Back in the late fall of 2014, when Saudi Arabia broke up OPEC for the first time and unleashed a torrent of crude oil on the world despite the protests of its fellow cartel members, oil prices crashed as a result of what then seemed to be a “calculated” move by Riyadh which hoped to put US shale out of business amid a flawed gamble betting that shale breakeven prices were around $60-80. They, however, turned out to be much lower, which coupled with Saudi misreading of the willingness of junk bond investors to keep funding US shale producers, meant that despite a 3 years stretch of low oil prices, US shale emerged stronger than ever before, with the US eventually eclipsing both Saudi Arabia and Russia as the world’s biggest crude oil producer.
Fast forward to March 2020, when Saudi Arabia doubled down in its attempt to crush shale, only to avoid angering long-time ally Donald Trump, the Crown Prince pretended that the latest flood of oil was an oil price war aimed at Moscow not Midland. And this time, unlike 2014, with the benefit of the global economic shutdown resulting from the coronavirus pandemic, the Saudis may have finally lucked out in the ongoing crusade against US oil, because as Bloomberg writes with “negative oil prices, ships dawdling at sea with unwanted cargoes, and traders getting creative about where to stash oil”, the next chapter in the oil crisis is now inevitable: “great swathes of the petroleum industry are about to start shutting down.”
As the recent OPEC summit so vividly demonstrated, the marginal price of oil is no longer determined by supply or cuts thereof (such as the recently announced agreement by OPEC+ for a 9.7mmb/d output cut), but rather by demand, or the lack thereof, which according to some estimate is as much as 36mmb/d lower, or roughly a third of the global oil market every day, as billions of people are stuck at home instead of driving, while major corporations mothball production in a world where major economies have ground to a halt.
The economic impact of the coronavirus has ripped through the oil industry in dramatic phases, Bloomberg’s Javier Blas writes. First it destroyed demand as lock downs shut factories and kept drivers at home. Then storage started filling up and traders resorted to ocean-going tankers to store crude in the hope of better prices ahead.
Now shipping prices are surging to stratospheric levels as the industry runs out of tankers, a sign of just how distorted the market has become.
Ironically, in its latest attempt to kill off shale, Saudi Arabia may have gone a step too far, as “the specter of production shut-downs – and the impact they will have on jobs, companies, their banks, and local economies – was one of the reasons that spurred world leaders to join forces to cut production in an orderly way. But as the scale of the crisis dwarfed their efforts, failing to stop prices diving below zero last week, shut-downs are now a reality. It’s the worst-case scenario for producers and refiners.“
In short, the entire oil production industry is shutting down, not because it wants to – of course – but because it has no choice. According to Goldman, in as little as three weeks there will be literally no place left on earth to store oil, and unless oil producers want to pay “buyers” to hold the oil as happened on that historic date of April 20, they have no choice but to shut in output.
Which brings us back to why in 2020 Riyadh has succeeded where it failed in 2014: as Bloomberg writes “in theory, the first oil output cuts should have come from the OPEC+ alliance, which earlier this month agreed to reduce production from May 1. Yet after the catastrophic price plunge on Monday, when West Texas Intermediate fell to -$40 a barrel, it’s the U.S. shale patch that is leading”
The best indicator of how the shale industry is reacting is the sudden collapse in the number of oil rigs in operation, which last week fell to a four-year low: “Before the coronavirus crisis hit, oil companies ran about 650 rigs in the US. By Friday, more than 40% of them had stopped working, with only 378 left.”
And while there is a delay between total US oil production and the rig count, it is now obvious that US production is set to collapse next:
“Monday really focused people’s minds that production needs to slow down,” said the co-head of oil trading at commodity merchant Trafigura. “It’s the smack in the face the market needed to realize this is serious.” Incidentally, Trafigura, one of the largest exporters of US crude from the U.S. Gulf of Mexico, believes that output in Texas, New Mexico, North Dakota and other states will now fall much faster than expected as companies react to negative prices…
Until prices collapsed on Monday, the consensus was that output would drop by about 1.5MM barrels a day by December. Now market watchers see that loss by late June. “The severity of the price pressure is likely to act as a catalyst for the immediate turn down in activity and shut-ins,” said Roger Diwan, oil analyst at consultant IHS Markit Ltd.
As detailed last week, this price shock has been especially acute in the physical market where producers of crude streams such as South Texas Sour and Eastern Kansas Common had to pay more than $50 a barrel to offload their output last week.
And so the US industry is finally shutting down as ConocoPhillips and shale producer Continental Resources have all announced plans to shut in output. Regulators in Oklahoma voted to allow oil drillers to shut wells without losing leases; New Mexico made a similar decision. Even North Dakota, which for years was synonymous with the U.S. shale revolution, is witnessing a rapid retrenchment, as Bloomberg notes that “oil producers have already closed more than 6,000 wells, curtailing about 405,000 barrels a day in production, or about 30% of the state’s total.”
However, it won’t be just the US: output cuts can be seen from Chad, a poor and landlocked country in Africa, to Vietnam and Brazil, producers are now either reducing output or making plans to do so. “I wouldn’t want to get sensational about it but yes, clearly there must be a risk of shut-ins,” Mitch Flegg, the head of North Sea oil company Serica Energy, said in an interview. “In certain parts of the world it is a real and present risk.”
In emergency board meetings last week, oil companies small and large discussed an outlook that’s the most somber any oil executive has ever witnessed. For the small firms, the next few weeks will be all about staying afloat. But even for the bigger ones, like Exxon Mobil Corp. and BP Plc, it’s a challenge. Big Oil will offer an insight into the crisis when companies report earnings this week.
Then on Friday, May 1, Saudi Arabia, Russia and the rest of OPEC+ will join the output cuts, slashing their output by 23%, or 9.7 million barrels a day. Saudi Aramco, the state-owned company has already cut production, and Russian oil companies have announced exports of their flagship Urals crude would drop in May to a 10-year low.
And yet, as warned here repeatedly, it may still not be enough, as every week, another 50 million barrels of crude are going into storage, enough to fuel Germany, France, Italy, Spain, and the U.K. combined, with estimates that the world will run out of land-based storage some time in late May or early June. Meanwhile, what’s not stored onshore, is stashed in tankers. As Bloomberg’s Blas points out, the U.S. Coast Guard on Friday said there were so many tankers at anchor off California that it was keeping an eye on the situation.
VIDEO: US Coast Guard says it’s keeping an eye on 27 oil tankers anchored off the coast of Southern California. Another great example of floating storage build-up as demand for oil and refined products plunge | #OOTT#Contango video via @USCGLosAngeles pic.twitter.com/B7pjWIsdnp
But if the two dozen or so tankers piled up off the coast of California is bad…
… and those next to Galveston, TX is worse…
… what is going on in that tanker parking lot off of Singapore is absolutely insane.
There is some good news: oil traders say after plunging by a third, US oil consumption has probably hit a bottom, and will start a very gentle recovery, although that also depends on how fast the US economy can reopen from the coronavirus coma.
But before even a modest recovery takes hold, the great shutdown will spread through oil refining too. Over the past week, Marathon Petroleum, one of the biggest U.S. refiners, announced it would stop production at a plant near San Francisco. Royal Dutch Shell has idled several units in three U.S. refineries in Alabama and Louisiana. And across Europe and Asia, many refineries are running at half rate. U.S. oil refiners processed just 12.45 million barrels a day on the week to April 17, the lowest amount in at least 30 years, except for hurricane-related closures.
The closures have already sent thousands packing: the oil and gas industry shed nearly 51,000 drilling and refining jobs in March, a 9% reduction that will only get worse in April. March’s job losses rise by 15,000 when ancillary jobs such as construction, manufacturing of drilling equipment and shipping are included, according to BW Research Partnership, a research consultancy, which analyzed Department of Labor data combined with the firm’s own survey data of about 30,000 energy companies.
“We’re looking at anywhere between five and seven years of job growth wiped out in a month,” Philip Jordan, the company’s vice president said in an interview. “What makes it sort of scary is this really is just the beginning. April is not looking good for oil and gas.”
And so, as the oil industry shuts down – at least for a few weeks (or perhaps months) – more refinery shutdowns are coming, oil traders and consultants said, particularly in the U.S. where lockdowns started later than in Europe and demand is still contracting. Steve Sawyer, director of refining at Facts Global Energy, said that global refineries could halt as much as 25% of total capacity in May.
“No one is going to be able to dodge this bullet.”
The Russian central bank sees several catalysts that could stop the oil rally in its tracks.
Bearish rig count report from Baker Hughes could signal a reverse in direction.
Supply will continue to increase rather than slow down in 2016 – even if there is a decline in shale production.
Battle for market share is one of the major catalysts not being considered.
I believe it’s very clear this oil rally is running on fumes and was never the result of an improvement in fundamentals. That means to me this rally is going to quickly run out of steam if it isn’t able to run up quicker on existing momentum. I don’t see that happening, and it could pull back dramatically, catching a lot of investors by surprise. The Russian central bank agrees, saying it doesn’t believe the price of oil is sustainable under existing market conditions.
Cited by CNBC, the Russian central bank said, “the current oil market still features a continued oversupply, on the backdrop of a slowdown in the Chinese economy, more supplies originating from Iran and tighter competition for market share.”
In other words, most things in the market that should be improving to support the price of oil aren’t. That can only mean one thing: a violent pullback that could easily push the price of oil back down to the $30 to $32 range. If the price starts to fall quickly, we could see panic selling driving the price down even further.
I think most investors understand this is not a legitimate rally when looking at the lack of change in fundamentals. I’ll be glad when the production freeze hoax is seen for what it is: a manipulation of the price of oil by staggered press releases meant to pull investors along for the ride. The purpose is to buy some time to give the market more time to rebalance. Once this is seen for what it really is, oil will plummet. It could happen at any time in my opinion.
Rig count increases for first time in three months
For the first time in three months, the U.S. rig count was up, increasing by one to 387. By itself this isn’t that important, but when combined with the probability that more shale supply may be coming to the market in 2016, it definitely could be an early sign of the process beginning.
EOG Resources (NYSE:EOG) has stated it plans on starting up to 270 wells in 2016. We don’t know yet how much additional supply it represents, but it’s going to offset some of the decline from other companies that can’t continue to produce at these price levels. There are other low-cost shale producers that may be doing the same, although I think the price of oil will have to climb further to make it profitable for them, probably around $45 per barrel.
It’s impossible to know at this time if the increase in the price of oil was a catalyst, or we’ve seen the bottom of the drop in rig counts. The next round of earnings reports will give a glimpse into that.
Fundamentals remain weak
Most of the recent strength of the price of oil has been the continual reporting on the proposed production freeze from OPEC and Russia. This is light of the fact there really won’t be a freeze, even if a piece of paper is signed saying there is.
We know Iran isn’t going to agree to a freeze, and with Russia producing at post-Soviet highs and Iraq producing at record levels, what would a freeze mean anyway? It would simply lock in output levels the countries were going to operate at with or without an agreement.
The idea is the freeze is having an effect on the market and this will lead to a production cut. That simply isn’t going to happen. There is zero chance of that being the outcome of a freeze, if that ever comes about.
And a freeze without Iran isn’t a freeze. To even call it that defies reality. How can there be a freeze when the one country that would make a difference isn’t part of it? If Iran doesn’t freeze production, it means more supply will be added to the market until it reaches pre-sanction levels. At that time, all Iran has promised is it may consider the idea.
What does that have to do with fundamentals? Absolutely nothing. That’s the point.
Analysis and decisions need to be based on supply and demand. Right now that doesn’t look good. The other major catalyst pushing up oil prices has been the belief that U.S. shale production will decline significantly in 2016, which would help support oil. The truth is we have no idea to what level production will drop. It seems every time a report comes out it’s revised in a way that points to shale production remaining more resilient than believed.
I have no doubt there will be some production loss in the U.S., but to what degree there will be a decline, when considering new supply from low-cost shale companies, has yet to be determined. I believe it’s not going to be near to what was originally estimated, and that will be another element weakening support over the next year.
Competing for market share
One part of the oil market that has been largely ignored has been the competition for market share itself. When U.S. shale supply flooded the market, the response from Saudi Arabia was to not cede market share in any way. That is the primary reason for the plunge in oil prices.
