Matt Badiali is an oil-industry geologist who has spent his career in the exploration-and-production arms of some of the most prominent petroleum firms in the world. His up-close knowledge of the industry has provided a springboard into oil-and-gas investing that has propelled him to the heights that few have reached.
Badiali’s focus has been on investment strategies in the North American market, including the use of sophisticated tax-sheltering strategies, low-cost petroleum-industry ETFs and plays that take advantage of short- and medium-term volatility in the North American oil-and-gas sector, particularly those where he can use his deep understanding of shale extraction as a foundation to predicting future price movements.
Matt Badiali remains bullish on oil in general and XOP in particular
As Matt Badiali’s loyal readers know, he has long been an outspoken advocate for the use of oil-and-gas ETFs as a means of cheaply investing in the petroleum industry without taking on the huge inherent risk of direct investment in petroleum products and their related financial instruments.
In a recent article, Badiali details why he believes that not only will the international price of oil continue to surge throughout the remainder of 2019 but that the XOP ETF is currently severely undervalued. Matt Badiali states that even if oil prices do not significantly increase throughout the rest of this year, then it is still likely that the XOP index will surge upwards, coming in line with the massive increase that has been seen so far, this year in oil prices.
XOP has stagnated amid sharp increases in oil prices
XOP is the stock-market ticker symbol for The SPDR S&P Oil and Gas Exploration and Production ETF. It is an exchange traded fund, which are also known as ETFs, that tracks small- and mid-cap exploration-and-production companies. Like most of the ETFs that Badiali personally uses and recommends, the XOP has extremely low management fees and has a much-attenuated risk profile relative to direct investment in petroleum assets, products and derivatives.
Since December of 2018, West Texas Intermediate Crude prices have surged by approximately 55 percent, rising from around $43 to around $66 today. Yet, the XOP has only increased by 33 percent. While oil is obviously a distinct asset from the companies that produce it, Badiali believes that most of the price increases that we have seen over the last year will pass directly through to the bottom lines of most of the firms included in the XOP fund.
This means that, barring a steep decline in crude-oil prices, investors should eventually recognize that XOP is sharply undervalued. This should eventually cause a significant upward correction in its price.
But Matt Badiali also believes that there is strong cause for bullishness on the price of oil itself.
Badiali sees oil soaring by the end of 2019
Matt Badiali sees several macroeconomic and geopolitical factors as being far from accurately priced into current oil firms and the funds like XOP that contain them. Badiali believes that oil demand will soar by the end of 2019. At precisely the same time, he sees massive downside risk to the global oil supply, with the possibility of global supply restrictions of 10 million barrels per day or larger. This could send prices rocketing upward.
Venezuelan production could entirely collapse
Badiali points out that Venezuela, among the world’s largest net oil exporters just a few years ago, has gone from producing 3 million barrels of oil per day in the mid-2000s to just over 800,000 barrels per day in 2018. And the country’s oil production has been rapidly declining since at least 2012, in an almost linear fashion.
Amid chaos in the streets, a starving population and a state-run oil company that cannot even finance its own operations through bond issues because its creditworthiness has been destroyed, Badiali says that the prospect of Venezuelan exports completely disappearing in the next year is a very real.
Iran sanctions may precipitate more than just a slight reduction global supply
Another once-major oil exporter is Iran. With production of 2.5 million barrels per day in 2019, Iran’s net oil exports went from 1.1 to 1.3 million barrels per day. However, sanctions threaten to shut that number straight down to zero.
With global demand currently at around 93 million barrels of oil per day, the absence of Iranian oil would have a very small but noticeable effect on global oil prices. However, the real concern, says Badiali, is that Iran may choose to take retaliatory actions against any U.S.-imposed sanctions.
Iran could probably exert military control over the strait of Hormuz, through which as much as 35 percent of the world’s oil passes. Despite America’s reputation as being the global hegemon that possesses unchallengeable military supremacy, Badiali is deeply concerned that the state of U.S. naval readiness has deteriorated to the point where remote operations against a well-trained and capable enemy like Iran could result in stalemate or outright defeat, being possibly worse than that suffered by America in its wayward military adventures in Afghanistan.
While such an outcome could be catastrophic to America’s ongoing imperial ambitions, Badiali says that Iran successfully shutting down the Strait of Hormuz, in successful defiance of the United States, could send the price of crude oil skyrocketing to levels that have not been seen in decades.
OPEC may not ramp up production fast enough in the face of rising demand
Any one of these potential shocks to oil supply could occur concomitantly with a spike in demand, a scenario that Badiali believes is more likely due to the relatively large 11 percent drop in global oil consumption that occurred in 2018. Should this come to pass, OPEC, an organization that accounts for up to a third of global oil production, could find it impossible to ramp up production to meet that demand by the end of the year.
In 2008, OPEC responded to slackening demand and slumping oil prices by cutting production by 8 percent. Badiali believes that we could easily see more than an 11 percent rebound in global oil demand in 2019. And this would mean that OPEC would have to scramble to massively increase its production to meet that demand.
Badiali warns against expecting a sudden ramp up from U.S. shale producers
Regardless of whether OPEC can or will raise its output to match increasing demand in 2019, Badiali says that the idea that U.S. shale producers could suddenly up their production to meet increased demand is simply not supported.
Badiali says that, while the long-term trend of U.S. shale oil production is looking up, a serious upswing in production over a three- to six-month time horizon would be nearly impossible. Although drilled-but-uncompleted wells, known as DUCs, have been growing in number, Badiali says that they are generally going to be less productive than their counterparts of 10 years ago. And historically, the entire U.S. oil industry has only been able to ramp up yearly production by around 1 million barrels per day.
Now is a good time to go long on oil ETFs
Direct investing in crude oil, gas and related financial instruments is too risky for many investors. But Badiali says that oil-and-gas ETFs will eventually capture any spike in crude oil prices while only exposing investors to a limited downside. Especially over a 1-year time horizon, the gains in oil prices will pass through to the earnings line in the form of almost pure profits. And this will eventually be reflected in the market prices of those ETFs.