High Oil Prices Are Here To Stay -- Here's How To Profit

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American oil production is surging. Yet oil prices remain near $100 a barrel.

You may be wondering: When will all of this additional production finally overtake demand and push the price of oil down?

You can find one answer in the price of oil futures -- which say we can expect oil to fall to closer to $80 in the coming few years and stay there.

Is the market correct? Are oil prices heading south?

I think that the answer is no, for several reasons -- especially after I listened to a recent presentation by Bill Thomas , the CEO and chairman of EOG Resources (NYSE: EOG ) .

EOG is, by a considerable margin, the largest horizontal oil producer in the world. That means the company has access to the best data available on horizontal oil production and resources.

Put simply, EOG and Thomas believe that the futures market is all wrong about oil prices. The company is bullish on oil and focused on producing more of it.

What EOG sees -- and the market doesn't seem to grasp -- is that for all intents and purposes, the horizontal oil boom is coming from only two plays: the Bakken Formation in the upper Midwest and the Eagle Ford Shale in South Texas. A slide from EOG's most recent investor presentation illustrates this clearly:

Fully three-quarters of the horizontal oil being produced in the United States comes from the Bakken and Eagle Ford. Without these plays, the horizontal boom would be barely noticeable.

Equally important to note is that production growth in both the Bakken and the Eagle Ford is slowing significantly. The growth of production both by rate and absolute amount in both of these plays appears to have peaked.

During his recent presentation, EOG's Thomas was asked what the next big horizontal oil play in the United States would be. His answer? There isn't going to be one.

EOG has scoured the United States and hasn't found a new play with anything close to the productive capability of the Bakken and Eagle Ford.

What makes the Bakken and Eagle Ford unique is that they are crude oil plays. Most of the other large horizontal plays are "combo" plays that have large hydrocarbon accumulations, but much of those hydrocarbons are in the form of natural gas and natural gas liquids.

For example, in his presentation, Thomas referred to the Permian Basin in West Texas as having lots of barrels of oil equivalent (BOEs) -- but heavy on the "equivalent" and light on the oil. There is going to be a lot of production from the Permian in the coming years, but a great deal of it won't be oil.

Large, profitable oil plays are few and far between, and they are getting harder and harder to find. The Bakken and the Eagle Ford are #1 and #1a, and there is no #2.

So what does this mean for investors? In my view, it means that while oil production in the United States will keep growing for the next several years, the pace of that growth is going to be greatly reduced. With annual global oil demand growing at roughly 1 million barrels a day and oil production outside of North America not growing at all, oil prices are going to remain high and perhaps even go higher.

The companies in the sweet spot are the ones that have locked up large land positions in the top horizontal oil plays. EOG is one of those; Continental Resources (NYSE: CLR ) is another.

EOG's Eagle Ford stake contains an astounding amount of oil. EOG has 564,000 acres in the Eagle Ford oil window, the largest position in the industry. EOG estimates it will eventually recover 3.2 billion barrels of oil from that land -- and over time, with improving techniques and technology, the company may well do better than that.

Continental Resources is primarily focused on the Bakken, where it produces nearly 100,000 barrels a day. Like EOG in the Eagle Ford, Continental is the largest leaseholder in the Bakken, with 1.2 million acres. (EOG also has a sizable position.)

Since 2008, Continental has increased its proved and probable oil reserves from 159 million barrels to over 1 billion barrels. That is a compound annual growth rate of 47% -- and there is likely more still to come.

These land positions should allow EOG and Continental to continue to increase reserves and production as oil prices rise in the coming decades. As an investor, I'm most excited by what the future might hold in these premier oil plays. Secondary recovery methods such as water flooding ( which I discussed last week ) or natural gas injection could significantly increase the amount of oil that these plays can produce.

The key is owning the land.

Risks to Consider: The greatest risk is a potential "cure" for oil as our primary transportation fuel. For example, the advent of affordable and high-performance electric cars could put a significant dent in global oil demand.

Action to Take --> It's looking like we're in for a future of high oil prices -- and the companies best positioned to thrive are oil producers like EOG and Continental that control the largest and best land positions in the Bakken and Eagle Ford.




The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

© Copyright 2001-2010 StreetAuthority, LLC. All Rights Reserved.


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