There has been no declaration by the Saudis that they are going to change their strategy in relationship to market share and have said numerous times they are going to let the market sort it out, as far as finding a balance between supply and demand. So the idea they are now heading in a different direction is a fiction created by those trying to find anything to push up the price of oil.
It is apparent some of the reason for increased U.S. imports comes from Saudi Arabia in particular lowering its prices to nudge out domestic supply. It’s also why the idea of inventory being reduced in conjunction with lower U.S. production can’t be counted on. It looks like imports will continue to climb while shale production declines.
More competition means lower prices, although in this case, Saudi Arabia is selling its oil at different price points to different markets. It’s the average that matters there, and we simply don’t have the data available to know what that is.
In the midst of all of this, Russia is battling the Saudis for share in China, while the two also battle it out in parts of Europe, with Saudi Arabia looking to take share away from Russia. Some of Europe has opened up to competitors because it doesn’t want to rely too much on Russia as its major energy source.
For this and other competitive reasons, I could never trust a production freeze agreement if it ever came to fruition. They haven’t been adhered to in the past, and they won’t be if it happens again. Saudi Arabia has stated several times that it feels the same way.
Conclusion
To me the Russian central bank is spot on in saying the chance of a sustainable oil rally is slim. It also accurately pointed out the reasons for that: it’s about the lack of the fundamentals changing.
With U.S. inventory increasing, rig counts probably at or near a bottom, no end in sight to oversupply continuing, and competition for a low-demand market heating up, there is nothing I see that can justify an ongoing upward price move. I don’t even see it being able to hold.
A weaker U.S. dollar has legitimately helped some, but it can’t support the price of oil on its own. When all the other factors come together in the minds of investors, and the price of oil starts to reverse direction, there is a very strong chance a lot of bullish investors are going to get crushed hard. It is probably time to take some profits and run for the exit if you’re in the oil market for the short term.
Irrational Oil Optimists About To Experience Some Panic Selling Pain
Summary
Short-term positions in oil getting more risky.
U.S. production will outperform estimates as shale producers add supply to the market.
Inventory will come under more strain as key U.S. storage facilities approach full capacity.
Dollar weakness isn’t enough to maintain oil price momentum.
The longer the price of oil has upward momentum, and the higher it goes, the more risky it becomes for investors because there is nothing outside of a weakening U.S. dollar to justify any kind of move we’ve seen the price of oil make recently.
The falling dollar isn’t enough to keep the oil price from falling to where it belongs, and that means when the selloff begins, it’s likely to gravitate into full-panic mode, with sellers running for the exits before they get burned.
This is especially risky for those looking to make a quick windfall from the upward movement of oil. I’m not concerned about those taking long-term positions in quality energy companies with significant oil exposure, since they’ve probably enjoyed some great entry points. There is, of course, dividend risk, along with the strong probability of further share erosion before there is a real recovery that has legs to stand on because it’s based on fundamentals.
For that reason, investors should seriously consider taking profits off the table and wait for better conditions to re-enter.
Oil has become a fear play. Not the fear of losing money, but the fear of not getting in on the fast-moving action associated with the quick-rising price of oil. Whenever there is a fear play, it is ruled by emotion, and no amount of data will convince investors to abandon their giddy profits until they lose much, if not all, of what they gained. Don’t be one of them.
Having been a financial adviser in the past, I know what a lot of people are thinking at this time in response to what I just said. I’ve heard it many times before. It usually goes something like this: “What if the price of oil continues to rise and I lose a lot of money because of leaving the market too soon?” That’s a question arising from a fear mentality. The better question is this: “What if the oil price plunges and panic selling sets in?”
Oil is quickly becoming a casino play on the upside, and the longer investors stay in, the higher the probability they’ll lose the gains they’ve enjoyed. Worse, too much optimism could result in losses if preventative action isn’t taken quickly enough.
What needs to be considered is why one should stay in this market. What is so convincing it warrants this type of increasing risk, which offers much less in the way of reward than even a week ago? What fundamentals are in place that suggest a sustainable upward movement in the price of oil? The answer to those questions will determine how oil investors fare in the near future.
U.S. shale production
The more I think on the estimates associated with U.S. shale production in 2016, measured against the statements made by stronger producers that they’re going to boost supply from premium wells this year, the more I’m convinced it isn’t going to fall as much as expected. New supply will offset a lot of the less productive and higher cost wells being shuttered. I do believe there will be some loss of production from that, but not as much as is being suggested.
There are various predictions on how much production is going to be lost, but the general consensus is from 300,000 bpd to 600,000 bpd. It could come in on the lower side of that estimate, but I don’t think it’ll be close to the upper end of the estimate.
What is unknown because we don’t have an historical guideline to go by is, the amount of oil these premium wells will add to supply. We also don’t know if the stated goals will be followed up on. I think they will, but we won’t know for certain until the next couple of earnings reports give a clearer picture.
When combined with the added supply coming from Iran, and the ongoing high levels of production from Saudi Arabia, Russia and Iraq, I don’t see how the current support for the price of oil can continue on for any length of time.
There is no way of knowing exactly when the price of oil will once again collapse, but the longer it stays high without a change in the fundamentals, the higher the risk becomes, and the more chance it could swing the other way on momentum, even if it isn’t warranted. It could easily test the $30 mark again under those conditions.
Inventory challenges
What many investors don’t understand about storage and inventory is it definitely matters where the challenges are located. That’s why Cushing being over 90 percent capacity and Gulf storage only a little under 90 percent capacity means more than if other facilities were under similar pressure. Together, they account for over 60 percent of U.S. storage.
With the imbalance of supply and demand driving storage capacity levels, the idea of oil staying above $40 per barrel for any period of time is highly unlikely. A lower U.S. dollar and the highly irrelevant proposed production freeze talks can’t balance it off.
Once the market digests this, which could happen at any time, we’ll quickly enter bear mode again. The problem is the price of oil is straining against its upper limits, and if momentum starts to deflate, the race to sell positions will become a sprint and not a marathon.
Uncertainty about shale is the wild card
As already mentioned, U.S. shale production continues to be the major catalyst to watch. The problem is we have no way of knowing what has already been unfolding in the first quarter. If investors start to abandon their positions, and we find shale supply is stronger than projected, it’ll put further downward pressure on oil after it has already corrected.
What I mean by that is we should experience some fleeing from oil before the next earnings reports from shale producers are released. If the industry continues to surprise on the upside of supply, it’ll cause the price of oil to further deteriorate, making the outlook over the next couple of months potentially ominous.
This isn’t just something that has a small chance of happening; it’s something that has a very strong probability of happening. Agencies like IEA have already upwardly revised their outlook for shale supply in 2016, and if that’s how it plays out, the entire expected performance for the year will have to be adjusted.
Conclusion
Taking into account the more important variables surrounding what will move the price of oil, shale production remains the most important information to follow. Not much else will matter if supply continues to exceed expectations. It will obliterate all the models and force analysts to admit this has little to do with prior supply cycles and everything to do with a complete market disruption. Many are still in denial of this. They’ll learn the reality soon enough.
That doesn’t mean there won’t eventually be a time when demand finally catches up with supply, but within the parameters of this weak global economy and oil supply that continues to grow, it’s going to take a lot longer to realize than many thought.
For several months, it has been understood that the market underestimated the expertise and efficiency of U.S. shale producers, and to this day they continue to do so. We will find out if that remains in play in the first half of 2016, and by then, whether it’ll extend further into 2017.
As for how it will impact the price of oil now, if we start to have some panic selling before the earnings reports, and the earnings reports of the important shale producers exceed expectations on the supply side, with it being reflected in an increase in the overall output estimates for the year, it will put more downward pressure on oil.
The other scenario is oil lingers around $40 per barrel until the earnings reports come out. There will still be a decline in the price of oil, the level of which would depend on how much more supply shale producers brought to the market in the first quarter than expected.
My thought is we’re going to experience a drop in the price of oil before earnings reports, which then could trigger a secondary exodus from investors in it for short-term gains.
For those having already generated some decent returns, it may be time to take it off the table. I don’t see how the shrinking reward can justify the growing risk.
The Mosul Dam in Iraq could collapse at any time, causing massive flooding across the country.
Iraq produces over four million barrels of oil per day, a number which will drop immediately when this event occurs.
The destruction of oil production in Iraq will immediately decrease world supply, lifting oil prices.
The Oil Situation: Since 2014, the oil market has been in a tailspin due to a multitude of global factors. As of March 2016, prices seem to have stabilized, although the persistence of crude oversupply continues to hang over the market. For months, declining US production and a potential output freeze by OPEC have been putting a potential floor in place. However, I believe an event is on the horizon which will change the equilibrium of oil prices immediately… the collapse of the Mosul Dam.
The Mosul Dam:The Mosul Dam is the largest dam in Iraq. It is located on the Tigris River in the western governance of Ninawa, upstream of the city of Mosul. Constructed in 1981, the dam has had a history of structural issues, requiring perpetual maintenance in order to maintain its integrity. Since 1984, this consisted of 300 man crews, working 24 hours a day across three shifts, filling holes in the bedrock through a process called grouting. For 30 years, this process worked, although it was always considered to be a ticking time bomb, dubbed “the most dangerous dam in the world” by the US Army Corps of Engineers.
In August 2014, the Islamic State of Iraq and the Levant took control of the dam, halting the maintenance process until it was retaken by Iraqi, Kurdish and US Forces two weeks later. Unfortunately, the damage was already done… since then, the maintenance crews have been limited to 30 personnel or less, and the equipment is inadequate to continue patching holes. Per the dam’s former chief engineer, Nasrat Adamo, “The machines for grouting have been looted. There is no cement supply. They can do nothing. It is going from bad to worse, and it is urgent. All we can do is hold our hearts.” As winter snows melt, the water levels will rise to unsustainable levels, and while it has two pressure release gates to avoid this scenario, one has been non-functioning for years, and using the second one alone risks the stability of the structure.
The Event: When the Mosul Dam collapses (and without reconstruction measures being implemented quickly, this is considered a ‘when’, not an ‘if’), a wave 45-65 feet high is expected to flood the country, drowning Mosul in four hours and reaching Baghdad within two to four days.
Estimates range from 500,000 to 1,500,000 lives lost. In addition to flooding, there will be secondary and tertiary effects… as demonstrated in America during Hurricane Katrina, panic and lawlessness can be equally as dangerous as the flooding itself, but even worse, diseases such as malaria and West Nile fever will follow. A catastrophic event of this magnitude will immediately push the entire country into chaos, and Iraq does not have the capability to respond without global support. The closest comparison to make is Haiti, which with billions in global assistance has not returned to normalcy in five years. Overall, I anticipate this catastrophe will take years to overcome… in the meantime, it will have a significant effect on the world’s supply of oil today.
The Effects:As of winter 2015, Iraq was producing 4.3M barrels per day, with the southern fields producing 3.3M barrels and the remaining 1M coming from the north. The graphic below (left) is from 2014, but gives a picture of the oil field placements. To the right is a topographical map, which gives us an idea of how the floodwaters will progress. Based on the elevation of where the flood would initiate, everything between Mosul and Baghdad will be completely covered, and while the wave will dissipate over time, the fields between Baghdad and Basra will see enough water (and everything that comes with it, to include bodies, disease and unexploded ordinance) to temporarily disable operations. Additionally, the pipeline between Kirkuk and Ramadi will be underwater, and there is a potential for damage to the Iraq Strategic Pipeline, which runs parallel to the direction of the water’s progression.
The world’s oversupply of oil is estimated around one million barrels per day. Assume that the above happens, and in a best-case scenario, only northern production is affected. What would occur immediately is the elimination of one quarter of Iraq’s oil output, rapidly pushing supply and demand into equilibrium. In a worst-case scenario, where all of Iraq’s oil is temporarily eliminated, it will move the supply deficit to three million barrels per day, leading to large ramifications on the world’s crude oil surplus within weeks.
While the true answer lies somewhere between these possibilities, what is undeniable is that a catastrophe of this magnitude will immediately move the price of crude oil up, and depending on the timeline to return to today’s production levels, that move could be enormous. In late 2015, the world produced 97M barrels per day, causing the price to collapse to $26.00 per barrel. In 2014, while producing 93M barrels per day, the price averaged near $110.00 prior to its fall. Although the above is simple extrapolation, demand continues to grow, so I think we can all agree that the price shift north will be significant.
