Oil $500 - By Flavious J. Smith, Jr.

We’re about to see once-in-a-lifetime opportunities to make major investments in the world’s best oil assets. Getting just one or two of these bets right could set up your portfolio for several decades.

OIL $ 500 WHY THE NEXT OIL SUPERCYCLE IS CLOSER THAN YOU THINK

BY FLAVIOUS J. SMITH, JR.

Published by Stansberry Research Edited by Fawn Gwynallen Designed by Lauren Thorsen Copyright 2017 by Stansberry Research. All rights reserved. No part of this book may be reproduced, scanned, or distributed in any printed or electronic form without permission.

Dedicated to my wife Melanie. We’ve been side by side through the booms and busts. It’s been a wild ride. Thank you for believing.

About Stansberry Research

Founded in 1999 and based out of Baltimore, Maryland, Stansberry Research is the largest independent source of financial insight in the world. It delivers unbiased investment advice to self-directed investors seeking an edge in a wide variety of sectors and market conditions. Stansberry Research has nearly two dozen analysts and researchers – including former hedge-fund managers and buy-side financial experts. They produce a steady stream of timely research on value investing, in- come generation, resources, biotech, financials, short-selling, macro- economic analysis, options trading, and more. The company’s unrelenting and uncompromised insight has made it one of the most respected and sought-after research organizations in the financial sector. It has nearly 200 employees operating in several offices in the U.S. plus one in Asia, and it serves 350,000 customers in more than 120 countries.

About the Author

Flavious J. Smith, Jr. Flavious J. Smith, Jr. is the editor of Commodity Supercycles , a monthly advisory focused on investments in energy, metals, and other natural resources. Before joining Stansberry Research in March 2017, Flavious spent 35 years building relationships with a vast network of leaders in the U.S. oil and gas industry. Flavious has a B.S. and M.S. from Vanderbilt University and a J.D. from Oklahoma City University School of Law. During his illustrious career, he gained experience and expertise in engineering, geology, geophysics, land, and operations... specifically in the Anadarko, Appalachian, Denver-Julesburg, East Texas, Gulf Coast, Hugoton, Permian, Powder River, Uinta, Wind River, and Williston Basins. In 2005, Flavious served as division land manager for EOG Resources’ (NYSE: EOG) Appalachian operations in Pittsburgh, Pennsylvania. He led the development of EOG’s Marcellus Shale land position. And he later became a division land manager for EOG’s Barnett Shale operations in Fort Worth, Texas. From 2008 to 2014, Flavious served as the chief oil and gas officer and executive vice president at Forestar Group (NYSE: FOR), building and leading the company’s oil and gas operating segment. And in 2014, Flavious became the managing partner and chief investment officer of The Flavious Smith Family Office, a multi-generational family office with investments in oil and gas, real estate, and aerospace.

Table of Contents

Foreword ................................................................................................... i PART I $500 Per Barrel Chapter 1 The Coming Crude-Oil Crisis .................................................................... 1 Chapter 2 The Anatomy of Oil’s Booms and Busts . ................................................ 13 Chapter 3 People Think There Is an Oil Glut. Here’s Why They’re Wrong. ......... 33 Chapter 4 How Do We Prepare for $500 Oil? ......................................................... 57 Chapter 5 War in the Middle East: An Old Story. An Ongoing Driver of $500 Oil. .... 71 Chapter 6 Innovation and Technology Will Drive the Winners in Oil $500 .......... 77 Chapter 7 What You Should Study and Our Investment Checklist ...................... 101

Chapter 8 Oil $500 Is Real ................................................................................... 109 Chapter 9 Where Are We Now? ............................................................................. 117 PART II An Introduction to the Rest of the Commodity Markets Introduction More About the Commodity Markets ................................................... 127 Chapter 1 Commodities & Supercycles: What Are They? ..................................... 129 Chapter 2 The $622 Million ‘Treasure’ . ................................................................ 137 Chapter 3 The Death of Coal Is a Myth . ................................................................ 147 Chapter 4 The Element That Feeds the World ...................................................... 161 Chapter 5 Our Most Controversial Strategy: Beating the Market . ....................... 173 Putting It All Together ................................................................ 183 Appendix Recommended Reading ........................................................................ 185

– Foreword – By Porter Stansberry Founder, Stansberry Research

I was invited to speak in 2012 at a seminar for big-shot commodities investors. There was probably a couple hundred people in the room who were all writing big checks for oil and gas exploration at the time. I asked the audience facetiously at the start of our presentation: “How many people here are long oil with their portfolio?” Of course, everybody in the room raised their hand. I said, “OK, but how many people here are really long oil? How many people here are investing more than a couple million dollars in oil and gas?”

Pretty much everybody in the room raised their hand. I led off my presentation with an expletive: “You guys are all F’ed.”

I went on to explain why oil was going to crash below $40 a barrel. (This was when it was well over $100.) None of their projects were economic below $50 or $60 a barrel at the time. So of course, they all laughed. They thought I was kidding. The head of the conference even wrote a Forbes article lambasting me for making such an “absurd” prediction.

But it’s interesting how many times these absurd predictions come true. Oil did crash to $40 a barrel.

People thought it was absurd when I debunked the “Peak Oil” story – the idea that oil production was in permanent decline…

In 2010, I was among the first people anywhere to write about the

Eagle Ford Shale and predict it would lead to a new all-time high in U.S. oil production. Then production soared.

