, so, what else did you take from this? What did U.S. production peak out at? 10.3 million barrels?

Muckerman: Something like that, we dropped below 9 [million] recently. But now, they're expected to boost another 1 million barrels a day over the next year or two.

O'Reilly: Guys, stop it. Guys.

Muckerman: [laughs] Yeah. They keep getting more efficient.

O'Reilly: Crowe used to talk about how, "These guys only know one thing, these wildcatters, and that's getting out there and finding some oil."

Muckerman: Yeah. If you read the history of some of these guys, The Frackers is a book by Greg Zuckerman? I think?

O'Reilly: I can Amazon it.

Muckerman: I know his last name is Zuckerman, because it rhymes so nicely with my last name, Muckerman. Great book, yeah, the history of Harold Hamm and Aubrey McClendon and a few other infamous wildcatters.

O'Reilly: This is available on amazon.com and fine bookstores everywhere. It is Gregory Zuckerman.

Muckerman: Gregory, good. My memory serves correctly.

O'Reilly: The Frackers: The Outrageous Inside Story of the New Billionaire Wildcatters. Yee-haw.

Muckerman: That book goes back, I think, several decades, and nothing has changed. Oil has just gotten cheaper to produce via fracking. So, if you really want to learn about this, what's going on in the United States, in my mind, that's the book to read.

O'Reilly: When did you last read it? That sounds awesome, I think I'm going to get this on my Kindle.

Muckerman: A couple years ago, I think The Fool got an advanced copy and we passed it around. I read it very quickly because it was very interesting.

O'Reilly: I do want to get your thoughts on something that Tyler Crowe said when I had him on the show. To your credit, you've been less euphoric with the oil prices, because all these guys, all they know is to --

Muckerman: Yeah, once it's break even, they're ready to go, baby.

O'Reilly: [laughs] "We're breaking even, we'll make it up on volume!" But, the other thing was, I think the day I had him on, there was another inventory build. I think it was just under 9 million barrels, it was unexpected, everyone was freaking out, oil fell 4.5% that day. And Crowe and I chatted about it, and his point was, the United States oil market in terms of consumption and, therefore, very closely tied to Cushing --

Muckerman: West Texas intermediate pricing at Cushing, yeah.

O'Reilly: It's 16% of the oil market. That's a lot, cool. But this is not the oil market.

Muckerman: Yeah, OPEC still reigns supreme.

O'Reilly: Well, no, his point was, everybody is worried about oversupply here, and it's being stored here, but his point was, the market fixates on U.S. supply and storage here because this is the only good data we have. For example, China's oil production is down 7%. But do we trust that? We definitely don't trust the Saudi Arabian numbers. They're all checking each other, or whatever, I don't know what that means.

Muckerman: Yeah. I don't know if we have any necessary reason -- just because a U.S. government agency isn't able to validate it doesn't mean that it's not true.

O'Reilly: Right, but it also doesn't mean --

Muckerman: Maybe they're thinking the same thing about our inventory numbers.

O'Reilly: Fine. It just seems odd to drive the price down of a global commodity, that arguably, our economy needs right now, down by 4.5% in a single day because of the inventory numbers in one market that represents 16% of the global market.

Muckerman: Well, I think it's because of the fact that --

O'Reilly: This has a "Mr. Market" Benjamin Graham feel to it, is the point.

Muckerman: I think maybe prices took a nosedive because they weren't all that high to continue to build inventory. That just means that these companies really don't care if oil is in the $40 range, they're going to continue to produce. It also means that demand isn't soaking up the new production. So, you look at, the IEA came out recently and suggested that oil demand growth -- not oil demand overall, but oil demand growth -- will slow in 2017 versus 2016. So, you had around 1.6 million barrels per day of new demand growth last year. They suggest only 1.4 million barrels of new demand growth this year. Meanwhile, the U.S. is likely going to produce 1 million more barrels per day, which is almost the entire new demand growth. And if OPEC wanted to, they could just reverse the cuts that they have, and that would totally absorb and likely over-supply the market. Goldman Sachs suggests that that's going to happen in 2018 or 2019 or 2020, when the historic spending of the early teens catches up to us because of the mega projects that were spent on 2011, 2013 --

O'Reilly: So, those aren't online yet, to your knowledge.