Conclusion: The subject of this article is admittedly morbid. The true fallout of this event is the loss of hundreds of thousands of Iraqi lives, and damage that would take years to erase. However, as informed investors, it would be irresponsible to not consider global events, and this has the potential to re-balance the oil market in a matter of days. When this occurs, over four million barrels per day can disappear from production, immediately shifting the direction of oil prices. Based on the above information, I believe a production cut decision by OPEC is irrelevant, as natural forces are preparing to address the oil oversupply on their own.
Last week, during the peak of the commodity short squeeze, we pointed out how this default cycle is shaping up to be vastly different from previous one: recovery rates for both secured and unsecured debts are at record low levels. More importantly, we noted how this notable variance is impacting lender behavior, explaining that banks – aware that the next leg lower in commodities is imminent – are not only forcing the squeeze in the most trashed stocks (by pulling borrow) but are doing everything in their power to “assist” energy companies to sell equity, and use the proceeds to take out as much of the banks’ balance sheet exposure as possible, so that when the default tsunami finally arrives, banks will be as far away as possible from the carnage. All of this was predicated on prior lender conversations with the Dallas Fed and the OCC, discussions which the Dallas Fed vocally denied accusing us of lying, yet which the WSJ confirmed, confirming the Dallas Fed was openly lying.
This was the punchline:
[Record low] recovery rate explain what we discussed earlier, namely the desire of banks to force an equity short squeeze in energy stocks, so these distressed names are able to issue equity with which to repay secured loans to banks who are scrambling to get out of the capital structure of distressed E&P names. Or as MatlinPatterson’s Michael Lipsky put it: “we always assume that secured lenders would roll into the bankruptcy become the DIP (debtor in possession) lenders, emerge from bankruptcy as the new secured debt of the company. But they don’t want to be there, so you are buying the debt behind them and you could find yourself in a situation where you could lose 100% of your money.“
And so, one by one the pieces of the puzzle fall into place: banks, well aware that they are facing paltry recoveries in bankruptcy on their secured exposure (and unsecured creditors looking at 10 cents on the dollar), have engineered an oil short squeeze via oil ETFs…
… to take advantage of panicked investors some of whom are desperate to cover their shorts, and others who are just as desperate to buy the new equity issued. Those proceeds, however, will not go to organic growth or even to shore liquidity but straight to the bank to refi loan facilities and let banks, currently on the hook, leave silently by the back door. Meanwhile, the new investors have no security claims and zero liens, are at the very bottom of the capital structure, and face near certain wipe outs.
In short, once the current short squeeze is over, expect everyone to start paying far more attention to recovery rates and the true value of “fundamentals.”
Going back to what Lipsky said, “the banks do not want to be there.” So where do they want to be? As far away as possible from the shale carnage when it does hit.
Today, courtesy of The New York Shock Exchange, we present just the case study demonstrating how this takes place in the real world. Here the story of troubled energy company “Lower oil prices for longer” Weatherford, its secured lender JPM, the incestuous relationship between the two, and how the latter can’t wait to get as far from the former as possible, in…
I am on record saying that Weatherford International is so highly-leveraged that it needs equity to stay afloat. With debt/EBITDA at 8x and $1 billion in principal payments coming due over the next year, the oilfield services giant is in dire straits. Weatherford has been in talks with JP Morgan Chase to re-negotiate its revolving credit facility — the only thing keeping the company afloat. However, in a move that shocked the financial markets, JP Morgan led an equity offering that raised $565 million for Weatherford. Based on liquidation value Weatherford is insolvent. The question remains, why would JP Morgan risk its reputation by selling shares in an insolvent company?
According to the prospectus, at Q4 2015 Weatherford had cash of $467 million debt of $7.5 billion. It debt was broken down as follows: [i] revolving credit facility ($967 million), [ii] other short-term loans ($214 million), [iii] current portion of long-term debt of $401 million and [iv] long-term debt of $5.9 billion. JP Morgan is head of a banking syndicate that has the revolving credit facility.
Even in an optimistic scenario I estimate Weatherford’s liquidation value is about $6.7 billion less than its stated book value. The lion’s share of the mark-downs are related to inventory ($1.1B), PP&E ($1.9B), intangibles and non-current assets ($3.5B). The write-offs would reduce Weatherford’s stated book value of $4.4 billion to – $2.2 billion. After the equity offering the liquidation value would rise to -$1.6 billion.
JP Morgan and Morgan Stanley also happen to be lead underwriters on the equity offering. The proceeds from the offering are expected to be used to repay the revolving credit facility.
In effect, JP Morgan is raising equity in a company with questionable prospects and using the funds to repay debt the company owes JP Morgan. The arrangement allows JP Morgan to get its money out prior to lenders subordinated to it get their $401 million payment. That’s smart in a way. What’s the point of having a priority position if you can’t use that leverage to get cashed out first before the ship sinks? The rub is that [i] it might represent a conflict of interest and [ii] would JP Morgan think it would be a good idea to hawk shares in an insolvent company if said insolvent company didn’t owe JP Morgan money?
The answer? JP Morgan doesn’t care how it looks; JP Morgan wants out and is happy to do it while algos and momentum chasing day traders are bidding up the stock because this time oil has finally bottomed… we promise.
So here’s the good news: as a result of this coordinated lender collusion to prop up the energy sector long enough for the affected companies to sell equity and repay secured debt, the squeeze may last a while; as for the bad news: the only reason the squeeze is taking place is because banks are looking to get as far from the shale patch and the companies on it, as possible.
We leave it up to readers to decide which “news” is more relevant to their investing strategy.
We grow up being taught a very specific set of principles.
One plus one equals two. I before E, except after C.
As we grow older, the principles become more complex.
Take economics for example.
The law of supply states that the quantity of a good supplied rises as the market price rises, and falls as the price falls. Conversely, the law of demand states that the quantity of a good demanded falls as the price rises, and vice versa.
These basic laws of supply and demand are the fundamental building blocks of how we arrive at a given price for a given product.
At least, that’s how it’s supposed to work.
But what if I told you that the principles you grew up learning is wrong?
With today’s “creative” financial instruments, much of what you learned no longer applies in the real world.
Especially when it comes to oil.
The Law of Oil
Long time readers of this Letter will have read many of my blogs regarding commodities manipulation.
With oil, price manipulation couldn’t be more obvious.
“…While agencies have found innovative ways to explain declining oil demand, the world has never consumed more oil.
In 2010, the world consumed a record 87.4 million barrels per day. This year (2014), the world is expected to consume a new record of 92.7 million barrels per day.
Global oil demand is still expected to climb to new highs.
If the price of oil is a true reflection of supply and demand, as the headlines tell us, it should reflect the discrepancy between supply and demand.
Since we know that demand is actually growing, that can’t be the reason for oil’s dramatic drop.
So does that mean it’s a supply issue? Did the world all of a sudden gain 40% more oil? Obviously not.
So no, the reason behind oil’s fall is not the causality of supply and demand.
The reason is manipulation. The question is why.
I go on to talk about the geopolitical reasons of why the price of oil is manipulated.
“On September 11, Saudi Arabia finally inked a deal with the U.S. to drop bombs on Syria.
But why?
Saudi Arabia possesses 18 per cent of the world’s proven petroleum reserves and ranks as the largest exporter of petroleum.
Syria is home to a pipeline route that can bring gas from the great Qatar natural gas fields into Europe, making billions of dollars for Saudi Arabia as the gas moves through while removing Russia’s energy stronghold on Europe.
Could the U.S. have persuaded Saudi Arabia, during their September 11 meeting, to lower the price of oil in order to hurt Russia, while stimulating the American economy?
… On October 1, 2014, shortly after the U.S. dropped bombs on Syria on September 26 as part of the September 11 agreement, Saudi Arabia announced it would be slashing prices to Asian nations in order to “compete” for crude market share. It also slashed prices to Europe and the United States.”
Following Saudi Arabia’s announcement, oil prices have plunged to a level not seen in more than five years.
Is it a “coincidence” that shortly after the Saudi Arabia-U.S. meeting on the coincidental date of 9-11, the two nations inked a deal to drop billions of dollars worth of bombs on Syria? Then just a few days later, Saudi Arabia announces a massive price cut to its oil.
Coincidence?
There are many other factors – and conspiracies – in oil price manipulation, such as geopolitical attacks on Russia and Iran, whose economies rely heavily on oil. Saudi Arabia is also flooding the market with oil – and I would suggest that it’s because they are rushing to trade their oil for weapons to lead an attack or beef up their defense against the next major power in the Middle East, Iran.
However, all of the reasons, strategies or theories of oil price manipulation could only make sense if they were allowed by these two major players: the regulators and the Big Banks.
How Oil is Priced
On any given day, if you were to look at the spot price of oil, you’d likely be looking at a quote from the NYMEX in New York or the ICE Futures in London. Together, these two institutions trade most of the oil that creates the global benchmark for oil prices via oil futures contracts on West Texas Intermediate (WTI) and North Sea Brent (Brent).
What you may not see, however, is who is trading this oil, and how it is being traded.
Up until 2006, the price of oil traded within reason. But all of a sudden, we saw these major price movements. Why?
“Until recently, U.S. energy futures were traded exclusively on regulated exchanges within the United States, like the NYMEX, which are subject to extensive oversight by the CFTC, including ongoing monitoring to detect and prevent price manipulation or fraud.
In recent years, however, there has been a tremendous growth in the trading of contracts that look and are structured just like futures contracts, but which are traded on unregulated OTC electronic markets. Because of their similarity to futures contracts they are often called ”futures look-a likes.”
The only practical difference between futures look-alike contracts and futures contracts is that the look-a likes are traded in unregulated markets whereas futures are traded on regulated exchanges.
The trading of energy commodities by large firms on OTC electronic exchanges was exempted from CFTC oversight by a provision inserted at the behest of Enron and other large energy traders into the Commodity Futures Modernization Act of 2000 in the waning hours of the 106th Congress.
The impact on market oversight has been substantial.
NYMEX traders, for example, are required to keep records of all trades and report large trades to the CFTC. These Large Trader Reports (LTR), together with daily trading data providing price and volume information, are the CFTC’s primary tools to gauge the extent of speculation in the markets and to detect, prevent, and prosecute price manipulation.
…In contrast to trades conducted on the NYMEX, traders on unregulated OTC electronic exchanges are not required to keep records or file Large Trader Reports with the CFTC, and these trades are exempt from routine CFTC oversight.
In contrast to trades conducted on regulated futures exchanges, there is no limit on the number of contracts a speculator may hold on an unregulated OTC electronic exchange, no monitoring of trading by the exchange itself, and no reporting of the amount of outstanding contracts (”open interest”) at the end of each day.
The CFTC’s ability to monitor the U.S. energy commodity markets was further eroded when, in January of this year (2006), the CFTC permitted the Intercontinental Exchange (ICE), the leading operator of electronic energy exchanges, to use its trading terminals in the United States for the trading of U.S. crude oil futures on the ICE futures exchange in London-called ”ICE Futures.”
Previously, the ICE Futures exchange in London had traded only in European energy commodities-Brent crude oil and United Kingdom natural gas. As a United Kingdom futures market, the ICE Futures exchange is regulated solely by the United Kingdom Financial Services rooority. In 1999, the London exchange obtained the CFTC’s permission to install computer terminals in the United States to permit traders here to trade European energy commodities through that exchange.
Then, in January of this year, ICE Futures in London began trading a futures contract for West Texas Intermediate (WTI) crude oil, a type of crude oil that is produced and delivered in the United States. ICE Futures also notified the CFTC that it would be permitting traders in the United States to use ICE terminals in the United States to trade its new WTI contract on the ICE Futures London exchange.
Beginning in April, ICE Futures similarly allowed traders in the United States to trade U.S. gasoline and heating oil futures on the ICE Futures exchange in London. Despite the use by U.S. traders of trading terminals within the United States to trade U.S. oil, gasoline, and heating oil futures contracts, the CFTC has not asserted any jurisdiction over the trading of these contracts.
Persons within the United States seeking to trade key U.S. energy commodities-U.S. crude oil, gasoline, and heating oil futures-now can avoid all U.S. market oversight or reporting requirements by routing their trades through the ICE Futures exchange in London instead of the NYMEX in New York.
