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Despite rising oil prices, energy business remains on fragile ground

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FILE - In this Tuesday, Oct. 18, 2016, file photo, oil show attendees walk past the Schlumberger booth at the Permian Basin International Oil Show at Ector County Coliseum, in Odessa, Texas. Schlumberger N.V. reports financial results Friday, Jan. 19, 2018. (Jacob Ford/Odessa American via AP, File)
FILE - In this Tuesday, Oct. 18, 2016, file photo, oil show attendees walk past the Schlumberger booth at the Permian Basin International Oil Show at Ector County Coliseum, in Odessa, Texas. Schlumberger N.V. reports financial results Friday, Jan. 19, 2018. (Jacob Ford/Odessa American via AP, File)Jacob Ford/MBI

The price of Texas crude briefly popped above $65 a barrel this week, creating a quandary for oil executives.

Should they lock in the highest price in four years with hedges, or should they gamble on the price going even higher.

The industry's history is littered with bankruptcy filings by chief executives who made the wrong bet.

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The oil and gas business is in a transition period, coming off of a bust, but without a clear boom on the horizon. These transition periods are the most dangerous, especially now, when the entire energy sector is in the midst of the most profound transformation since Spindletop.

In the coming months, the U.S. will break its record for monthly oil production set in 1970, pumping an average of 10.2 million barrels a day. By the end of the year, the U.S. could start producing more crude than Saudi Arabia, according to the U.S. Energy Information Administration.

Oil companies and their support systems are raking in significant profits for the first time since 2014, when the bust began. Shale drillers are controlling their spending and recording profits from operations, a first, while services provider Halliburton reported a 50 percent jump in revenue in the fourth quarter.

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To help guarantee sustained profits, 43 companies studied by consulting firm IHS Markit hedged 25 percent of their 2018 production at an average price of $53.40 a barrel. They're not collecting $64 for those barrels, but neither will they suffering lower prices should the market collapse.

"Companies are seeking more predictable cash flows because of greater investor demands to improve corporate returns and keep capital spending within cash flow," said Paul O'Donnell, principal energy analyst at IHS Markit. "The higher level of hedging is less about supporting aggressive production growth and more about increasing investor confidence that these companies are serious about becoming more financially disciplined."

Discipline is critical at times like these. Because the only thing propping up prices is a commitment by the Organization of the Petroleum Exporting Countries and its partners, most importantly Russia, to keep 1.8 million barrels a day in spare capacity off the market.

That's a dangerously fragile deal on which to bet an investor's money.

This month's higher prices are also unlikely to last, if most reputable analysts are correct. Most have forecast an average price of $55 for West Texas Intermediate in 2018, and $60 for Brent, the international benchmark.

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While oil gets most of the attention, a more interesting and equally important commodity is natural gas, which recently surpassed coal to become the dominant fuel used to generate electricity in the U.S. Between wells drilled specifically for gas, and the huge amount produced from oil wells, America is awash with the stuff.

Rock bottom prices, though, are leading electric companies to build more gas-fired power plants and shutdown coal-fired facilities. This year, the U.S. also will become a net exporter of natural gas for the first time since 1957, with billions of cubic feet loaded onto tankers as liquefied natural gas or flowing to Mexico, at least as long as the North American Free Trade Agreement remains intact.

The energy revolution, though, is about more than fossil fuels. Forty-three corporations in 10 countries directly contracted for 5.4 gigawatts of electricity produced by wind and solar sources in 2017, smashing the previous record of 4.4 gigawatts in 2015, according to Bloomberg New Energy Finance.

A gigawatt is enough power for 700,000 homes, and that kind of growth is cutting into demand for coal and natural gas as well. Soon renewable energy will power automobiles as well.

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Analysts at Bank of America-Merrill Lynch last week said electric cars will take 40 percent of the personal transportation market by 2030, and 90 percent by 2050. They also expect demand for oil to peak in 2035, which is in line with predictions made by Royal Dutch Shell and consulting firm Wood Mackenzie.

While that may sound like the distant future, most large oil firms make major investment decisions on 20-year or 30-year time frames. Which brings us back to the oil executive's quandary: Will future oil prices generate enough profit to justify the investment decision I must make today?

There are many reasons why the price of oil and natural gas could rise or fall precipitously. OPEC and Russia are unpredictable, Venezuela is in chaos and a global recession could cut demand off at the knees.

In unpredictable periods like this one, keeping debt low and profits high is the only sure way to survive whatever comes next. And that's where smart energy executives and investors will concentrate.

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