Now, my good friend Flavious Smith, Jr. and I are making another absurd prediction. Our long-term prediction is that oil will trade for more than $500 per barrel.

That probably sounds nuts to you. After all, oil is cheap.

And to the average Joe, it doesn’t look like that’s going to change anytime soon. Global supply continues to outpace demand, and current prices make it uneconomic for most companies to drill. I’m not saying oil prices are going to bounce back tomorrow. They still have a little more “work” to do on the downside… I believe we’re entering a five- to 10-year period where oil will form a major bottom ... before shooting hundreds of percent higher in the coming years . We’re about to see once-in-a-lifetime opportunities to make major investments in the world’s best oil assets. Getting just one or two of these bets right could set up your portfolio for several decades. The reason is simple: Oil demand is going to absolutely soar over the next several years . The Road to Oil $500

Oil is so cheap right now because supply outpaces demand. There’s more oil being produced than people can consume.

The Organization of the Petroleum Exporting Countries (OPEC) agreed to cut two million barrels a day of oil production in late 2016. But the cuts didn’t work. Oil in storage has continued to grow.

In June 2017, there was a 66-day supply of oil in storage. That’s more than when OPEC agreed to the cuts in 2016.

In the United States, we have rarely had more than 30 days of supply in storage. The U.S. Energy Information Administration (EIA) says that inventories would have to be cut globally by 400 million barrels to bring supply back in line with demand.

To do that, you’re going to have to either increase consumption or reduce supply by another million barrels a day for more than a year.

Instead, the glut will continue to grow as U.S. producers ramp up production. The current forecast has the U.S. producing more crude oil than Saudi Arabia by the end of 2018. So we have a very high likelihood of a big wipeout in oil prices. A lot of U.S. oil companies will go bankrupt as a result of lower prices, and that sets the stage for an important long-term bottom in oil. Oil is going to form a bottom in the next couple years. You want to be ready. You want to know what to buy. You want to watch for it. You want to wait and get your price, and then you’re going to be set for a decade or so of outrageously good returns. It’s One of The Biggest Extremes I’ve Ever Seen If you don’t believe we’re approaching a massive turning point in the markets, just take a look at this chart... So where does oil $500 come in?

iii

The chart shows the commodities-to-stocks ratio over the past 47 years. This ratio compares commodities – as tracked by the S&P GSCI Commodity Index – with the benchmark S&P 500. The circles at the top of the chart show times when commodities have become extremely expensive relative to stocks. And the circles at the bottom of the chart show times when commodities have been extremely cheap compared with stocks. As you can see, this ratio has now fallen to an extreme rarely seen over the past five decades... You may recall the first... It was just before President Nixon took the U.S. dollar off the gold standard. Over the next several years, inflation shot higher... commodities soared... and stocks entered a brutal bear market. The second bottom occurred just before the final run-up in the dot- com boom. Again, over the next decade, commodities dramatically outperformed stocks. The broad GSCI Commodity Index rose nearly 300% from January 1999 through the end of 2007, while the S&P 500 gained less than 30%. iv In fact, it’s now even lower than either of the previous two bottoms...

Today’s historic lows suggest “real” assets could once again be set to beat financial assets over the next several years.

The third bottom will come . And oil will be the best investment you can make over at least the next decade . But the trick to being successful is knowing which assets to buy... and when .

That’s where my great friend Flavious comes in.

Flavious is a legend in the oil and gas space. A 35-year veteran of the business, he has worked on nearly all of the most important onshore oil and gas basins in the U.S., including the Anadarko, Appalachian, Denver-Julesburg, East Texas, Gulf Coast, Hugoton, Permian, Powder River, Uinta, Wind River, and the Williston Basins. He led the development of both Marcellus and the Barnett Shale assets for EOG Resources (EOG) – the “best of breed” firm that pioneered the use of the next-generation technologies that unlocked vast quantities of shale oil in the U.S. He later served as the chief oil and gas officer and executive vice president at Forestar Group (FOR), building and leading the company’s oil and gas operating segment. In short, Flavious has the knowledge, experience, and network that can only be developed over decades of work at the top of the industry. For more than a decade now, we’ve been warning folks that “Peak Oil” was a myth... and correctly predicting that soaring U.S. oil production would cause oil prices to plunge lower than most folks believed possible. But now, for the first time in years, Flavious is seeing the long-term trend shift from down to up once again… As he’ll discuss in this book, demand will soon outpace supply. Global production is at a stand still. And thanks to the modern industrial revolution in China and India, demand is set to skyrocket over the coming decades.

That new dynamic could eventually send oil prices to more than $500 per barrel before it all ends .

If you’re an early investor in the right American companies, you will get filthy rich.

Regards,

Porter Stansberry Founder, Stansberry Research

PART I

$500 Per Barrel

– Chapter 1 –

The Coming Crude-Oil Crisis

There are 12 million cattle in Texas. I’m sure I passed them all on the way to Alpine.

In early 2017, I decided to drive out and see the hottest new oil play in West Texas for myself. It’s called the “Alpine High.” It’s about six hours from Fort Worth... straight southwest on I-20. Alpine, Texas is a town of about 6,000 people. In the late 1800s, it was a campsite for cattlemen and rail workers. Today, there’s nothing much to see out there. It’s high desert for Texas. About 4,500 feet above sea level, it’s around 60 degrees at night. That makes the 100-degree days tolerable. The trip took me through Midland, Texas. Most of the people there work in the oil business in some way or another. Midland has about 150,000 people – 155,000 in good times and 140,000 in bad. Outside Midland, I stopped at the Toot’n Totum convenience store to get gas and a cup of coffee. I asked the fellow behind the desk, “How’s it going?” He said, “Pretty good.” His name was Raphael. He had been a “roustabout” driving a backhoe for eight years, making $25 an hour plus time-and-a-half overtime. But that was at $100-a-barrel oil. Everyone was drilling then. And Midland was a boomtown. Since the collapse of oil and gas prices, those jobs disappeared. Raphael was out of work for six months until he started working the store’s day shift for eight bucks an hour. It’s still cattle country – big ranches, big sky.