As an increasing number of U.S. energy trades occurs on unregulated, OTC electronic exchanges or through foreign exchanges, the CFTC’s large trading reporting system becomes less and less accurate, the trading data becomes less and less useful, and its market oversight program becomes less comprehensive.
The absence of large trader information from the electronic exchanges makes it more difficult for the CFTC to monitor speculative activity and to detect and prevent price manipulation. The absence of this information not only obscures the CFTC’s view of that portion of the energy commodity markets, but it also degrades the quality of information that is reported.
A trader may take a position on an unregulated electronic exchange or on a foreign exchange that is either in addition to or opposite from the positions the trader has taken on the NYMEX, and thereby avoid and distort the large trader reporting system.
Not only can the CFTC be misled by these trading practices, but these trading practices could render the CFTC weekly publication of energy market trading data, intended to be used by the public, as incomplete and misleading.”
Simply put, any one can now speculate and avoid being tagged with illegal price. The more speculative trading that occurs, the less “real” price discovery via true supply and demand become.
With that in mind, you can now see how the big banks have gained control and cornered the oil market.
Continued from the Report:
“…Over the past few years, large financial institutions, hedge funds, pension funds, and other investment funds have been pouring billions of dollars into the energy commodities markets…to try to take advantage of price changes or to hedge against them.
Because much of this additional investment has come from financial institutions and investment funds that do not use the commodity as part of their business, it is defined as ”speculation” by the Commodity Futures Trading Commission (CFTC).
…Reports indicate that, in the past couple of years, some speculators have made tens and perhaps hundreds of millions of dollars in profits trading in energy commodities.
This speculative trading has occurred both on the regulated New York Mercantile Exchange (NYMEX) and on the over-the-counter (OTC) markets.
The large purchases of crude oil futures contracts by speculators have, in effect, created an additional demand for oil, driving up the price of oil to be delivered in the future in the same manner that additional demand for the immediate delivery of a physical barrel of oil drives up the price on the spot market.
As far as the market is concerned, the demand for a barrel of oil that results from the purchase of a futures contract by a speculator is just as real as the demand for a barrel that results from the purchase of a futures contract by a refiner or other user of petroleum.
Although it is difficult to quantify the effect of speculation on prices, there is substantial evidence that the large amount of speculation in the current market has significantly increased prices.
Several analysts have estimated that speculative purchases of oil futures have added as much as $20-$25 per barrel to the current price of crude oil, thereby pushing up the price of oil from $50 to approximately $70 per barrel.”
The biggest banks in the world, such as Goldman Sachs, Morgan Stanley, Citigroup, JP Morgan, are now also the biggest energy traders; together, they not only participate in oil trades, but also fund numerous hedge funds that trade in oil.
Knowing how easy it is to force the price of oil upwards, the same strategies can be done in reverse to force the price of oil down.
All it takes is for some media-conjured “report” to tell us that Saudi Arabia is flooding the market with oil, OPEC is lowering prices, or that China is slowing, for oil to collapse.
Traders would then go short oil, kicking algo-traders into high gear, and immediately sending oil down further. The fact that oil consumption is actually growing really doesn’t matter anymore.
In reality, oil price isn’t dictated by supply and demand – or OPEC, or Russia, or China – it is dictated by the Western financial institutions that trade it.
“For years, I have been talking about how the banks have taken control of our civilization.
…With oil prices are falling, economies around the world are beginning to feel the pain causing a huge wave of panic throughout the financial industry. That’s because the last time oil dropped like this – more than US$40 in less than six months – was during the financial crisis of 2008.
…Let’s look at the energy market to gain a better perspective.
The energy sector represents around 17-18 percent of the high-yield bond market valued at around $2 trillion.
Over the last few years, energy producers have raised more than a whopping half a trillion dollars in new bonds and loans with next to zero borrowing costs – courtesy of the Fed.
This low-borrowing cost environment, along with deregulation, has been the goose that laid the golden egg for every single energy producer. Because of this easy money, however, energy producers have become more leveraged than ever; leveraging themselves at much higher oil prices.
But with oil suddenly dropping so sharply, many of these energy producers are now at serious risk of going under.
In a recent report by Goldman Sachs, nearly $1 trillion of investments in future oil projects are at risk.
…It’s no wonder the costs of borrowing for energy producers have skyrocketed over the last six months.
…many of the companies are already on the brink of default, and unable to make even the interest payments on their loans.
…If oil continues in this low price environment, many producers will have a hard time meeting their debt obligations – meaning many of them could default on their loans. This alone will cause a wave of financial and corporate destruction. Not to mention the loss of hundreds of thousands of jobs across North America.”
You may be thinking, “if oil’s fall is causing a wave of financial disaster, why would the banks push the price of oil down? Wouldn’t they also suffer from the loss?”
Great question. But the banks never lose. Continued from my letter:
“If you control the world’s reserve currency, but slowly losing that status as a result of devaluation and competition from other nations (see When Nations Unite Against the West: The BRICS Development Bank), what would you do to protect yourself?
You buy assets. Because real hard assets protect you from monetary inflation.
With the banks now holding record amounts of highly leveraged paper from the Fed, why would they not use that paper to buy hard assets?
Bankers may be greedy, but they’re not stupid.
The price of hard physical assets is the true representation of inflation.
Therefore, if you control these hard assets in large quantities, you could also control their price.
This, in turn, means you can maintain control of your currency against monetary inflation.
And that is exactly what the banks have done.
The True World Power
Last month, the U.S. Senate’s Permanent Subcommittee on Investigations published a 403-page report on how Wall Street’s biggest banks, such as Goldman Sachs, Morgan Stanley, and JP Morgan, have gained ownership of a massive amount of commodities, food, and energy resources.
The report stated that “the current level of bank involvement with critical raw materials, power generation, and the food supply appears to be unprecedented in U.S. history.”
For example:
“…Until recently, Morgan Stanley controlled over 55 million barrels of oil storage capacity, 100 oil tankers, and 6,000 miles of pipeline. JPMorgan built a copper inventory that peaked at $2.7 billion, and, at one point, included at least 213,000 metric tons of copper, comprising nearly 60% of the available physical copper on the world’s premier copper trading exchange, the LME.
In 2012, Goldman owned 1.5 million metric tons of aluminum worth $3 billion, about 25% of the entire U.S. annual consumption. Goldman also owned warehouses which, in 2014, controlled 85% of the LME aluminum storage business in the United States.” – Wall Street Bank Involvement with Physical Commodities, United States Senate Permanent Subcommittee on Investigations
From pipelines to power plants, from agriculture to jet fuel, these too-big-to-fail banks have amassed – and may have manipulated the prices – of some of the world’s most important resources.
The above examples clearly show just how much influence the Big Banks have over our commodities through a “wide range of risky physical commodity activities which included, at times, producing, transporting, storing, processing, supplying, or trading energy, industrial metals, or agricultural commodities.”
With practically an unlimited supply of cheap capital from the Federal Reserve, the Big Banks have turned into much more than lenders and facilitators. They have become direct commerce competitors with an unfair monetary advantage: free money from the Fed.
Of course, that’s not their only advantage.
According to the report, the Big Banks are engaging in risky activities (such as ownership in power plants and coal mining), mixing banking and commerce, affecting prices, and gaining significant trading advantages.
Just think about how easily it would be for JP Morgan to manipulate the price of copper when they – at one point – controlled 60% of the available physical copper on the world’s premier copper trading exchange, the LME.
How easy would it be for Goldman to control the price of aluminum when they owned warehouses – at one point – that controlled 85% of the LME aluminum storage business in the United States?
And if they could so easily control such vast quantities of hard assets, how easy would it be for them to profit from going either short or long on these commodities?
Always a Winner
But if, for some reason, the bankers’ bets didn’t work out, they still wouldn’t lose.
That’s because these banks are holders of trillions of dollars in FDIC insured deposits.
In other words, if any of the banks’ pipelines rupture, power plants explode, oil tankers spill, or coal mines collapse, taxpayers may once again be on the hook for yet another too-big-to-fail bailout.
If you think that there’s no way that the government or the Fed would allow this to happen again after 2008, think again.
Via the Guardian:
“In a small provision in the budget bill, Congress agreed to allow banks to house their trading of swaps and derivatives alongside customer deposits, which are insured by the federal government against losses.
The budget move repeals a portion of the Dodd-Frank financial reform act and, some say, lays the groundwork for future bailouts of banks who make irresponsibly risky trades.”
Recall from my past letters where I said that the Fed wants to engulf you in their dollars. If yet another bailout is required, then the Fed would once again be the lender of last resort, and Americans will pile on the debt it owes to the Fed.
It’s no wonder that in the report, it actually notes that the Fed was the facilitator of this sprawl by the banks:
“Without the complementary orders and letters issued by the Federal Reserve, many of those physical commodity activities would not otherwise have been permissible ‘financial’ activities under federal banking law. By issuing those complementary orders, the Federal Reserve directly facilitated the expansion of financial holding companies into new physical commodity activities.”
The Big Banks have risked tons of cash lending and facilitating in oil business. But in reality they haven’t risked anything. They get free money from the Fed, and since they aren’t supposed to be directly involved in natural resources, they obtain control in other ways.
Remember, the big banks – and ultimately the Fed who controls them – are the ones who truly control the world. Their monetary actions are the cause of many of the world’s issues and have been used for many years to maintain control of other nations and the world’s resources.
But they can’t simply go into a country, put troops on the ground and take over. No, that would be inhumane.
“Currency manipulation allows developed countries to print and lend to other developing countries at will.
A rich nation might go into a developing nation and lend them millions of dollars to build bridges, schools, housing, and expand their military efforts. The rich nation convinces the developing nation that by borrowing money, their nation will grow and prosper.
However, these deals are often negotiated at a very specific and hefty cost; the lending nation might demand resources or military and political access. Of course, developing nations often take the loans, but never really have the chance to pay it back.
When the developing nations realize they can’t pay back the loans, they’re at the mercy of the lending nations.
The trick here is that the lending nations can print as much money as they want, and in turn, control the resources of developing nations. In other words, the loans come at a hefty cost to the borrower, but at no cost to the lender.”
This brings us back to oil.
We know that oil’s crash has put a heavy burden on many debt facilities that are associated with oil. We also know that the big banks are all heavily leveraged within the sector.
If that is the case, why are the big banks so calm?
The answer is simple.
Asset-Backed Lending
Most of the loans associated with oil are done through asset-backed loans, or reserve-based financing.
It means that the loans are backed by the underlying asset itself: the oil reserves.
So if the loans go south, guess who ends up with the oil?
According to Reuters, JP Morgan is the number one U.S. bank by assets. And despite its energy exposure assumed at only 1.6 percent of total loans, the bank could own reserves of up to $750 million!
“If oil reaches $30 a barrel – and here we are – and stayed there for, call it, 18 months, you could expect to see (JPMorgan’s) reserve builds of up to $750 million.”
No wonder the banks aren’t worried about a oil financial contagion – especially not Jamie Dimon, JP Morgan’s Chairman, CEO and President:
“…Remember, these are asset-backed loans, so a bankruptcy doesn’t necessarily mean your loan is bad.” – Jamie Dimon
As oil collapses and defaults arise, the banks have not only traded dollars for assets on the cheap, but gained massive oil reserves for pennies on the dollar to back the underlying contracts of the oil that they so heavily trade.
The argument to this would be that many emerging markets have laws in place that prevent their national resources from being turned over to foreign entities in the case of corporate defaults.
Which, of course, the U.S. and its banks have already prepared for.
“…If the Fed raises interest rates, many emerging market economies will suffer the consequence of debt defaults. Which, historically means that asset fire sales – often commodity-based assets such as oil and gas – are next.
Historically, if you wanted to seize the assets of another country, you would have to go to war and fight for territory. But today, there are other less bloody ways to do that.
Take, for example, Petrobras – a semi-public Brazilian multinational energy corporation.
…Brazil is in one of the worst debt positions in the world with much of its debt denominated in US dollars.
Earlier this year (2015), Petrobras announced that it is attempting to sell $58 billion of assets – an unprecedented number in the oil industry.
Guess who will likely be leading the sale of Petrobras assets? Yup, American banks.
“…JPMorgan would be tasked with wooing the largest number of bidders possible for the assets and then structure the sales.”
