Oil: the Fickle Mistress

As some in the S.E.C. know, I had a prior life as an independent oil and gas producer. Energy, especially oil, can be very hard to live with — kind of like a mistress. In the late 1970s, under Jimmy Carter’s huge government programs, the Natural Gas Policy Act, and the Windfall Profits Tax, many of the independent producers were making more money than ever before. But inflation and interest rates were soaring and the country as a whole was stagnant. Our Industry was dependent upon the tax advantages set by Washington, DC.

A very common saying in business is, “Just tell us the rules and we will figure out how to play the game.” That is what was going on until Ronald Reagan was elected. Carter believed in government controls and Reagan believed in the free market. Reagan deregulated oil and gas and the prices fell dramatically.

During the Carter administration, with the prices set artificially high using government controls, we were making huge profits—and many times drilling in hard to produce basins where the costs of production were extremely high. But when Reagan deregulated oil and gas, the prices fell to reflect supply and demand. Our own lifting costs were over $12.00 per barrel and we were getting about $7.50 per barrel at the low point.

The chart below does not reflect the premiums paid or lost because of where the production actually comes from. For instance, oil produced in certain areas that have excessive transportation costs (think North Dakota and Alaska) is priced less than West Texas Intermediate, which the chart reflects. Anyway, that is when we shut down our exploration company.


The other thing we have to keep in mind when looking at oil (much more than natural gas) is the fact that while our US producers have to make a profit (price paid less lifting costs) to stay in business, the OPEC members have a much different criterion. All they have to do is have enough cash flow to give their citizens subsidies to keep their governments from being overthrown. So, we have to make a profit and they have to stay in power.

So what is the situation today? Saudi Arabia is protecting its market share by not lowering production to support the price. By doing that they are still selling enough oil to fund the government and hoping to put some of the new producers in the United States (resulting from the shale oil explosion) out of business. And they are putting stress on Russia and Iran. Remember, Iran is an arch enemy of the Saud family and Russia is Iran’s best friend in the area.

I still invest in oil and gas through a company in Dallas that is run by one of my former employees. Five States hedges about 85% of its production. Even though the price of crude oil hit the lower $40s per barrel this week, we are selling at $85.00 per barrel for the next two years. It is basically options and is the same thing Southwest Airlines does in reverse. Southwest has kept its operations costs low by buying aviation fuel on the futures market. I would be surprised if Southwest is not buying futures at these prices today. It is all puts and calls.

Are we going to see fallout from the crude oil prices falling by over 50%? In my opinion, the answer is yes. Mid-stream companies like Halliburton and Schlumberger are already laying off employees. There are some large shale oil producers that are putting their production—and entire companies in some instances—on the market because they cannot make their debt payments. I think we will see several large companies that borrowed heavily declare bankruptcy over the next couple of years. The drilling contractors are already seeing huge slowdowns and cancellations of drilling contracts. As a result of this, many smaller towns and cities are going to see huge reductions in their tax revenues.

A good example is North Dakota. The North Dakota Legislative Council staff just released the “DETAIL OF PROPOSED REVENUE CHANGES, 2013–15 Biennium Estimated Revenues.” The report estimates that North Dakota will experience a $5.6 billion shortfall in revenue over the next couple of years. This is going to be very disruptive, but it is what will happen to communities that are too dependent on energy in their economies. Texas is much less dependent upon energy than it was in the 1970s so it will probably be OK as a whole, but cities like Houston, Midland, and towns in the southern part of the state in the big shale plays there are already feeling the slowdown. It will get worse for some.

What are we to do? First, if I had hotel or apartment rooms for lease in energy dependent areas, I would hedge them by going to the larger companies and giving them a cut rate to take big blocks of rooms for extended periods of time. I would lower my price expectations for industrial and just make certain I had good leases with reputable tenants that will survive the coming energy recession. Office space would be no different.

Second, we are prowling for acquisitions in oil and gas and for well-constructed real estate in first-tier areas. Don’t be afraid to move forward. Know what you are looking for and hedge your acquisitions as well as you can.

And remember, “You can’t steal in slow motion.”


  1. Excellent comments from a long time experienced investor! Thanks Bill! your incite if very helpful.

  2. Bill, thanks for your write up on gas and oil. Mark Dotzour, who will be our guest speaker at our luncheon in Dallas, was the guest speaker at ABORS Meeting in Austin. 50% of his talk was on gas and oil throughout the world. Your write up was right on with Mark comments on gas and oil.