I asked what the latest oil news was.

“Out by Alpine and Pecos, it’s booming,” he said.

Like most folks around Midland, Raphael has seen the booms and busts. Sometimes, when times are tough, a little excitement turns out to be just hype. He’s got a steady job and has saved a little. He’ll wait for things to come back into full swing before giving that up. As you head west fromMidland on I-20 toward Odessa, you pass what’s known as “Oilfield Row.” It’s about 10 miles of metal buildings and open yards usually full of oilfield equipment and pipe. It’s desolate now. I counted six stores open. Drilling contractor Helmerich & Payne had 36 drilling rigs stacked in its yard. The U.S. Bureau of Labor Statistics estimates that each land-based rig employs about 350 people. That’s 12,600 jobs. It started getting dark as I turned south on Farm to Market Road 1776. I was still about two hours out of Alpine. As I drove a little closer, I saw a gas flare. It was big... I’d say 20 feet in the air. It lit up the ground for about 1,000 feet in all directions. As I drove on, I saw several more. By 9 p.m., I could drive without headlights. But I left ‘em on. As I said, there are 12 million cows in Texas... I didn’t want to buy one that night. The road to Alpine is lonely, and Farm to Market Road 1776 is the loneliest stretch. You could drive all day and pass five cars. But that night, 18-wheeler traffic had picked up – and pickup traffic was through the roof. Sure enough, it’s an oil boom right in the middle of an oil crash . We Can’t Stay on the Sidelines

Before I go on... let me introduce myself. My name is Flavious Smith.

I’m an oil guy – 35 years in the business. I have worked most of the major onshore oil and gas basins across the U.S... the Anadarko, Appalachian,

Denver-Julesburg (DJ), East Texas, Gulf Coast, Hugoton, Permian, Powder River, Uinta, Wind River, and Williston Basins, to name a few.

In 2005, I served as Division Land Manager for EOG Resources’ (EOG) Appalachian operations in Pittsburgh. There I led the development of EOG’s Marcellus Shale assets. In 2006, I was a Division Land Manager in EOG’s Barnett Shale operations in Fort Worth. Then in 2008, I moved on to the Forestar Group (FOR) to build and lead Forestars’ oil and gas operating segment, serving as chief oil and gas officer and executive vice president. While there, I also served on the oil and gas and real estate investment committees, evaluating opportunities and making recommendations for acquisitions and investments. And I have experience in oil and gas land work, engineering, geology, geophysics, and operations. I know the players. I love the business. And I love to share my experiences. For my latest trip, I decided to head to Alpine after attending the February North American Prospect Expo (NAPE) in Houston. It’s a gathering of about 20,000 oil and gas dealmakers. Everybody was selling something... whether they were from the Marcellus Shale in Pennsylvania, the Bakken in North Dakota, or the Wolfberry in Texas’ Permian Basin. There was even a row of international discoveries on display. I looked at an offshore deal in the Mediterranean, off the coast of Israel. The idea of visiting the Mediterranean was enticing. But the deal was just too tough. The numbers didn’t make sense. I’ve even owned my own oil and gas company.

Everyone at NAPE was talking about the Alpine High discovery. I had to see it for myself.

Alpine High is owned by the big independent oil producer Apache (APA).

How a $19 billion oil company with Texas roots kept this project a secret as long as it did, I’ll never know. But for three or four years, Apache had been hard at work. Quietly using lease brokers, it bought

up 307,000 acres around Alpine and Pecos in southern Reeves County, Texas... acreage it believed held big oil and gas resources. Then on September 7, 2016, the company stepped forward. Apache announced its new discovery – the Alpine High. How good was Alpine High? Good enough for the company to spend two years of testing and buying acreage before the results were even in. Apache estimates the oil reserve holds 75 trillion cubic feet of rich gas. That’s gas with lots of liquids – liquids that can be stripped out to make butane, propane, and other -anes. And its official estimates say the Alpine High has 3 billion barrels of oil. But Apache thinks there’s more than that. Its estimates only account for two of the five possible formations stacked on top of each other. That’s industry talk for “upside.” Even at those conservative estimates, Apache has a winner on its hands. Drilling and completion will cost about $4 million. That’s about 20% less than other Midland Basin wells. The land was cheap, too, at about $1,300 per acre. I’m sharing my trip to Alpine because it is a reminder that good things can happen even in tough times like these . And as resource investors, we must always be looking for value . We can’t wait for good things to happen... because by then, the big opportunities will be gone. Yes, things are going to get worse before they get better. But remember, commodity prices follow a cyclical pattern. What goes down will eventually come back up. We’re going to get to the point when demand from countries that are evolving – like China and India – will completely overwhelm our ability to meet their needs with existing supply. This is the long-term trend that we’re interested in... It’s a supercycle . The current bear market in oil prices will make lots of people nervous about investing in this industry. Don’t make that mistake...