Muckerman: They're coming online. But, the bulk of them will be full force in the next few years. And these are the projects that have a long lifespan compared to shale oil.

O'Reilly: Remember in another episode, we talked about how, in 2015 or 2016, it was the lowest capex spend on oil production growth since World War II.

Muckerman: Right. And now we're raising by 25 billion over last year.

O'Reilly: That's something, I Like Ike, like ... [laughs] 

Muckerman: Yeah, something tells me there's more money in circulation than there was back then, so you would imagine it would be higher, even if oil prices --

O'Reilly: There was a crash or something, yeah. It was something there, yeah. So, what kind of projects were those? When would those be not coming online? Would it be now? I would think.

Muckerman: In terms of when companies aren't spending on those mega projects?

O'Reilly: Was it 2015? Or 2016?

Muckerman: They're both fairly equal.

O'Reilly: OK. The last two years. Lowest spending on U.S. domestic oil production growth since Eisenhower was in the White House. That was shale, right? It was shale projects.

Muckerman: That was where most people were leaving their money. Yeah, the mega projects were taking a backseat. So, I guess, if you have to imagine, 2011 to 2013, projects are coming on this year through 2019, so that's six years, basically.

O'Reilly: For the big projects.

Muckerman: For the mega projects to come online. If you stop spending in 2015 or 2016, then you would imagine, 2021 or 2022, things might start to auto-correct. And I have seen that written, that there might be a supply shortage because of those couple years where companies pull back the reins. But that's five or six years from today. 

O'Reilly: I also remember, last year, there was an oil lease auction in the Gulf of Mexico and nobody showed up. [laughs] 

Muckerman: Yeah, nobody showed up. That's because offshore oil, no one is really spending there anymore, because these projects take a long time, they're very expensive. One day, maybe. But who know what demand is going to look like in 2021?

O'Reilly: Right. I'm going to have a super-powered Tesla with a solar panel on the roof.

Muckerman: Exactly. You have half a million people on order for Teslas here in the United States. That's just in our country alone. Then, you have UAE, the United Arab Emirates, signing a contract with the Hyperloop One, the company that took Elon Musk's idea and is trying to connect Abu Dhabi and Dubai via Hyperloop, and now they're trying to do the same thing in Europe. If stuff like that takes over, faster transport than airlines. I mean...where's America signing Hyperloop contracts? They're building the test facilities out in Nevada, and they're not even signing contracts in the U.S.

O'Reilly: I don't know, we could do it.

Muckerman: We could, but we're not.

O'Reilly: You need to -- no, I'm just kidding. So, any companies you are interested in these days? I know you like the midstream because you don't know...well, really, nobody knows --

Muckerman: I mean, if the U.S. is going to produce 1 million more barrels per day in the next couple years, and then yeah, the pipelines are going to be bursting at the seams.

O'Reilly: I've written about the pipelines a bunch, too. The thing that I like about them is they're one of the closer things you can get to a monopoly these days.

Muckerman: Yeah. Kinder Morgan (NYSE: KMI) is trying to build a 430-mile pipeline for natural gas from the Permian Basin to the Gulf Coast. Enbridge just completed their merger with Spectra Energy, so now it's very well hedged, oil versus natural gas, Spectra being more natural gas, Enbridge being more oil-heavy. Those are the behemoths. So, chances are they're going to get a piece of the pie.

O'Reilly: Did we ever get to talk about that $4.5 billion pipeline that Kinder Morgan is building up there for the oil sands to get it to the West Coast, up there by Seattle?

Muckerman: I think we did. It's an expansion on their existing pipeline.

O'Reilly: That's right, it's an expansion.

Muckerman: So, they're just going to add, basically -- I mean, not "basically," it's not a basic project --

O'Reilly: Correct me if I'm wrong, but I think it tripled the amount of oil that can go through it.

