Before I get into today’s update, I wanted to tip you off to some changes happening here at The Energy Strategist (TES).

My goal with this service has always been two-fold. I want to make sure you are well-informed about the energy markets, and I want to provide advice that will make you money. A lot of money.

As part of that, I’ve worked with my publisher over the past month to push through some changes to the format of our service and website.

First, you may notice that today’s article isn’t attached to a biweekly issue of TES. One of the weaknesses of a rigid biweekly newsletter schedule is that some developments in the energy markets warrant immediate coverage. Some stock picks warrant more timely updates. 

Often, I would have an update that I wanted to push out to subscribers immediately, but if it weren’t a portfolio action, we would wait until it was time for the scheduled issue. 

Starting today, that’s no longer a problem. The Energy Strategist will now operate on a more flexible publishing schedule. Instead of a bi-weekly newsletter format, I’ll send you updates and trades as soon as I can. 

For now, our portfolios are unchanged, and you can continue to expect regular Buy and Sell advice. However, I plan to clean them up and condense them soon. Currently, they’ve become a bit overwhelming and confusing to follow. I’ll be keeping you up to date in the weeks ahead as I make adjustments to our portfolios.

We’ve also made some small changes to the membership website. I encourage you to check it out. We’ve adapted the homepage to include an easy to follow chronological feed of my latest updates and alerts. We’ve also streamlined the site’s navigation. Now, instead of choosing through multiple drop-down menus, you can easily access all of our updates, new trades, and live chats by clicking on the “Alerts” button at the top of the site.

I’m curious to hear what you think. If you have specific questions about the change or anything you’d like to see addressed on a regular basis, please post your suggestions in our Stock Talk forum. 

Your input is valuable to me. I know the kinds of information I want to give you, but in an ideal world what information do you want that you aren’t currently getting? Let me know in the forum.

Okay, with that out of the way, on to today’s update on OPEC.

OPEC In A Shale-Induced Bind 

In my recent article Where Oil Prices Are Headed, I discussed the OPEC cuts that were decided at the cartel’s meeting last November. These cuts successfully boosted oil prices, but they also helped spur U.S. oil production, which has now risen about half a million barrels in six months. 

But last week at an energy conference in Houston, Saudi energy minister Khalid al-Falih warned U.S. shale producers that there would be no “free ride” for them. He said U.S. producers should not assume OPEC will extend the cuts they made to start the year, and that they would not be bailed out by OPEC if they increase production too quickly.

I think this demonstrates a fundamental misunderstanding from the energy minister on the difference between how OPEC functions, and how the U.S. oil industry functions.

OPEC consists of 13 countries. Notably, 41% of the world’s oil production is controlled by these 13 entities. The U.S. produces 13% of the world’s oil, but there are thousands of companies contributing to that production. Each of these companies acts in its own self-interest and based on its own expectations for future prices. That’s an entirely different situation than with OPEC.

So it is possible for OPEC to agree to collectively cut a million barrels per day (bpd) of production (which would be about 2.6% of the group’s 2015 production), but virtually impossible (and in fact illegal) for U.S. producers to collude in the same fashion. Thus, Saudi’s energy minister is asking U.S. shale producers to do something voluntarily, which in reality only the market can force to happen.

What that means is that U.S. oil production will continue to be dictated by market forces. Should that production continue to rise – nullifying some of OPEC’s production cuts – how will OPEC respond? Nervous investors would like to know.

Let’s review OPEC’s options. 

The group’s next meeting is May 25th in Vienna. It can choose to keep the production cuts decided upon last November, expand the cuts, or abandon them. 

If they maintain the course set at the previous meeting, that means keeping 1.2 million bpd of oil off the market, plus presumably the 0.6 million bpd contribution via agreements with some non-OPEC producers like Russia. In reality, not everyone is fully complying with the cuts, so production would decline by a total of perhaps 1.2-1.5 million bpd overall. 

U.S. production has risen about half a million bpd since last September and is forecast to continue higher. On the other hand, this is also approximately the same rate at which global crude oil demand is rising. So if OPEC maintains a steady course, global crude oil inventories will likely continue to come down even as U.S. production increases.

Should OPEC decide to enact additional cuts at its May meeting, the price of oil will almost certainly rally, but U.S. producers will add rigs at an even faster pace. But it will take at least six months for a drilling decision to materialize into oil production. Global inventories will come down even more quickly than the current pace in this scenario. U.S. producers should benefit in this scenario, but it is unclear if the increase in oil prices would be enough to offset the loss of production OPEC would suffer from these cuts.

But what the market fears most of all is that OPEC could abandon the production cuts and once again allow member countries to produce as much as they please. A move like this is the only way for OPEC to back up its talk that it won’t “take the hit” for U.S. shale producers. This course of action would once again slow U.S. shale production, but the price crash that would ensue would also hit OPEC members hard. That’s a tough sell within OPEC.

This puts OPEC in a no-win situation concerning U.S. shale oil producers.  If it maintains the cuts or makes additional cuts, shale producers will benefit. If OPEC abandons the production cuts to hamper U.S. shale oil growth once more, it will nevertheless “take the hit” as oil prices drop. 

My observation has been that OPEC usually sticks with a course of action once it starts down a path. I expect to see the group maintain the current production cuts (with possible minor adjustments). If they decide to make a change, I think it’s unlikely they will do so until later in the year, after there is more clarity around the growth of U.S. production and global demand. 

What does this mean for investors? The recent price drop is a buying opportunity, but given the outside chance that OPEC could abandon the production cuts that went into effect in January, I would pick up quality companies that can easily survive $40 oil but will thrive when prices are above $50. 

I have recently highlighted our #10 Best Buy EOG Resources (NYSE: EOG). The company has increased free cash flow for five straight years, and I consider the company’s management to be among the best in the business. The recent dip in oil prices took EOG under $95 a share, which is a screaming Buy in my opinion. Buy EOG up to $120.

Also near the top of my wish list is Apache (NYSE: APA). It’s going to be a more aggressive pick than EOG, as the company has higher debt and is spending heavily to develop its huge new Permian discovery announced last year. But the market hasn’t properly given the company credit for this discovery, which contains an estimated 3 billion barrels of oil. Buy Apache up to $60.

More aggressive picks here are Whiting Petroleum (NYSE: WLL) and Continental Resources (NYSE: CLR). A more conservative pick, which is officially a Hold at the moment, is Chevron (NYSE: CVX), which owns a lot of acreage in the Permian Basin. 

I’m also looking hard at a few fracking sand providers. It can be a risky space, but at the moment one seems to be rising above the others. If the company I’m eyeing makes the cut, I’ll let you know ASAP with a new trade. 

I’ll continue to monitor OPEC’s statements closely and adjust advice accordingly. Should the May meeting outcome be a return to no quotas, we will become defensive quickly.