In other words, it’s the time from bust to boom to bust. It’s something I’m calling “Oil $500.” We’re approaching the next bottom. Oil still has farther to drop. But when demand for oil ramps up, oil prices will move much, much higher. And for businesses that are prepared – like the ones we’ll show you in this book – their shares will soar. Like my grandfather always told me, “Boy, you can’t score a touchdown if you’re not in the game.” My Alpine trip proved you just can’t assume nothing good is happening. Oil prices will move higher. You want to be in the game now. There Is Bad News... And Good News Oil prices are down and going lower. Reports estimate that 200,000 oil and gas jobs have been lost in the U.S. since mid-2014. Companies are going broke, and many that aren’t broke are strangled with debt. According to corporate law firm Haynes & Boone, from January 2015 through December 2016, there were 114 exploration and production company bankruptcies totaling $74.2 billion in debt. Add that to the 111 oilfield service company bankruptcies totaling $18.8 billion in debt, and you have 125 company bankruptcies with $93 billion in debt. But there is some hope. Goldman Sachs says 100,000 jobs might return by 2018. I’m not sure where you’ll find the talent. Most of those old oil survivors are working at the Toot’n Totum now, or they have left to work construction or at the local car lot. Oil prices have been stuck around $40-$50 a barrel since 2016. And $50 oil makes almost every oil play in the U.S. uneconomic… Worldwide, $50 oil is killing entire economies. The cost of getting a barrel of oil out of the ground in Russia is about $70. The cost in Iran is in the mid-$60s. The cost in the North Sea around Western Europe is $55. As I write in summer 2017, it is all bad news.

With a few exceptions, only the Saudis are in the catbird seat. Their cost of production is around $25 per barrel.

As for worldwide supply and demand, production in early 2017 is about 98.5 million barrels per day. Demand is about 97 million barrels per day. Estimates for 2018 aren’t that much different. Not much to get excited about, right?

But here’s the thing...

In the next few years, oil demand will skyrocket. And you need to be in the game!

Here’s why….

The U.S. is the largest consumer of oil on the planet. Our oil consumption is about 7.2 billion barrels per year. That’s about 19.5 million barrels per day. Put another way, there are 325 million Americans that use about 22 barrels of oil per person per year . That’s right. You use about 22 barrels of oil each year. Japan has 127 million people, who consume about 1 billion barrels of oil each year. That’s 11 barrels of oil per person per year . Both the U.S. and Japanese economies are industrialized, and the standard of living is high. We make a lot of stuff, we drive a lot of cars, we watch a lot of TV, and we have air conditioning. Frankly, we are well-off. And we use a lot of oil. There are 1.3 billion people in India... three times the combined population of the U.S. and Japan. Yet India uses just 1.5 billion barrels of oil per year, or about 4.1 million barrels per day. That’s 1.1 barrels of oil per person per year . Now, let’s talk China. There are 1.4 billion people in China. That’s also three times the number of people in the U.S. and Japan combined . The But the total population of both countries is only 452 million people.

Chinese use 4 billion barrels of oil per year. That’s 11 million barrels per day. And that’s only three barrels of oil per person per year . But here’s the kicker... China is in the middle of its second industrial revolution. Poverty is decreasing, and the middle class is growing. The standard of living is rising dramatically. They are driving cars and scooters, not riding bicycles. They watch TV, they use a lot of electricity, and they are making a lot of stuff. So is India. It will add another 241 million “people of working age” between 2010 and 2030. Most of them will be driving cars, watching TV, and making stuff. India will soon surpass China and have the most people of any country in the world. And remember, India only uses 1.1 barrels of oil per person per year.

See where this is going?

There are 2.7 billion people in India and China combined. What happens when 2.7 billion people begin to use oil at the rate of America and Japan?

BOOM!

The U.S. and Japan use an average of 19 barrels of oil per person per year. But let’s say that China and India consume just five barrels of oil per person every year by 2030. That’s just 13.5 billion barrels per year (2.7 billion people times 5 barrels of oil). That would increase world demand by 9.5 billion barrels per year... or about 26 million barrels per day. And don’t think I’m the first to identify this trend. Former EOG CEO Mark Papa described this phenomenon to me in 2007. It was one of the driving factors behind that company’s shift from gas production to oil.

But the big question now is where will an additional 26 million barrels of oil per day come from?

Our bet is the good ol’ USA.

And what part of the U.S. will be the center of the universe for oil production? The Permian Basin, the king of the U.S. oil basins.

The Permian Is the Place to Be

In the Permian Basin, oil has been king since 1921. The Permian area has produced 30 billion barrels of oil in its lifetime. Now, the Permian churns out about 2 million barrels of oil a day, equal to almost 25% of the crude oil in the U.S. That’s twice as much as the Bakken and Eagle Ford shale fields combined. (Apache’s Alpine High is in the Permian.) The Permian is attractive for a simple reason: It makes money. Drilling and operating wells there is profitable, even at $50 a barrel. Drilling a well requires a lot of upfront cash. Obviously, keeping the costs as low as possible is critical to making wells profitable. Permian wells are among the best at returning cash. And they return it fast. The market likes that, which is good for us as investors. In 2017, all but four zones make money at $50 per barrel. More than half make money at $40 per barrel. Let me show you why this place is so profitable when Russia, Iran, and Western Europe aren’t...

The Permian Basin covers an area of West Texas (and part of New Mexico) roughly 250 miles wide by 300 miles long.