Muckerman: Yeah. Essentially, they'll just build additional pipelines next to the existing one. But then, you have to scratch your head about oil sands, because that's an expensive way to produce oil, it's super unclean, relatively speaking.

O'Reilly: [Royal Dutch] Shell (NYSE: RDS-A) (NYSE: RDS-B) just sold their sands up there.

Muckerman: Yeah, they're completely sold out. But somebody bought it. So somebody believes in it.

O'Reilly: That's what makes a market. [laughs] 

Muckerman: That's right. If Shell had come out and said, "We want to sell this, but we can't," then maybe I would say, "Kinder Morgan, what the heck are you doing?"

O'Reilly: Do you remember before this stuff started, Whiting Petroleum, they were like, "We're going to put ourselves up for sale."

Muckerman: Yeah, and nobody bought. That was the doldrums. Looking back, somebody probably should have bought them, because they were offering for dirt cheap at the bottom of the barrel, in terms of oil prices.

O'Reilly: That's right. I'm going to do that.

Muckerman: [laughs] You're going to go buy Whiting Petroleum? Go back in time?

O'Reilly: I'm going to LBO that, I'm going to put down $8. [laughs] 

Muckerman: But yeah, in terms of some producers, again, we can keep harping on EOG [Resources] and Pioneer [Natural Resources], Permian leaders --

O'Reilly: I wrote about them two years ago, man, we need something new. [laughs] 

Muckerman: There's nothing new to talk about. They're still the biggest and the best. They're the ones that are probably going to increase their spending the most. When you look at that $25 billion number in capex that's going to increase over 2016 spending, about $15 billion of that is coming from U.S. producers.

O'Reilly: Before we head out, I actually want to get your opinion on this piece that The Motley Fool's Greg Brewer put out on Shell Oil's dividend.

Muckerman: What'd they do?

O'Reilly: It's just, 7%, it's pretty. They have those capex plans, and it's like, how long can they keep this going?

Muckerman: Be wary of high energy production dividends. That's all I can say. Not to Shell in particular.

O'Reilly: [laughs] Be wary of oil men bearing dividends.

Muckerman: Not to say anything about Shell in particular. But that's just my own MO.

O'Reilly: We can't help but notice that EOG doesn't pay a huge one.

Muckerman: Right, and companies that have in the past have not for long.

O'Reilly: Although midstream is usually OK.

Muckerman: Midstream is fairly predictable compared to the upstream in even the downstream.

O'Reilly: We need cowboy hats when we talk about wildcatting.

Muckerman: I mean, I have a bolo tie from back in the day when I was working on the wildcatters.

O'Reilly: I'm going to go get a cowboy hat, I'm going to go to King Street here and get a cowboy hat.

Muckerman: Nice little bolo tie with a turquoise pendant in the middle.

O'Reilly: I should have worn that when Crowe and I went to Texas.

Muckerman: I'm sure there's a cowboy hat around the office somewhere?

O'Reilly: Do you think?

Muckerman: Of course. I mean, there's a shark with a helicopter attached to it flying around the office every day, so, if there's not a cowboy hat, I think we need to solve that.

O'Reilly: Ladies and gentlemen, he's not kidding. All right. Thanks for your time, man! We'll see you next week, hopefully.

Muckerman: Yes, we will.

O'Reilly: Kind of sort of maybe. That is it for us, folks. Be sure to tune in tomorrow for the Technology show with Dylan Lewis. If you're a loyal listener and have questions or comments, we would love to hear from you. Just email us at industryfocus@fool.com. As always, people on this program may have interests in the stocks that they talk about, and The Motley Fool may have formal recommendations for or against those stocks, so don't buy or sell anything based solely on what you hear on this program. For Taylor Muckerman, I am Sean O'Reilly, thanks for listening and Fool on!

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Sean O'Reilly has no position in any stocks mentioned. Taylor Muckerman owns shares of Alphabet (C shares), Amazon, Enbridge, and Tesla. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Enbridge, Facebook, Kinder Morgan, and Tesla. The Motley Fool owns shares of EOG Resources and ExxonMobil. The Motley Fool has a disclosure policy.