As history has shown, emerging market fire sales due to debt defaults are often won by the US or its allies. Thus far, it appears the Petrobras fire sale may be headed that way.
‘Brazilian state-run oil company Petróleo Brasileiro SA said Tuesday (September 22, 2015) it is closing a deal to sell natural-gas distribution assets to a local subsidiary of Japan’s Mitsui & Co.’
The combination of monetary policy and commodities manipulation allows Western banks and allies to accumulate hard assets at the expense of emerging markets. And this has been exactly the plan since day one.
As the Fed hints of raising rates, financial risks among emerging markets will continue to build. This will trigger a reappraisal of sovereign and corporate risks leading to big swings in capital flows.”
Not only are many of the big banks’ practices protected by government and Fed policies, but they’re also protected by the underlying asset itself. If things go south, the bank could end up owning a lot of oil reserves.
No wonder they’re not worried.
And since the banks ultimately control the price of oil anyway, it could easily bring the price back up when they’re ready.
Controlling the price of oil gives U.S. and its banks many advantages.
For example, the U.S. could tell the Iranians, the Saudis, or other OPEC nations, whose economies heavily rely on oil, “Hey, if you want higher oil prices, we can make that happen. But first, you have to do this…”
You see how much control the U.S., and its big banks, actually have?
At least, for now anyway.
Don’t think for one second that nations around the world don’t understand this.
Just ask Venezuela, and many of the other countries that have succumbed to the power of the U.S. Many of these countries are now turning to China because they feel they have been screwed.
The World Shift
The diversification away from the U.S. dollar is the first step in the uprising against the U.S. by other nations.
As the power of the U.S. dollar diminishes, through international currency swaps and loans, other trading platforms that control the price of commodities (such as the new Shanghai Oil Exchange) will become more prominent in global trade; thus, bringing some price equilibrium back to the market.
And this is happening much faster than you expect.
Chinese President Xi Jinping returned home Sunday after wrapping up a historic trip to Saudi Arabia, Egypt, and Iran with a broad consensus and 52 cooperation agreements set to deepen Beijing’s constructive engagement with the struggling yet promising region.
During Xi’s trip, China upgraded its relationship with both Saudi Arabia and Iran to a comprehensive strategic partnership and vowed to work together with Egypt to add more values to their comprehensive strategic partnership.
Regional organizations, including the Organization of Islamic Cooperation (OIC), the Cooperation Council for the Arab States of the Gulf (GCC) and the Arab League (AL), also applauded Xi’s visit and voiced their readiness to cement mutual trust and broaden win-win cooperation with China.
AL Secretary General Nabil al-Arabi said China has always stood with the developing world, adding that the Arab world is willing to work closely with China in political, economic as well as other sectors for mutual benefit.
The Belt and Road Initiative, an ambitious vision Xi put forward in 2013 to boost inter-connectivity and common development along the ancient land and maritime Silk Roads, has gained more support and popularity during Xi’s trip.
…Xi and leaders of the three nations agreed to align their countries’ development blueprints and pursue mutually beneficial cooperation under the framework of the Belt and Road Initiative, which comprises the Silk Road Economic Belt and the 21st Century Maritime Silk Road.
The initiative, reiterated the Chinese president, is by no means China’s solo, but a symphony of all countries along the routes, including half of the OIC members.
During Xi’s stay in Saudi Arabia, China, and the GCC resumed their free trade talks and “substantively concluded in principle the negotiations on trade in goods.” A comprehensive deal will be made within this year.”
In other words, the big power players in the Middle East – who produce the majority of the world’s oil – are now moving closer to cooperation with China, and away from the U.S.
As this progresses, it means the role of the U.S. dollar, and its value in world trade, will diminish.
And the big banks, which hold trillions of dollars in U.S. assets, aren’t concerned.
Term structure – contango says too much oil around.
Brent-WTI says Iran will flood the market.
Crack spreads could crack the recent lows for crude.
OPEC meeting is the next big event – signals are that these guys cannot agree on anything.
Crude oil and a turbulent world.
The price of crude oil has not looked this bad since March, when it made lows of $42.03, or on August 24, when it fell to $37.75. On Friday, November 20, active month January NYMEX crude oil settled at $41.90 per barrel. The expiring December contract traded down to lows of $38.99 on the session. There are very few positive things to say about the future prospects for the price of crude oil at this time. The fundamental structural state of the oil market is bearish for price.
Term Structure – contango says too much oil around
Two weeks ago, the IEA told us that the world is awash in crude oil. The international agency told us that worldwide inventories have swelled to 3 billion barrels.
When crude oil was trading over $100 per barrel on the active month NYMEX futures contract during the summer of 2014, the market was in backwardation. Deferred futures prices were lower than nearby prices. This condition tells us that a market is tight, or there is a supply deficit. As the price of oil began to fall, term structure moved from backwardation to contango. This told us that the market moved from deficit to a condition of oversupply. This past week, the contango on the nearby versus one-year oil spread once again validated the glut condition in crude oil.
(click to enlarge)The December 2015 versus December 2016 NYMEX crude oil spread closed last week at over $8.00 per barrel. The contango has increased to 20.46%, the highest level yet for this spread. The January 2016 versus January 2017 NYMEX spread also made a new high and traded above the $7 level.
Brent crude oil futures have rolled from December to January. The January 2016 versus January 2017 Brent crude oil spread was trading around the $7.62 or 17% level last Friday. Market structure is telling us that huge inventories of crude oil will weigh on the price in the weeks ahead. At their current levels, a new low below the current support at $37.75 seems likely. Meanwhile, a location/quality spread in crude oil is also telling us that prospects for the oil price are currently bleak.
Brent-WTI says Iran will flood the market
The benchmark for pricing North American crude is the NYMEX West Texas Intermediate (WTI) price. When it comes to European, African and Middle Eastern crudes, Brent is the benchmark pricing mechanism. For many years, Brent crude traded at a small discount to WTI. That is because WTI is sweeter crude; it has lower sulfur content. This makes WTI more efficient when it comes to processing the oil into the most ubiquitously consumed oil product, gasoline.
That changed in 2010. The Arab Spring caused uncertainty in the Middle East to rise. As the majority of the world’s oil reserves are located in this region, the price of Brent crude rose relative to the price of WTI. Brent crude included a political premium. Additionally, increasing production from the United States, due to the extraction of oil from shale, exacerbated the price differential between the two crudes. In 2011, the price of Brent traded at over a $25 premium to the price of WTI. Recently, the spread between these two crudes has been converging. While the spread on January futures was trading at a premium of $2.40 for the Brent futures as of last Friday, it had moved much lower during the week.
The premium of Brent over WTI has evaporated over the course of 2015. The reason is two-fold. First, the number of operating oil rigs in the United States has fallen dramatically over the past year, indicating that production of the energy commodity will fall. Last Friday, Baker Hughes reported that the total number of oil rigs in operation as of November 20 stands at 564 down from 1,574 at this time last year. While lower U.S. production is one reason for a decline in the spread, increased production of Iranian crude oil has had a more powerful effect on the spread.
The nuclear nonproliferation agreement with Iran means that sanctions will ease and Iran will pump and export more crude oil in the weeks and months ahead. Iran has stated that their production will initially rise by 500,000 barrels per day and it will eventually rise to over one million. These two factors have caused the Brent-WTI spread to converge. The price trend in this spread is a negative for the price of crude at this time.
Crack spreads could crack the recent lows for crude
Recently, we have seen divergence emerging in crude oil processing spreads. Gasoline cracks have been outperforming crude oil, while heating oil crack spreads continue to trade at the weakest level in years.
Last Friday, the NYMEX gasoline crack spread closed at just over $14 per barrel.
The monthly chart of the gasoline crack highlights the recent strong action in this spread. Gasoline is a seasonal product; it tends to trade at the lows during this time of year. In 2014, the high in the gasoline crack at this time of year was $12.36. Therefore, compared to last year, gasoline prices are strong relative to the price of raw crude oil. This could be due to the current low level of gasoline futures – the December NYMEX gasoline futures contract closed last Friday at $1.2866 and the January futures closed at $1.2670 per gallon. The current low level of gasoline prices has increased demand from drivers as refineries work to process heating oil as the winter is only a few weeks ahead. In September U.S. drivers set a record for miles traveled by automobile.
The heating oil processing spread is a very different story. While the gasoline crack is relatively strong, the heating oil crack is very weak.
(click to enlarge)Last Friday, the January heating oil processing spread closed at around the $17.50 per barrel level. Last year at this time, the low in this spread was $22.73. In 2013, the low was $24.53 and in 2012, the low was $37.75 per barrel. The current level of the heating oil crack spread is seasonally the lowest since November 2010 when it traded down to $12.35 per barrel. In November 2010, crude oil was trading above $84 per barrel.
One of the many reasons that the crude oil price is weak these days is that demand for seasonal products, heating oil and diesel fuel, is low and inventories of distillates are high. As you can see, there are very few bullish signs in the fundamental structure for the crude oil market these days. In two weeks, the oil cartel will sit down to decide what to do now that the commodity they seek to “control” is awash in a sea of bearishness.
OPEC meeting is the next big event – Signals are that these guys cannot agree on anything
When OPEC met in November 2014, the price of crude was around the $75 per barrel level. When they met late last spring, the price had recovered to around $60. In both cases, the cartel left production levels unchanged. The stated production ceiling for the members of OPEC is 30 million barrels per day. The member nations are currently producing over 31.5 million barrels per day and increasing Iranian production means that OPEC output will likely rise. As the price of oil falls, the members need to sell more to try to recoup revenue. For the weaker members, the oil revenue is an imperative. Even the stronger members are under pressure. Saudi Arabia recently began selling bonds; they are borrowing money from the markets to replace lost income due to the lower crude oil price.
Meanwhile, OPEC’s current strategy is to continue to produce to flush high cost producers out of the market and build market share for the cartel members. However, OPEC did not count on a global economic slowdown, particularly in China. At the December 4 meeting of oil ministers in Vienna, it is likely that demand for crude oil will be an important consideration.
Dominant members of the cartel remain at odds. Saudi Arabia and Iran are on opposite sides and are involved in a proxy war in Yemen. The weaker members of OPEC want the stronger members to shoulder the burden of production cuts, and that is not likely to happen any time soon. In a hint of the discord between the member nations, on November 17, OPEC’s board of governors was unable to agree on the cartel’s long-term strategy plan and they tabled the issue until 2016. The issues revolve around ceiling output, setting production quotas and methods of maximizing member profits.
This tells us that unless the cartel is planning a giant spoof on the market, there is probably going to be no change in production policy. The current level of cheating or daily sales above the production ceiling may even increase. At this point, I doubt whether OPEC members could agree on whether it is sunny or cloudy outside given vast political, economic and cultural divergences among member nations. This means that selling will continue and even increase over the months ahead.
Crude oil and a turbulent world
All of the news, fundamentals and technicals for crude oil point to new lows and a challenge of the December 2008 lows of $32.48 per barrel. Last week, Goldman Sachs came out with a prediction that oil could fall to $20 per barrel. This is not such a bold call given the current state of the oil market, the strength of the dollar and the overall bear market for raw material prices. Last week, copper put in another multi-year low, iron ore fell to new lows and the Baltic Shipping Index fell to the lowest level since 1985.
However, all of the bad news for crude oil is currently in the price. We have seen this before. In March when crude oil traded to lows, there were calls for crude oil to fall – Dennis Gartman, the respected commodity analyst, went on CNBC and said that crude oil could fall to $10 per barrel as the energy commodity could go the way of “whale oil.” In late August, when oil fell to recent lows at $37.75, there were multiple calls for oil to fall to the low $30s and $20s. In both cases, powerful recovery rallies followed these bearish market calls. Following the March 2015 lows, oil rallied for over two months and gained 48.9%. In August of this year, a seven-week rally took oil 35% higher. The bearish prediction by Goldman Sachs last week could just turn out to be a contrarian’s dream.
There are a number of issues, big issues, going on in the world that can turn crude oil on a dime. First, Brent has fallen relative to WTI and the political premium for oil has evaporated. In 1990, when Saddam Hussein invaded Kuwait, the price of crude oil doubled in a matter of minutes. While the Middle East has always been a turbulent and dangerous part of the world, I would argue that today, it is far more turbulent and far more violent. The odds of attacks against oil fields and refineries in the Middle East have increased exponentially particularly given the recent ISIS attacks in France and around the world. At the same time, all of the bearish fundamental news about crude oil has decreased the political premium, and it is politics and war that could turn out to outweigh all of the current fundamentals.