In addition to its sheer size, a key to the Permian’s profitability is its “stacked formations.” In the Permian, one piece of land likely contains three or more zones layered on top of one another. Each zone is capable of producing oil. We call that “stacked pay.” The oil and gas business has changed. In years past, Permian production was all “conventional” vertical wells. But most of the big conventional fields have been discovered, and that technology reached its full potential years ago. Now, “unconventional” horizontal drilling has changed the way we look at oil exploration. New technologies developed in the mid-2000s by companies like Haliburton (HAL) and Schlumberger (SLB) have revolutionized this method. We can now drill a mile deep and two miles sideways. With horizontal drilling came “fracking” (or hydraulic fracturing), which involves cracking open the rocks in a drilling area and forcing sand (called proppant) into the cracks to hold them open. High-pressure water is pumped into the drilled well to fracture the rock. The proppant enters the fractures and lets the oil flow easier from the oily rocks. Fracking also makes “bad” rocks into better rocks. Bad rocks are rocks that contain oil but won’t let the oil loose. Fracking helps the oil move out of the rocks and into the well bore. More oil, more money.

The following cross section shows how horizontal wells are drilled in the Permian.

The Permian has a mature and well-developed infrastructure. That’s technical talk for having lots of gathering and transportation pipelines. And it’s all connected to Cushing, Oklahoma. Cushing is the biggest U.S. oil hub. And Cushing is linked directly to refineries on the Gulf Coast. That means the Permian has reliable oil sales. Solid economics, good land positions, mature infrastructure, and access to reliable markets make the Permian the king of U.S. oil basins.

As we said earlier, oil trades for between $40 and $50 a barrel in early 2017.

The pullback in prices since 2014 has beaten down most exploration

and production (E&P) players. (These are the companies that drill the wells and produce the oil and gas.) But with population growth in China and India, we see good news ahead for oil prices . That’s why the Permian makes the most sense. It’s a low-cost basin. It has the infrastructure in place. And most important... it’s where the oil is. In this market, we want to find companies with good balance sheets that are led by experienced management teams, with quality assets and the ability to execute. When we find one, we need to be in the game.

– Chapter 2 –

The Anatomy of Oil’s Booms and Busts

If you were an oil man in 1980, you were considered the smartest guy in the room. Oil prices had climbed from around $3.39 per barrel in 1970 to nearly $35 per barrel in 1980 – a 10 times boom in just 10 years.

And the guys who paid attention got rich.

These guys had big houses. They drove big cars. And they wore Rolexes.

They started their own companies left and right. It would have been stupid not to, wouldn’t it?

And everyone – I mean everyone – borrowed money.

It couldn’t hurt, they thought. Any money they borrowed they’d make back 10 times over. But that’s the fallacy with us oil guys. We are optimists. Every day is brighter. The big one is just one more well away. No one plans for lower prices. We’re too busy making money.

And that’s why, in 1981, no one was prepared for the crash.

Natural gas prices fell from $9 to $3 in a matter of months. Most companies went bankrupt. No one could pay back what they had borrowed. Half the homes in Oklahoma City – ground zero – were for sale or in foreclosure.

It was a blood bath.

You see, the oil industry is a cyclical market. It’s volatile. It booms and busts like crazy.

During the boom times, everyone is happy and making money fast. But what no one was prepared for in 1981 – what any smart investor should have known from history – is that any cyclical asset like oil can turn around and bust for years.

I found that out during my first years on the job…

‘It’s Boom Time in the Oil Field!’

It was 11:30 a.m. on “lingerie Thursday,” July 1981.

Escaping the 105-degree heat, I ducked in for lunch at Michael’s Plum – an oil and gas industry hangout in Oklahoma City. Every day, the old guys went there to talk about the old days. The young guys went to show off their Rolexes.

It was the middle of the oil and gas boom.

Every Thursday at Michael’s Plum was “lingerie day.” That’s the day the waitresses wore lingerie. It was marked on everyone’s calendar. (Things were different in corporate America back then.) On that particular day, I sat at a table with four other guys, most older than me. I was in my first year of law school. Just got a job as a Landman, negotiating and acquiring oil and gas drilling leases for Southwestern Energy Production Company. I was making $30,000 a year. I was feeling my oats. But I still wore a Tag watch. I knew two of the guys at my table. One was Mike. He was my age and an independent Landman who checked courthouse records and bought oil and gas leases. Mike earned about $300 a day plus expenses. He’s the one who invited me to this bustling hot spot.

The other guy (a 28-year-old whose name I don’t remember) had started a drilling mud company. Drilling mud, made of Bentonite, is a kind of clay and comes in paper bags about the size of lawn fertilizer. It makes the well bore slick. Keeps the drill pipe from getting stuck. Both Mike and the “mud guy” wore Rolexes. The mud guy’s was gold. 14 karat, I think. Mike’s was stainless. I didn’t know the other three guys at the table. But I could tell from the small talk that one worked for a drilling company. He wore a gold Rolex. Not that cheap 14K gold, but solid 18K. The second was a young independent who started his own exploration company. No surprise, everyone had started their own exploration company in Oklahoma. He used the drilling guy to drill most of his wells. The independent didn’t wear a watch. Never trusted a guy without a watch. The last guy was a banker – a loan officer at Penn Square Bank. His name was Bill. He talked a good game. He was engaging. He was the guy you wanted to drink with. We ordered drinks before our lunch. Bill and I got scotch. Mike ordered Jack and Coke. The rest had martinis. (Things were different in corporate America back then.) The waitress brought the drinks and Bill toasted the table. Then without missing a beat, he reached into his briefcase and pulled out some legal papers. “Who needs money?” he asked. Who Needs Money?

