Here’s one way to take advantage of low oil prices.
When we look at the global petroleum market, we must differentiate between two separate and very distinct types of producers: low-cost producers and high-cost producers. When laymen look at the industry, they usually only look at the price per barrel to help determine whether the products they purchase (such as gasoline) will be high or low. What investors look at, or need to look at, is a far more important metric: the all-in production and operational cost per barrel.
Operational Cost Per Barrel
In times of elevated oil prices (more than $100 per barrel), it seems that all oil producers are equal because they are all generating returns well above their initial production costs. When the price a barrel fetches in the open market begins to fall, this is when the differential between low-cost producers and high-cost producers becomes very stark. And this is when laymen need to put on investors’ goggles to truly understand the dynamics of the oil market, and to position to benefit.
In this environment of lower oil prices, we are seeing the winners and losers on the supply side of the equation (note I’m not using the term “low oil prices,” because I don’t qualify $80 a barrel as low by any historical standard; low oil prices are what we saw 15-20 years ago when prices were at $10 a barrel). Lower oil prices have an effect both on high-cost and low-cost producers; in this case, the low-cost producers are able to bear the brunt of lower prices while producers with a higher cost base are either going out of business or are taking huge hits to their operational margins.
Low Cost vs. High Cost Producers
In the spectrum of petroleum cost production, you find many different players, differentiated by geography, technology and quality. At the end of the day, cost is a function of reservoir operations. The lowest-cost producers are the traditional oil producers, such as Saudi Arabia, the UAE and even parts of the United States.
When you go down to the country level, cost is a function of reservoir location. Generally speaking, the lowest cost oil is located in onshore locations; offshore oil is generally more expensive than onshore, due to the technological extraction methods employed; and finally shale oil that requires “fracking” techniques to get it out of the ground is on the costliest side of the spectrum.