by Investing Daily, Investing Daily
Article of the Week from Investing Daily
— this post authored by Stephen Leeb
Are a recession and brutal market correction closer at hand than most people think? One region of the U.S. likely holds the answer. And it isn’t Washington, D.C.
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It’s the Permian Basin, a vast oil shale formation located in southwestern Texas and adjacent parts of New Mexico. In the past year the Permian added more barrels of oil to production than any other shale formation currently produces. Its ability to continue to add rapidly to production may be all that stands between today and a market crash.
For investors, one message is to focus on the companies discussed below. As long as they do well, it will signal the economy and market are relatively safe.
Oil’s Pivotal Role
To understand these predictions, you need to understand the critical role of oil prices in the economy. More than a decade ago my wife and I wrote a book titled “The Oil Factor”. Written when oil was trading near $30, it was the first to forecast triple-digit oil prices.
The book also set forth an observation some analysts have dubbed “Leeb’s Law” (as Dave Harder and Janice Dorn did in their book “Mind, Money, and Markets”). That observation: if oil prices rise sharply in too brief a time, the market tanks. Often a recession follows as well.
Specifically, if oil prices double within a 12-month stretch, watch out. One example: the horrific 1973-75 recession that began with the OPEC oil embargo and soaring oil prices. Another: the 1987 crash, which followed a doubling in oil prices. And another: the 2000 market crash, which also followed a big jump in oil.
A few years after the book’s release, our thesis continued to hold true. Skyrocketing oil prices were a major culprit in the 2008 Great Recession, the worst economic debacle since the Depression.
Can the Permian Keep It Up?
This brings us back to the Permian Basin. Today it accounts for more than 50% of total U.S. fracking output. Even more to the point, it accounted for nearly 60% of the increase in fracking output for the 12 months projected through February by the EIA. Increasingly the Permian will be the critical factor in fracking output and overall U.S. oil production.
In fact, over the next three to five years, the Permian likely will be the largest source of additional oil supply in the world. We should all keep our fingers crossed that the basin will live up to the hopes of the optimists. As demand burgeons, the world will likely need all the excess oil it can get.
A big reason for rising demand will be China’s continued push to create infrastructure in the East and throughout the developing world. Science magazine recently termed today “the most explosive era of infrastructure expansion in human history.” Some 90% of that expansion, according to Science, is occurring in the developing world.
A Recipe for Disaster
Many analysts were surprised by how strong oil demand has been over the past several years. They shouldn’t have been. Nor should they be shocked to see demand continue to ratchet up. A gain in demand in 2018 of 1.5 million or even 1.7 million barrels a day could easily happen. And a comparable rise in following years also wouldn’t surprise me.
Meanwhile, OPEC and friends have very little excess capacity, though Brazil and Canada, perhaps, may be able to hike oil production a bit. And oil inventories in the developed world are close to five-year averages.
In other words, we face the possible combination of no inventory buffer and a market increasingly aware that global oil supply will start to lag rising demand. That’s a recipe for soaring oil prices and potential economic catastrophe.
It’s why the Permian is the world’s best hope of avoiding a potential train wreck. We estimate the basin will have to increase its production by about 1 million barrels a day to keep worldwide supply and demand roughly in balance.
Market Bellwethers
Stocks with the biggest stakes in the Permian are the ones to watch. If they fly in the market, we’d heave a sigh of relief. If they falter, take shelter.
Two plays that stand out as such barometers are Pioneer Natural Resources (NYSE: PXD) and Diamondback Energy (NYSE: FANG). Both are well-managed companies whose operations focus on the Permian. They will be excellent bellwethers to how the basin is performing. Imagine that – two companies will tell you more about the market’s future than any economist or market guru.
If you’re an income-oriented investor, the Permian has companies of interest for you, too. Two big companies with large stakes in it are Chevron (NYSE: CVX) and Occidental Petroleum (NYSE: OXY). Both will spend about $2 billion to $3 billion in the Permian in 2018 but will have plenty left over to pay investors very decent incomes. Chevron yields 3.3% and Occidental more than 4%. I expect a dividend increase from both in 2018.