The mud guy said things were moving so fast, he needed about $1 million to keep up. “It’s for inventory.”

Mike stayed quiet. After all, field guys bill day-work for a living. He drove a new F-150. He was set.

The drilling guy said, “I need $5 million.” He was buying a deep drilling rig that could go to 25,000 feet. He worked in the Anadarko Basin where it was deep, expensive, and gassy. Gas prices in the deep basin were $9 per thousand BTUs (or about a thousand cubic feet). The independent chimed in… “Once the rig is checked out, we have big plans,” he said. He needed $5 million, too. The waitress stopped by again. Bill ordered prime rib for the table and another round of drinks. She was in a different nighty. We all noticed. Bill handed the mud guy and the drilling guy the papers. They were bank loans. Bill said, “Just fill in the amount you need. I’ll run ‘em through.” They were signature notes. No collateral. The guys filled in the amounts and signed their names. Bill gathered up the notes, ordered Dom Pérignon champagne, and toasted the group: By July 1982 – 12 months later – gas prices had tanked. Thursdays at Michael’s Plum were long gone. I never saw the mud guy again. Word was he went broke and checked in to rehab. The drilling guy and the independent, like everybody else, went broke, too. Mike and I still see each other. Usually at Jack’s Onion Burger on the north side. Jack’s is owned by Jack Hodges, who used to own Hodges Trucking. It was a huge outfit. Moved drilling rigs and equipment all over the Anadarko. The only thing Jack is moving today is burgers. “It’s a $10 million day. Here’s to luck and higher prices.” No One Saw It Coming!

Bill, at the bank, had his own set of problems….

Penn Square had grown. And grown fast. It was an oil and gas lending powerhouse.

But it grew so fast, it outgrew its ability to lend. When it could no longer support its loans, it packaged and sold them to larger banks, like Continental Illinois. Continental took all the paper Penn Square could deliver. And when the loans kept coming, another bank, SeaFirst, stepped in. They all were fast and loose. Sloppy paperwork, no paperwork… it didn’t seem to matter. Oil and gas prices were high and going higher. No one wanted to miss out on the oil boom. Oklahoma was ground zero. Then in July 1982, Penn Square suddenly locked its doors. Oil prices had collapsed from $9 to $3 per barrel. People were lined up outside the shopping mall bank. Depositors couldn’t get their money. Continental and SeaFirst were faced with billions of dollars in uncollectable loans. No one could pay them back. The money was gone. It was an interesting time. A time that builds character. Odds are good the mud guy landed on his feet. So too for the drilling guy and the independent. Last I heard, Mike was still buying leases, but making $500 a day not $300. As for Bill? As I said, it was a time that builds character. Word is he’s a solid husband and father. And that’s all we need to know. No one saw the crash coming back then. No one saw it coming in 2014, either… Oil and gas prices were strong. Business was booming. Banks were lending. Wells were drilling. Oil and gas was flowing. Most investors don’t plan for lower prices. They’re too busy making money. But if you want to make money AND KEEP IT, you need to understand the cyclicality of the oil markets. In this chapter, we’re going to show you every boom and bust in the history of the oil markets. The most important thing to remember is that every high has a low, and every low has a high.

Since 2014, it has been all bust for oil.

In 2017, oil prices are down and going lower. Estimates are that 200,000

oil and gas jobs were lost in the U.S. since mid-2014. Companies are going broke, and many that aren’t broke are strangled with debt.

But we are nearing the end of that bust. In the coming years, we could see a boom bigger than most folks can imagine.

And you need to be in the game!

A History of Oil’s Boom and Bust Cycle

Investing in oil has always been about cycles.

Led by the fundamentals of supply and demand, prices rise and fall. But geopolitics has always played a role. Let’s explore the booms and busts throughout history to better understand how oil markets react…

Before the industrial revolution in the mid-1800s, people in Europe and the U.S. used wood or coal to heat their homes.

Lubricants were extracted from lard and whale oils. Solvents like alcohol and turpentine were made from wood.

And to a limited extent, oil was refined from coal, coal tars, and shales. The oil market was very small in the 19th century, but the value of these products was extraordinary. Prices for lubricants, solvents, and lighting oils was about $2 per gallon. That’s about $80 per barrel in 1850 ($1,900 per barrel in 2010 dollars). The industrial revolution brought new drilling technologies, and the surprising discovery of oil from wells drilled in Pennsylvania changed the world. We could now collect oil from wells drilled to depths of less than 100 feet. Oil supplies became abundant. Kerosene, refined from crude oil produced in Pennsylvania, began to replace whale oil as a lighting source. In the 1860s, the U.S. started shipping domestically refined oil to Great Britain. With an endless supply of oil, prices crashed to about $9 per barrel (about $230 per barrel in 2010 dollars) – an 88% drop.

The first oil boom and bust cycle was upon us.

Over the next 150 years, the oil markets would see consistent cycles of booms and busts as oil replaced coal as the energy source that fueled America’s growth to a world super power…

What Are the Causes of Oil Boom Markets and Why Do They Crash?

When oil supply is higher than oil demand, we see a bust in oil prices.

When demand is higher than supply, we see a boom. Many times, these booms come from a disruption in supply cause by war. In 1861, the U.S. Civil War increased demand for oil lubricants and solvents as the need for wagons, guns, cannons, and ammunition increased. At the end of the war, demand for those products fell sharply. And oil prices did the same . They declined from around $8 in 1864 to $0.67 in 1887 .

