Why The World Is Now Carefully Monitoring The Carnage In This Major Market

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With the Dow tumbling nearly 300 and crude oil plunging another 4.25 percent, today a legend in the business discusses the carnage in a key market and why the investing world is now carefully monitoring the situation.

Drilling For Oil On The Floor Of The NYSE – The virtual collapse in oil prices is mirrored in near rock bottom prices for lots of oil companies. In some cases the stock prices are so low; they are at a discount to the one year average of the value of their proven reserves.

If you “knew” that the price of crude were headed back up to $60 or $70, it might be cheaper to get extra reserves by buying a depressed energy stock than by actually drilling new wells.

That was the thought that popped into my mind when I read an absolutely marvelous interview in the latest (invaluable) Welling on Wall Street. Kate interviewed the very knowledgeable Tom Petrie of Petrie Partners. Here is a key portion:

In my book – when I did the hardcover version that came out in early 2014 – I remember commenting that I thought it would be very difficult to get global output much over 90 million barrels a day and sustain that level. The reason was the embedded declines expected in the older production. Of the say 92 million barrels a day of production we have today, more than three-quarters of it – probably more than 80% of it – is coming from fields that are somewhere between 25 and 35 years old. They’re very mature reservoirs, in places where irreversible declines characterize most of what has been developed there.

We think that a conservative number for that embedded decline – the amount by which production from these tired reservoir is diminished each year – is on the order of 4 to 4.5 million barrels a day – and that may be conservative – but it’s a good number to use for trying to assess the issue here.

To put that into perspective, the absence of the supply that will result from these embedded production declines is probably going to be the foremost factor in rebalancing the supply surplus that the world is dealing with today.

Later in the interview, Mr. Petrie implies that we may begin to see that deterioration in production in the second half of this year.

So, how will we know that crude is turning or even has turned? One thing I’ll be watching for will be signs of M&A activity in the energy stocks. I think that if the smart money thinks a turn is really near, they will scoop up a competitor just to secure some relatively cheap reserves.

Overnight And Overseas – Map looks like a rerun of Monday morning. Shanghai closed up on mortgage adjustments. Rest of map is universally red. Europe is off the earlier lows with financials and miners getting pounded. The dollar is softer again, helping some commodities but not gold. Oil under pressure as Russian production hits 20 year highs.

Consensus – Crude is center stage yet again with WTI set to challenge $30. Let’s see if S&P finds support at the 1817/1821 band. Stick with the drill – stay wary, alert and very, very nimble.

February 2 (King World News) – Art Cashin