Moreover, a surprise from outside of the Middle East could foster an increase in the price of oil. The world is now almost counting on Chinese economic weakness. Last week, Jamie Dimon, the Chairman of JPMorgan Chase, said that he is bullish on Chinese growth. If China does begin to show signs of growth, this could turn out to be supportive of crude oil and commodities in general, which remain mired in a bear market. Right now, the price of crude oil looks awful and fundamentals support a new low. However, all of that bearish data is in the price, and any surprise, in a world that always seems be full of surprises, could ignite the price once again. We saw this in March and again in August. As oil makes new lows, keep in mind that crude oil is a complicated puzzle. It is the unknown that will likely dictate the next big price move in oil. I am watching crude oil now and wondering whether Goldman Sachs called the turn in the market with their bearish forecast.
As a bonus, I have prepared a video on my website Commodix that provides a more in-depth and detailed analysis of the current state of the oil market to illustrate the real value implications and opportunities.
The moon was a waning crescent sliver Sept. 9 when a man emerged from an oil tanker, sidled up to a well outside Cotulla, Texas, and siphoned off almost 200 barrels. Then, he drove two hours to a town where he sold his load on the black market for $10 a barrel, about a quarter of what West Texas Intermediate currently fetches.
“This is like a drug organization,” said Mike Peters, global security manager of San Antonio-based Lewis Energy Group, who recounted the heist at a Texas legislative hearing. “You’ve got your mules that go out to steal the oil in trucks, you’ve got the next level of organization that’s actually taking the oil in, and you’ve got a gathering site — it’s always a criminal organization that’s involved with this.”
From raw crude sucked from wells to expensive machinery that disappears out the back door, drillers from Texas to Colorado are struggling to stop theft that has only worsened amid the industry’s biggest slowdown in a generation. Losses reached almost $1 billion in 2013 and likely have grown since, according to estimates from the Energy Security Council, an industry trade group in Houston. The situation has been fostered by idled trucks, abandoned drilling sites and tens of thousands of lost jobs.
“You’ve got unemployed oilfield workers that unfortunately are resorting to stealing,” said John Chamberlain, executive director of the Energy Security Council.
In Texas, unemployment insurance claims from energy workers more than doubled over the past year to about 110,000, according to the Workforce Commission. In North Dakota, average weekly wages in the Bakken oil patch decreased nearly 10 percent in the first quarter of 2015, compared with the previous quarter, according to the Federal Reserve Bank of Minneapolis.
With dismissals hitting every corner of the industry, security guards hired during boom times are receiving pink slips. That’s leaving sites unprotected.
“There are a lot less eyes out there for security,” said John Esquivel, an analyst at security consulting firm Butchko Inc. in Tomball, Texas, and a former chief executive of the U.S. Border Patrol in Laredo. “The drilling activity may be quieter, but I don’t think criminal activity is.”
Special Charges
States are trying to get a handle on the theft, which can include anything from drill bits that can fetch thousands on the resale market, to copper wiring that can be melted down, to the crude itself. Texas lawmakers met earlier this month in Austin to craft a bill that would increase penalties related to the crime. A similar measure passed both houses of the legislature this year, but Republican Governor Greg Abbott vetoed it, saying it was “overly broad.” Lawmakers, at the urging of industry, are hoping to revive it next legislative session.
In Oklahoma, law-enforcement officers recently teamed with the Federal Bureau of Investigation to intensify their effort. In North Dakota, the FBI earlier this year opened an office in the heart of oil country to combat crimes including theft, drug trafficking and prostitution.
The lull in drilling has given oil companies more time to scrutinize their operations — and their losses.
During booms “they are moving at such a rapid pace there’s not a lot of auditing and inventorying going on,” said Gary Painter, sheriff in Midland County, Texas, in the oil-rich Permian Basin. “Whenever it slows down, they start looking for stuff and find out it never got delivered or it got delivered and it’s gone.”
Oil theft is as old as Spindletop, the East Texas oilfield that spewed black gold in 1901 and began the modern oil era. In the early 1900s, Texas Rangers were often deployed to carry out “town taming” in oil fields rife with roughnecks, prostitutes, gamblers and thieves. In 1932, 18 men were indicted for their role in a Mexia ring that included prominent politicians and executives and resulted in the theft of 1 million barrels.
The allure of ill-gotten oil money remains strong.
In April, the Weld County Sheriff’s office in Colorado recovered almost $300,000 worth of stolen drill bits. In January, a Texas man pleaded guilty to stealing three truckloads of oil worth nearly $60,000 after an investigation by the FBI and local law-enforcement officers. Robert Butler, a sergeant at the Texas Attorney General’s Office whose primary job is to investigate oil theft, said in the legislative hearing that he is investigating a case of 470,000 barrels stolen and sold over the past three years worth about $40 million.
In Texas, oilfield theft has become entangled with Mexican drug trafficking, as the state’s newest and biggest production area, the Eagle Ford Shale region, lies along traditional smuggling routes. That’s thrust oil workers in the middle of cartel activity, and made it even more difficult to track stolen goods across the U.S.-Mexico border, said Esquivel, the retired Border Patrol agent.
Trickling Away
Oil thieves are a slippery bunch. Criminals sand off serial numbers of stolen goods to evade detection or melt them for scrap. Tracking raw crude is even trickier, since tracing it to its originating well is almost impossible once it’s mixed with other oil. Many companies fail to report the crime, making it difficult for investigators to trace the origins of stolen goods.
Many of the crimes are inside jobs, with thieves doubling as gate guards, tank drivers or well servicers. Last year, a federal grand jury indicted three Texas men in connection with the theft of $1.5 million worth of oil from their employers, including Houston’s Anadarko Petroleum Corp.
“Your average person wouldn’t know the value of a drill bit or a piece of tubing or a gas meter,” said Chamberlain. “It’d be like breaking into a jewelry store; unless you know what’s valuable, you wouldn’t know what to steal.”
After some initial excitement, November has seen crude oil prices collapse back towards cycle lows amid demand doubts (e.g. slumping China oil imports, overflowing Chinese oil capacity, plunging China Industrial Production) and supply concerns (e.g. inventories soaring). However, an even bigger problem looms that few are talking about. As Iraq – the fastest-growing member of OPEC – has unleashed a two-mile long, 3 million metric ton barrage of 19 million barrel excess supply directly to US ports in November.
Crude prices are already falling:
But OPEC has another trick up its sleeve to crush US Shale oil producers. As Bloomberg reports,
Iraq, the fastest-growing producer within the 12-nation group, loaded as many as 10 tankers in the past several weeks to deliver crude to U.S. ports in November, ship-tracking and charters compiled by Bloomberg show.
Assuming they arrive as scheduled, the 19 million barrels being hauled would mark the biggest monthly influx from Iraq since June 2012, according to Energy Information Administration figures.
The cargoes show how competition for sales among members of the Organization of Petroleum Exporting Countries is spilling out into global markets, intensifying competition with U.S. producers whose own output has retreated since summer. For tanker owners, it means rates for their ships are headed for the best quarter in seven years, fueled partly by the surge in one of the industry’s longest trade routes.
Worst still, they are slashing prices…
Iraq, pumping the most since at least 1962 amid competition among OPEC nations to find buyers, is discounting prices to woo customers.
The Middle East country sells its crude at premiums or discounts to global benchmarks, competing for buyers with suppliers such as Saudi Arabia, the world’s biggest exporter. Iraq sold its Heavy grade at a discount of $5.85 a barrel to the appropriate benchmark for November, the biggest discount since it split the grade from Iraqi Light in May. Saudi Arabia sold at $1.25 below benchmark for November, cutting by a further 20 cents in December.
“It’s being priced much more aggressively,” said Dominic Haywood, an oil analyst at Energy Aspects Ltd. in London. “It’s being discounted so U.S. Gulf Coast refiners are more incentivized to take it.”
So when does The Obama Administration ban crude imports?
And now, we get more news from Iraq:
*IRAQ CUTS DECEMBER CRUDE OIL OSPS TO EUROPE: TRADERS
So taking on the Russians?
* * *
Finally, as we noted previously, it appears Iraq (and Russia) are more than happy to compete on price.. and have been successful – for now – at gaining significant market share…
Even as both Iran and Saudi Arabia are losing Asian market share to Russia and Iraq, Tehran is closely allied with Baghdad and Moscow while Riyadh is not. That certainly seems to suggest that in the long run, the Saudis are going to end up with the short end of the stick.
Once again, it’s the intersection of geopolitics and energy, and you’re reminded that at the end of the day, that’s what it usually comes down to.
WTI Tumbles To $43 Handle After API Confirms Huge Inventory Build
API reported a huge 6.3 million barrel inventory build (notably larger than expected) extending the series of build to seven weeks. Even more worrying was the massive 2.5 million barrel build at Cushing, even as gasoline inventories fell 3.2mm. WTI immediately dropped 35c, breaking back to a $43 handle after-hours.
Four US Firms With $4.8 Billion In Debt Warned This Week They May Default Any Minute
The last 3 days have seen the biggest surge in US energy credit risk since December 2014, blasting back above 1000bps. This should not be a total surprise since underlying oil prices continue to languish in “not cash-flow positive” territory for many shale producers, but, as Bloomberg reports, the industry is bracing for a wave of failures as investors that were stung by bets on an improving market earlier this year try to stay away from the sector. “It’s been eerily silent,” in energy credit markets, warns one bond manager, “no one is putting up new capital here.”
The market is starting to reprice dramatically for a surge in defaults...
Eleven months of depressed oil prices are threatening to topple more companies in the energy industry. As Bloomberg details,
Four firms owing a combined $4.8 billion warned this week that they may be at the brink, with Penn Virginia Corp., Paragon Offshore Plc, Magnum Hunter Resources Corp. and Emerald Oil Inc. saying their auditors have expressed doubts that they can continue as going concerns. Falling oil prices are squeezing access to credit, they said. And everyone from Morgan Stanley to Goldman Sachs Group Inc. is predicting that energy prices won’t rebound anytime soon.
The industry is bracing for a wave of failures as investors that were stung by bets on an improving market earlier this year try to stay away from the sector. Barclays Plc analysts say that will cause the default rate among speculative-grade companies to double in the next year. Marathon Asset Management is predicting default rates among high-yield energy companies will balloon to as high as 25 percent cumulatively in the next two to three years if oil remains below $60 a barrel.
“No one is putting up new capital here,” said Bruce Richards, co-founder of Marathon, which manages $12.5 billion of assets. “It’s been eerily silent in the whole high-yield energy sector, including oil, gas, services and coal.”
That’s partly because investors who plowed about $14 billion into high-yield energy bonds sold in the past six months are sitting on about $2 billion of losses, according to data compiled by Bloomberg.
And the energy sector accounts for more than a quarter of high-yield bonds that are trading at distressed levels, according to data compiled by Bloomberg.
Barclays said in a Nov. 6 research note that the market is anticipating “a near-term wave of defaults” among energy companies. Those can’t be avoided unless commodity prices make “a very large” and “unexpected” resurgence.
“Everybody’s liquidity is worse than it was at this time last year,” said Jason Mudrick, founder of Mudrick Capital Management. “It’s a much more dire situation than it was 12 months ago.”
While the crude oil tanker backlog in Houston reaches an almost unprecedented 39 (with combined capacity of 28.4 million barrels), as The FT reports that from China to the Gulf of Mexico, the growing flotilla of stationary supertankers is evidence that the oil price crash may still have further to run, as more than 100m barrels of crude oil and heavy fuels are being held on ships at sea (as the year-long supply glut fills up available storage on land). The storage problems are so severe in fact, that traders asking ships to go slow, and that is where we see something very strange occurring off the coast near Galveston, TX.
FT reports that “the amount of oil at sea is at least double the levels of earlier this year and is equivalent to more than a day of global oil supply. The numbers of vessels has been compiled by the Financial Times from satellite tracking data and industry sources.”
The storage glut is unprecedented:
Off Indonesia, Malaysia and Singapore, Asia’s main oil hub, around 35m barrels of crude and shipping fuel are being stored on 14 VLCCs.