The first boom and the first bust.

By the 1880s, the U.S. produced 85% of the world’s oil – 64 million barrels of oil per year. It was used to make kerosene, lubricants, and stove fuels. But abundant supplies and limited use kept oil prices low.

That began to change with the invention of the low-cost, mass- produced Ford Model T in 1908. Two years later, gasoline overtook

kerosene as the largest fuel source. And by World War I, oil prices had begun to rise. Boom! Much like the Civil War did, the Great War increased demand for fuel to move troops, equipment, and supplies around the world. And prices rose 500% from $0.64 in 1915 to $3.07 in 1920 .

By 1927, America had more cars per capita than any country in the world. One in five people owned a car. In Europe, one in 40 people owned a car. Demand for gasoline skyrocketed – becoming the driver of world crude oil prices.

But just as the automobile arrived and oil prices began to rise…

Bust. The Great Depression hit and the discovery of new oil fields in Texas sent supply shooting up. The increased supply drove oil prices down 70% from $1.88 per barrel in 1926 to $0.65 per barrel in 1930 .

By 1931, Congress imposed a tariff on imported crude oil to prohibit Russia from dumping cheap crude into the U.S. By limiting that supply, Congress hoped to drive prices back up.

At the same time, the U.S. instituted conservation efforts. But oil was abundant. Supply outpaced demand. So prices remained low.

Even though the discovery of the giant East Texas Field around Wichita Falls in North Texas and the Old Panhandle Field in the Texas Panhandle decimated oil prices… it also sparked a new era in oil production in the United States… Texas would become the largest oil producer in the country, producing 40% of U.S. crude between 1935 and 1960. By 1940, the U.S. produced 60% of the world’s oil. And prices had started to climb slightly.

Boom! As the 1930s came to a close, tensions with Japan were growing. In response to Japan’s aggressions in the Pacific, the U.S. embargo’s oil shipped to Japan. Prices started going up. And then in 1941… Pearl Harbor. During the war years, the U.S. rationed gasoline and worldwide supply of oil remained high above demand. In 1938, oil was discovered in Saudi Arabia. And within a few years, Saudi Arabia became the largest oil exporter in the world. However, U.S. imports of Saudi oil remained low for several years as domestic supply was more than enough to meet demand in the States…

By the time World War II ended, the U.S. was a global powerhouse.

In 1948, the U.S. was producing more than 5 million barrels of oil per day. And as Europe and Japan began to rebuild from the war, the U.S. was providing 50% of the world’s oil. Prices doubled from $1.05 per barrel in 1946 to $2.08 in 1958 .

Demand for domestic oil was growing, too, as the U.S. quickly transformed into a mobile society. President Eisenhower pushed the Interstate highway system linking major cities with high-capacity roadways. This spurred the transport of goods and supplies by truck. Auto sales grew from 26 million cars in 1946 to 40 million by the early 1950s. And oil consumption exploded in a post-war boom. In the 1960s and 1970s, transportation accounted for 70% of oil consumption in the U.S. By that time, U.S. reliance on oil had grown so much that it went from being a net exporter of oil (in 1945) to importing one third of its oil demand from emerging global oil supplier Saudi Arabia… Bust.

Starting in 1956, oil prices began a gradual decline…

That year, Egypt seized the Suez Canal. That disruption took 10% of world oil off the market. But oil was so plentiful, prices were barely affected.

Concerned with low oil prices, the Arab nations created the Organization of Petroleum Exporting Countries (OPEC) in 1960. The

members – Saudi Arabia, Iraq, Iran, Kuwait, Qatar, and Venezuela – controlled over 80% of the world’s crude exports at that time.

Then in 1967, Syria, Egypt, and Jordan attacked Israel in the Six Day War. The U.S. and Britain supported Israel in the conflict. And in retaliation, OPEC declared an oil embargo on exports to those countries. Prices started to rise as demand in those areas exceeded supply. The U.S. increased production by 1 million barrels per day to compensate. In 1972, U.S. oil production peaked at 9 million barrels of oil per day… making it not only the largest consumer of oil in the world, but also the largest producer. Boom! In 1973, oil prices went from trickling higher to a full-on boom when another oil embargo sent the global price of oil soaring.

In October of 1973, Syria and Egypt once again attacked Israel in the Yom Kippur War. And again, OPEC declared an embargo on Israel’s allies – namely the U.S. and U.K.

This time, almost 15% of traded world oil went off the market. World oil shortages hit Europe, Japan, and the U.S. Demand surged as supply fell. And oil prices jumped from $3 per barrel in 1973 to $14 per barrel in 1978.

Then the real gains came...

Iran was engulfed in civil war from January 1978 to February 1979. The Shah of Iran – Mohammad Reza Shah Pahlavi – was deposed. And Iranian oil production declined from 5 million barrels a day to zero – 5% of the world’s oil supply gone.

Iran took 444 American hostages. The U.S. severed diplomatic ties to the country. And global oil prices doubled in 12 months .

Prices soon spiked again...

In 1980, Iran and Iraq began an eight-year war that threatened oil supplies from the Persian Gulf. The U.S. sent military assets to insure the free flow of oil in the region, but 4 million barrels of oil per day was removed from the global market.

Prices rose from $14 per barrel in 1978 to nearly $37 per barrel in 1980.

