I hope everyone had a nice Thanksgiving! While we were eating our turkey the leaders of OPEC met to discuss their plan for oil production. As the price of oil has dropped dramatically many traders had expected OPEC to drop its production in an attempt to lower supply and get prices moving upward once more. They did not, and while most were shopping on Black Friday, the markets we follow here at Iron Capital were getting hit, especially in the energy sector.
For those who have not noticed, there has been an energy boom going on in North America. New technology has allowed oil production in the U.S. and Canada to reach record levels, which has changed the balance of power in the world of energy. One of the reasons OPEC did not cut production is that they knew doing so would only allow non-OPEC members, mainly us, to gain even more market share. Some assume this means OPEC wishes to crush U.S. and Canadian oil producers in a price war, but I don’t believe that is the case. If that were true, OPEC could have voted to increase production; at least they claim they could do so.
No, OPEC’s move is a realization that they are losing their power to control oil markets, and as a result also losing their ability to use oil as a political bargaining chip. Had they cut production, the gap would simply be filled from the West. This has happened in spite of anti-energy government policy; imagine what could be done if we had more balanced policy.
Alas, we are not here to discuss government policy, we are here to invest. What does this mean for investors? Short-term traders seem to think it means an end to oil production and the entire energy sector in the U.S. We think that is a typical Wall Street overreaction. Oil prices were bound to drop with all the new production; the real surprise is that it has taken this long. While the lower price of oil may hurt those directly selling oil, it is not likely to stop the drilling. Most wells that are producing today were planned and started years ago. As recently as 2009 oil prices averaged $61 per barrel. The vast majority of oil operations in the U.S. and Canada are still very profitable with oil at these levels, and as long as they are profitable they are going to keep pumping oil. As an investor we have long recommended that the prudent way to take advantage of this environment is by owning the companies that are selling the shovels, not the prospectors looking for gold (or oil).
The knee-jerk trading response has been to hurt these companies as well. It is times like this that provide the greatest opportunity to long-term investors. It is also times like this that test the investor’s discipline. It is difficult to invest in companies that are temporarily out of favor with the trading crowd, but that is exactly where long-term opportunities are the best. Nothing has changed in the energy world that impacts the long-term reality. The companies that we follow have all continued to exceed our expectations in their real-world operations even as traders attack their stock. These types of disconnects are the cloth from which long-term opportunity is cut.
I was unfortunately under the weather last week, so this Insight did not get out before the Thanksgiving feast. However, even in bed with a fever I have much to be thankful for and this is the annual list:
1. I am thankful for irrational traders that bestow long-term opportunity on those of us who are willing to see it.
2. I am thankful for the opportunity to coach my son and his teammates (the Whale Sharks) in basketball for another season.
3. I am thankful that my beloved Wake Forest has a new coach and this rebuilding year may actually be just that, a year upon which they can build.
4. I am thankful for my family, immediate and extended.
5. Of course I am still grateful for Mama’s pumpkin cheese cake even if I didn’t feel well enough to partake as freely as I would prefer.
6. Last but certainly not least, I am thankful for you, our clients and friends of the firm. Your trust in Iron Capital is our greatest asset and we value you every day of the year.
Chuck Osborne, CFA