“A lot of the storage off Singapore is fuel oil as the contango is stronger,” said Petromatrix analyst Olivier Jakob. Fuel oil is mainly used in shipping and power generation.
Off China, which is on course to overtake the US as the world’s largest crude importer, five heavily laden VLCCs — each capable of carrying more than 2m barrels of oil — are parked near the ports of Qingdao, Dalian and Tianjin.
In Europe, a number of smaller tankers are facing short-term delays at Rotterdam and in the North Sea, where output is near a two-year high. In the Mediterranean a VLCC has been parked off Malta since September.
On the US Gulf Coast, tankers carrying around 20m barrels of oil are waiting to unload, Reuters reported. Crude inventories on the US Gulf Coast are at record levels.
A further 8m barrels of oil are being held off the UAE, while Iran — awaiting the end of sanctions to ramp up exports — has almost 40m barrels of fuel on its fleet of supertankers near the Strait of Hormuz. Much of this is believed to be condensate, a type of ultralight oil.
And unlike the last oil price collapse during the financial crisis only half of the oil held on the water has been put there specifically by traders looking to cash in by storing the fuel until prices recover. Instead, sky-high supertanker rates have prevented them from putting more oil into so-called floating storage, shutting off one of the safety valves that could prevent oil prices from falling further.
A widening oil market structure known as contango — where future prices are higher than spot prices — could make floating storage possible.
The difference between Brent for delivery in six months’ time and now rose to $4.50 last week, up from $1.50 in May. Traders estimate it may need to reach $6 to make sea storage viable.
JBC Energy, a consultancy, said in many regions onshore oil storage is approaching capacity, arguing oil prices may have to fall to allow more to be stored profitably at sea.
“Onshore storage is not quite full but it is at historically high levels globally,” said David Wech, managing director of JBC Energy.
“As we move closer to capacity that is creating more infrastructure hiccups and delays in the oil market, leading to more oil being backed out on to the water.”
Patrick Rodgers, the chief executive of Euronav, one of the world’s biggest listed tanker companies, said oil glut was so severe traders were asking ships to go slow to help them manage storage levels.
“We are being kept at relatively low speeds. The owners of the oil are not in a hurry to get their cargoes. They are managing their storage capacity by keeping ships at a certain speed.”
As a result of all this, something very unusual going on off the coast of Galveston, where more than 39 crude tankers w/ combined cargo capacity of 28.4 million bbls wait near Galveston (Galveston is area where tankers can anchor before taking cargoes to refineries at Houston and other nearby plants), vessel tracking data compiled by Bloomberg show, which compares w/ 30 vessels, 21 million bbls of capacity in May. Vessels wait avg of 5 days, compared w/ 3 days May.
As AP puts it, “a traffic jam of oil tankers is the latest sign of an unyielding global supply glut.”
More than 50 commercial vessels were anchored outside ports in the Houston area at the end of last week, of which 41 were tankers, according to Houston Pilots, an organization that assists in navigation of larger vessels. Normally, there are 30 to 40 vessels, of which two-thirds are tankers, according to the group.
Although the channel has been shut intermittently in recent weeks because of fog or flooding, oil traders pointed to everything from capacity constraints to a lack of buyers.
“It appears that the glut of supply in the global market is only getting worse,” said Matt Smith, director of commodity research at ClipperData. Several traders said some ships might have arrived without a buyer, which can be hard to find as ample supply and end-of-year taxes push refiners to draw down inventories.
Crude Jumps After API Reports Modest Inventory Draw (First In 8 Weeks) Despite Another Big Build At Cushing
11/17/2015: After seven straight weeks of significant inventory builds, API reported a modest 482k draw. That was all the algos needed and WTI immediately ramped back above $41.00. However, what they likely missed was the 2nd weekly (huge) build in Cushing (1.5mm barrels) as we warned earlier on land storage starting to really fill…
In short: “The US is the last place with significant onshore crude storage space left.”
Which leads directly to Citi’s conclusion: “‘Sell the rally’ near-term as fundamentals remain very sloppy and inventory constraints are becoming increasingly more binding.”
Saudis want Big Oil to win – have predictable working relationship with them.
Big Oil is waiting on the sidelines until the price of properties drop.
Those with DUC wells and enough reserves will be able to survive the onslaught.
U.S. shale oil remains viable, but the players are going to change.
As the strategy of Saudi Arabia becomes clearer, along with the response of shale producers to low oil prices, the question now has to be asked as to whether or not the big oil companies support the decision by Saudi Arabia to crush frackers until they have to offer their various plays at fire sale prices.
With the emergence of frackers came a significant number of new competitors in the market that didn’t have an interest in playing nice with OPEC and Saudi Arabia, as major oil companies have in the past. This was a real threat as other OPEC members and shale companies started to take share away from Saudi Arabia.
The general consensus is Saudi Arabia isn’t interested in crushing any particular competitor, rather it’ll keep production at high levels until the weakest producers capitulate. I have thought that as well until recently.
What changed my thinking was analyzing who was the biggest threat to OPEC and Saudi Arabia, and in fact it is the shale industry in the U.S. The reason I draw that conclusion is the energy industry had its traditional competitors in place for many years, and other than occasional moves to impact the price of oil using production levels as the weapon, it has been a relatively stable industry. Shale changed all that.
I think what bothered Saudi Arabia in particular was it didn’t have a working relationship with many of these new competitors, who have been very aggressive with expanding production capacity over the last few years. They were in fact real competitors who were working to take market share away from existing players. And with Saudi Arabia being the low-cost producer with the highest reserves in the world, it was without a doubt a direct assault on its authority and leverage it historically has had on the oil market. Its response to frackers is obvious: it isn’t willing to give up share for any reason.
Where the challenge for Saudi Arabia now is it has started to have to draw on its own reserves and issue bonds to make up for budget shortfalls. It has plenty of reserves, but it appears we now have a clear picture on when it would really come under pressure, which is within a four to five year period. That’s the time it has to devastate its shale competitors.
The other problem for the country is it could take down some members of OPEC in the process, where there are already significant problems they’re facing, which could lead to unrest.
From a pure oil perspective, it seems to be an easy read. Saudi Arabia can outlast the small shale producers with no problem. I think that’s its goal. But it is putting enormous pressure on other countries as well, and there will be increasing pressure for them to slow production in order to support oil prices.
This even extends to Russia, which produces more oil than any other country.
My belief is Saudi Arabia is attempting to force consolidation in the shale industry, so it can resume its dealings with big oil players it has worked with for many years. I believe it’s also what big oil players want. All they have to do is sit back and experience some temporary pain and wait for some of the attractive plays to come onto the market at low prices.
So far the price is still high in the U.S., but as time goes on, the smaller companies will be forced to sell, one way or another. That’s the big opportunity for investors. Identifying those companies with the resources and desire to acquire these properties is the key. That and evaluating the plays with the most potential for those buying them up.
At what price can Saudi crush shale oil?
There are analysts predicting oil price levels that are all over the board. I’ve seen those that believe it’s going to shoot up to over $100 per barrel again, and those that have estimated it could fall to as low as $15 per barrel.
The best way to analyze this is to consider what Saudi Arabia can handle over the longest period of time without destroying its own economy and industry, meaning at what price it can remain fairly healthy and outlast its competitors.
Looking at the price movement of oil and the range it’s now settled into, I think it’s close to what the Saudi have been looking for.
Most smaller shale producers will struggle to make it, if the price of oil remains under $60 per barrel, which it will probably do until Saudi Arabia cuts back on production. There will be occasional moves above that, and probably below $50 per barrel again as well, but I think we can now look to somewhere in the $50 per barrel area as the target being sought. We’ll probably see this be the price range oil will move in for the next couple of years, with $50 being the desired low and $60 being the desired high.
I don’t mean by this Saudi Arabia can absolutely control the price of oil, but it can influence the range it operates in, and I think that’s where we are now.
For that reason oil investors should be safe in investing under these assumptions, understanding there will be occasional price moves outside of that range because of usual trading momentum.
Response from shale oil companies
Some may question why the price of oil got slammed not too long ago, falling below $40 per barrel, if the probable price range for oil is about $10 to $20 per barrel higher.
As mentioned above, some of that was simply from trading momentum. It didn’t take long for it to rebound soon afterward.
The other element was the response by shale companies to the new price of oil, which threatened their ability to pay interest on loans that were due.
Frackers weren’t boosting production because they believed they could outlast Saudi Arabia; they kept production levels high because they had to continue to sell even into that low-price environment or default on their payments. This was a major factor in why prices dropped so far over the short term.
With the bulk of the over $5 trillion spent on shale exploration and development coming from companies operating in the U.S., that is also where the bulk of the risk is.
Much of the efficiencies have been wrung out of operations, and moving to higher producing wells that are less costly to operate can only last so long. I believe efficiencies will position some in the industry to survive the current competitive environment, but they will also have to have enough reserves to tap into in order to do so.
Top producing shale wells are at their highest level of productivity in the first 6 months it goes into operation. It gradually fades after that.
Larger players like EOG Resources (NYSE:EOG) have continued to drill, but they are stopping short of production, with approximately 320 DUC wells ready to bring online when the price of oil reaches desired levels. Its smaller competitors don’t have the resources to wait out existing production levels, which is what will again offer the opportunity for patient investors.
In other words, most of what can be done has been or is currently being done, and from now on it’s simply a waiting game to see how long the Saudis are willing to keep the oil flowing.
Most shale producers believed the lowest oil prices would sustainably fall and would be about $70 per barrel. Decisions were made based upon that assumption.
Big oil and Saudi Arabia
Saudi Arabia and big international energy companies have had close relationships a long time via Saudi Aramco, the state-owned firm.
Those relationships, while competitive, still operated within parameters most agreed upon. Shale producers weren’t playing that game, as they invested trillions and aggressively went after market share. If Saudi Arabia wanted to maintain market share, it had to respond.
If the smaller shale producers thought their strategy though, they must have underestimated the will of Saudi Arabia to fight back against them. Either that or they became overly optimistic and started to believe their own press about the shale revolution.
It’s a revolution for sure, but the majority of those that helped launch it won’t be finishing it.
My point is big oil, in my opinion, doesn’t mind quietly standing on the sidelines as their somewhat friendly competitors destroys their competition and prepares the way for them to acquire shale properties at extremely attractive prices.
I’ve said for some time the shale revolution will go on. The oil isn’t going anywhere. What is changing is who the players will end up being, and what properties they’ll end up acquiring.
With EOG, the strongest shale player, it said the prices of those plays now for sale are still too high; that means the smaller players still think they have some leverage.
My only thought is they are hoping for the large players to enter a bidding war and they can at least recoup some of their capital. I think they’re going to wait until they’re desperate and have no more options.
Sure, some big players may lose out on a desirable property or two, but everyone will get a piece of the action. It appears once the prices move down to levels they’re looking for, at that time they’ll swoop in and make their bids. At that time it’s going to be a buyer’s market.
Big oil companies are the preferable players Saudi Arabia wants to do business with and compete against. They will play the game with them, and there won’t be a lot of surprises.
Some of the companies to watch
Some of the larger companies that have already filed for bankruptcy this year include Hercules Offshore (NASDAQ:HERO), Sabine Oil & Gas (SOGC) and Quicksilver Resources (OTCPK:KWKAQ).
Companies known to have hired advisers for that purpose are Swift Energy (NYSE:SFY) and Energy XXI Ltd. (NASDAQ:EXXI).
Some under heavy pressure include Halcón Resources Corporation (NYSE:HK), SandRidge Energy, Inc. (NYSE:SD) and Rex Energy Corporation (NASDAQ:REXX).
There are more in each category, but I included only those that had at least a decent market cap, with the exception of those that already declared bankruptcy.
Here are a couple of other companies to look at going forward, which can be used for the purpose of analyzing ongoing low prices.
Stone Energy’s credit facility of $500 million is reaffirmed, but may not be liquid enough to endure the next couple of years, even though in the short term it does have decent liquidity. If Saudi Arabia keeps up the pressure, it’s doubtful it will be able to survive on its own. There are quite a few companies falling under these parameters, including Laredo (NYSE:LPI). The basic practice of all of them was to limit the amount of leverage they have in place in order not to have paying off interest as the priority use of their capital, while maintaining a strong credit facility.
I’m not saying these companies will survive, but they will survive if the price of oil stays low, but it will take a lot more to root them up than their highly leveraged peers.