From 1967 through 1980, 6% of the world’s oil supply was removed from the market. Prices pushed higher, and an oil boom ensued . Lingerie Thursdays at Michael’s Plum were in full swing. The bank loans were flowing freer and the Rolexes were getting heavier. But as you know by now, every boom comes with a bust in the oil industry . And the world was about to experience one of the largest busts of all time . Bust. In 1981, interest rates were 20%. The U.S. economy was in a recession. World oil consumption began to decline. Oil imports in the U.S. fell

from 45% in the mid-1970s to 28% by 1982. Gasoline use also fell as fuel standards forced fuel efficiencies up from 20 miles per gallon to almost 30 miles per gallon in 1978.

Oil prices fell 57% from $35 per barrel in 1981 to $15 by 1986 .

Then Boom ... Iraq invaded Kuwait. Iraq and Kuwait accounted for 9% of world oil production in 1990. The U.S. determined that Saudi Arabian oil supplies were at risk, and so President George H.W. Bush sent U.S. military forces to protect Saudi Arabia and its oilfields. Oil prices spiked. The U.S. released 34 million barrels of oil from its strategic oil reserve, and Operation Desert Storm was over in six months. And, of course, bust . Oil prices began to retreat as the threat diminished. Oil dropped from $40 per barrel in 1990 to less than $20 per barrel in 1991. The ninth post-war recession began in July 1990.

By the 21st century, we were back to a…

Boom!

The U.S. was approaching record demand for oil…

World oil demand outpaced supply as Asia entered a new industrial revolution. And the U.S. led the world in new oil-production technologies, like horizontal drilling and hydraulic fracturing… making it possible to recover billions of barrels of oil from previously non- productive rocks. Just as the first well in Pennsylvania changed the oil industry in the 1859, unconventional drilling and fracking forever changed the oil industry in 2005. The price of oil in the summer of 2008 hit $147 per barrel – up from $39 in 2004… an incredible 273% gain in four years.

Fuel prices skyrocketed. Oil drillers spent and borrowed billions to develop new unconventional resources. Gasoline prices exceeded $4 per gallon. The industrial revolutions in China and India, with populations over 1.5 billion each, increased their thirst for oil.

Demand was at record highs. And prices remained up. People thought it would last forever. In late 2008, the global financial markets collapsed. Oil prices fell 78% but quickly snapped back to new highs due to tensions in the Middle East. (Where have we heard this story before?) Like 1980, nobody expected oil would fall again. Prices were at all-time highs. Surely, the party was just getting start. But nobody ever learns from history. And soon enough, then came 2014… Bust. U.S. oil production was booming. Driven by new tight/shale oil fields in the Bakken, Eagle Ford, and Permian basin, U.S. production exceeded 4 million barrels per day… more than all the OPEC producers except for Saudi Arabia.

And as always happens in situations like that, supply outstripped demand. Prices fell to $50 per barrel .

For many companies, it cost more to drill a well than they earned from selling the oil. Production was no longer economic.

At $50 per barrel, oil and gas companies curtailed drilling and cut costs. Production fell. In 2015, U.S. output hit its highest level in 100 years. Oil prices sank below $40. Then on January 20, 2016, prices slid to $27 per barrel. In 2017, prices are bouncing around between $45-$50 per barrel. Supply is outpacing demand. Storage of crude oil in the U.S. is at record highs. And U.S. exploration and production companies continue to drill and complete wells… adding to bloated supplies and keeping prices low. As of July 2017, there are 6,000 wells that have been drilled and are awaiting completion onshore in the U.S. The world is in a “second industrial revolution.” As less developed countries like China and India emerge from agrarian economies to modern industrial societies, billions of people will require energy and oil to fuel their development. As in early 20th century America, transportation will be a major driver of this need for oil. In the U.S., there are 750 cars per every 1,000 people. With a population of 324 million people, that’s about 244 million cars burning fuel refined from crude oil. In China, there 22.5 cars per every 1,000 people today. With a population of 1.6 billion, that’s about 36 million cars. What happens when there are 100 cars per 1,000 people? 200 cars per 1,000 people? Ok, what happens with there are 750 cars per 1,000 people in China?With 1.6 billion people, that’s 1.2 billion cars . That’s an enormous demand for oil. In India, there are eight cars per thousand people in 2017. India has 1.25 billion people. What happens when India has 750 cars per thousand people. That’s 937.5 million cars . Within the next 15 years, we could see another 2.1 billion additional But another boom is coming. The biggest oil boom in history.

cars in China and India alone… all burning fuel refined from oil. And that’s not even counting growth in other parts of the world. Now that’s an oil boom! It’s not just about cars. Oil is the catalyst of our civilization. There are approximately 7.5 billion people on the Earth. Oil is about agriculture and food. It is about distribution. It is about raw materials. It is about almost every economic and social transaction that takes place. All we need for the next boom – the biggest oil boom in history – is for demand to once again surpass production capacity. It is not entirely clear when that will happen. But it looks like we are nearer to that point than not… Saudi Arabia claims it could increase production to around 12 million barrels per day, but there’s no proof that’s achievable. It will likely reach a ceiling at 10.72 barrels per day (its all-time high in 2016). OPEC’s production as a whole is in decline. With few exceptions, OPEC members are producing at peak levels already. It is not clear if further investment will change the decline going forward.

Russia produces 10.91 million barrels per day as of March 2016. OPEC and Russia account for 40% of world oil production. It’s doubtful that Russia and Saudi Arabia have excess capacity now.

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