Clayton Williams (NYSE:CWEI) recently put itself up for sale because it can’t afford to continue operating at these prices. It has approximately 340,000 acres under its control, and two of the most productive shale basins in the U.S.
Once it announced it was open to selling, the share price skyrocketed, but since it’s struggling to afford extracting the oil, it’s puzzling as to why some believe it’s going to attract a premium price. It’s possible because of the quality of assets, but it would make more sense for larger companies to wait.
This will be a good test on how big oil companies are going to respond. It’s possible they may be willing to pay for the higher quality shale plays, but under these conditions shareholders would resist paying a significant premium.
If Clayton Williams does go for a premium, it doesn’t in any way mean that’s how it’ll work out for most of the shale companies.
There would have to be a significant reason they would pay such a high price. In the case of CWEI, the catalyst would be high production.
Conclusion
All of this sounds neatly packaged, and if all things proceed as planned, this is how it will play out.
Where there could be some risk is if the Middle East explodes and oil production is interrupted. That would change this entire scenario, and if it were to happen soon, shale companies still in operation would not only survive, but thrive.
Barring that level of disruption, which would have to be something huge, this is how it will play out. After all, with everything going on there now, it hasn’t done anything to disrupt Middle East oil. It would take a big event or a series of events to bring it about. That’s definitely a possibility, but it’s one that is unlikely.
Once all of this plays out, there is no doubt in my mind the bigger oil companies will be much stronger and able to produce a lot more oil.
What we’ll probably see happen is for them to cut back on production to levels where everyone is happy, including the Saudi.
That’s what this war is all about, because shale oil deposits remain in the ground. While some companies can quickly resume production because of the nature of shale oil, which can ramp up production fast, it depends on the will and determination of Saudi Arabia and whether or not the geopolitical situation remains under control.
I don’t care too much about the number of rig counts in shale plays because production can be resumed or initiated quick. The risk is how leveraged the shale companies are, and whether or not they have to continue production at a loss in order to pay off their interest on loans in hopes the price of oil will rise.
What I’m looking for with existing plays is for companies like EOG Resources, which continues to develop wells, but does so without the idea of completing them and bringing them into production until the price of oil rebounds.
Shale oil in the U.S. is alive and well, but those companies overextended and few resources are going to be forced to sell at bargain prices. That will produce a lot of added value to the big oil companies waiting on the sidelines watching it all unfold.
As the housing boom of the 2000’s minted new millionaires every second Tuesday. So, too, the shale oil boom minted wealth faster than McDonald’s mints new diabetics.
Estimates by the UND Center for Innovation Foundation in Grand Forks, are that the North Dakota shale oil boom was creating 2,000 millionaires per year. For instance, the average income in Montrail County has more than doubled since the boom started.
Despite the Great Recession, the oil boom resulted in enough jobs to provide North Dakota with the lowest unemployment rate in the United States. The boom has given the state of North Dakota, a state with a 2013 population of about 725,000, a billion-dollar budget surplus. North Dakota, which ranked 38th in per capita gross domestic product (GDP) in 2001, rose steadily with the Bakken boom, and now has per capita GDP 29% above the national average.
I wonder how many North Dakotan’s have any idea the effect low oil prices are going exert on their living standards, freshly elevated house prices, employment stats, and government revenues.
We’re all about to find out. Here is the last piece in our 5-part series by Harris Kupperman exploring what this means for the fracking industry, oil in general, and the one topic nobody is paying much attention to: the petrodollar.
Enjoy!
——————————
Date: 27 September 2015
Subject: There Will Be Blood – Part V
Starting at the end of 2014, I wrote a number of pieces detailing how QE was facilitating the production of certain real assets like oil where the production decision was no longer being tied to profitability. For instance, shale producers could borrow cheaply, produce at a loss and debt investors would simply look the other way because of the attractive yields that were offered on the debt. The overriding theme of these pieces was that the eventual crack-up in the energy sector would precipitate a crisis that was much larger than the great subprime crisis of last decade as waves of shale defaults would serve as the catalyst for investors to stop reaching for yield and once again try to understand what exactly they owned.
Fast forward 9 months from the last piece and most of these shale producers are mere shells of themselves. If you got out of the way—good for you. Amazingly, these companies can still find creative ways to tap the debt markets, stay alive and flood the market with oil. Eventually, most won’t make it and I believe that the ultimate global debt write-off is in the hundreds of billions of dollars—maybe even a trillion depending on which larger players stumble. That doesn’t even include the service companies or the employees who have their own consumer and mortgage debt.
I believe that shale producers are the “sub-prime” of this decade. As they vaporize hundreds of billions in investor capital, thus far, there has been a collective shrug as everyone ignores the obvious – until suddenly it begins to matter. By way of timelines, I think we are now getting to the early summer of 2008 – suddenly the smart people are beginning to realize that something is wrong. Credit spreads are the life-line of the global financial world. They’re screaming danger. I think the equity markets are about to listen.
High-yield – 10-year spread is blowing out
Then again, a few hundred billion is a rounding error in our QE world. There is a much bigger animal and no one is talking about it yet – the petrodollar.
Roughly defined, petrodollars are the dollars earned by oil exporting countries that are either spent on goods or more often tucked away in central bank war chests or sovereign wealth funds to be invested. I’ve read dozens of research reports on the topic and depending on how its calculated, this flow of capital has averaged between $500 billion and $1 trillion per year for most of the past decade. This is money that has been going into financial assets around the world – mainly in the US. This flow of reinvested capital is now effectively shut off. Since many of these countries are now running huge budget deficits, it seems only natural that if oil stays at these prices, this flow of capital will go in reverse as countries are forced to sell foreign assets to cover these deficits.
Over the past year, the carnage in the emerging markets has been severe. Barring another dose of QE, I think this carnage is about to come to the more developed world as the petrodollar flow unwinds and two decades of central bank inspired lunacy erupts.
We agree with Harris, and not coincidentally the petrodollar unwind forms a part of the global USD carry trade unwind I’ve been harping on about recently.
Capitalist Exploits subscribers will receive a free report on 3 actionable trades in the oil and gas sector later this week. Leave us your email address here to get the report.
– Chris
“So, ladies and gentlemen… if I say I’m an oil man you will agree. You have a great chance here, but bear in mind, you can lose it all if you’re not careful.” – Daniel Day-Lewis, There Will Be Blood
West Texas Intermediate crude oil is at a 6-year low of $43 a barrel.
And back in December 2014, “Bond King” Jeff Gundlach had a serious warning for the world if oil prices got to $40 a barrel.
“I hope it does not go to $40,” Gundlach said in a presentation, “because then something is very, very wrong with the world, not just the economy. The geopolitical consequences could be — to put it bluntly — terrifying.”
Writing in The Telegraph last week, Ambrose Evans-Pritchard noted that with Brent crude oil prices — the international benchmark — below $50 a barrel, only Norway’s government is bringing in enough revenue to balance their budget this year.
And so in addition to the potential global instability created by low oil prices, Gundlach added that, “If oil falls to around $40 a barrel then I think the yield on ten year Treasury note is going to 1%.” The 10-year note, for its part, closed near 2.14% on Tuesday.
On December 9, 2014, WTI was trading near $65 a barrel and Gundlach said oil looked like it was going lower, quipping that oil would find a bottom when it starts going up.
WTI eventually bottomed at $43 in mid-March and spend most all of the spring and early summer trading near $60.
On Tuesday, WTI hit a fresh 6-year low, plunging more than 4% and trading below $43 a barrel.
In the last month, crude and the entire commodity complex have rolled over again as the market battles oversupply and a Chinese economy that is slowing.
And all this as the Federal Reserve makes noise about raising interest rates, having some in the market asking if these external factors — what the Fed would call “exogenous” factors — will stop the Fed from changing its interest rate policy for the first time in over almost 7 years.
In an afternoon email, Russ Certo, a rate strategist at Brean Capital, highlighted Gundlach’s comments and said that the linkages between the run-up, and now collapse, in commodity prices since the financial crisis have made, quite simply, for an extremely complex market environment right now.
“There is a global de-leveraging occurring in front of our eyes,” Certo wrote. “And, I suppose, the smart folks will determine the exact causes and translate what that means for FUTURE investment thesis. Today it may not matter other than accurately anticipating a myriad of global price movements in relation to each other.”
US production remains high due to high-grading, well design, cost efficiencies, and lower oil service contracts.
High-grading from marginal to core areas can increase per well production from 200% to 500% depending on area, which means one core well can equate to several marginal producers.
Shorter stages, increased proppant and frac fluids increase production and flatten the depletion curve.
EOG’s work in Antelope field provides a framework for other operators to increase production while completing fewer wells.
Few operators are currently developing Mega-fracs, this provides significant upside to US shale production as others start producing more resource per foot.
US Oil production remains at volumes seen when WTI was at $100/bbl. Many analysts believed operators couldn’t survive, but $60/bbl may be good enough for operators to drill economic wells. Oil prices have decreased significantly, and the US Oil ETF (NYSEARCA:USO) with it. Many were wrong about US production, and the belief $60/bbl oil would decrease US production. Although completions have been deferred, high-grading and mega-fracs have made up for fewer producing wells. When calculating US production going forward, it is important to account for the number of new completions. If more wells are completed, the higher the influx of production should be. We are finding the quality of geology and well design have a greater effect on total production than originally thought.
There are several factors influencing US production. Operators have moved existing rigs to core areas. This decreases its ability getting acreage held by production. In the Bakken, rigs have moved near the Nesson Anticline.
In the Eagle Ford, Karnes seems to be the area of interest. Midland County in the Permian has also been attractive. Operators have decided to complete wells with better geology. When an operator completes wells in core acreage versus marginal leasehold, we see increased production per location. This is just part of the reason US production remains high.
The average investor does not understand the significance. Most think wells have like production, but areas are much different. When oil was at a $100/bbl, it allowed operators to get acreage held by production, although payback times were not as good. Marginal acreage was more attractive, even at lower IRRs. Operators have a significant investment in acreage, and do not want to lose it. Because of this, many would operate in the red expecting future rewards. Just because E&Ps lose money, does not mean the business isn’t economic. It is the way business is done in the short term as oil is an income stream. Wells produce for 35 to 40 years, and once well costs are paid back there are steady revenues. Changes in oil prices have changed this, as now operators will have to focus on better acreage.
Re-fracs are starting to influence production. Although most operators have not begun programs, interest is high. Re-fracs may not be a game changer, but could be an excellent way to increase production at a lower cost. This is not as significant with well designs of today, but older designs left a significant amount of resource. More importantly, when operators began, it was drilling the best acreage. Archaic well designs could leave some stages completely untouched. Current seismic can now identify this, and provide for a better re-frac. We expect to see some very good results in 2016. In conjunction with high-grading, well design continues to be the main reason production has maintained. Changes to well design have been significant, and the resulting production increases much better than anticipated.
No operator is better than EOG Resources (NYSE:EOG) at well design. From the Bakken, to the Eagle Ford and Permian it continues to outperform the competition.
The following map courtesy of ShaleMapsPro.com does a good job of illustrating EOG’s exposure in the Eagle Ford.
(Source: Shalemapspro.com)
EOG’s focusing of frac jobs closer to the well bore has provided for much better source rock stimulation (fraccing). Since more fractures are created, there is a greater void in the shale. This means more producing rock has contact with the well. EOG continues to push more sand and fluids in the attempt to recover more resource per foot. To evaluate production, it must be broken into days over 6 to 12 months. To evaluate well design, locations must be close to one another and by the same operator. This consistency allows us to see advantages to well design changes. Lastly, we compare marginal acreage it is no longer working to the high-grading program. This is how operators are spending less and producing more.
EOG is working in the Antelope field of northeast McKenzie County. This is Bakken core acreage and considered excellent in both the middle Bakken and upper Three Forks.
The center of the above map is the location of both its Riverview and Hawkeye wells. These six wells are located in two adjacent sections. The pad is just west of New Town in North Dakota. Riverview 100-3031H was completed in 6/12. It is an upper Three Forks well. 39 stages were used on an approximate 9000 foot lateral. 5.7 million pounds of sand were used with 85000 barrels of fluids.
Riverview 100-3031H was a progressive well design for 2012. It produced well. To date it has produced 379 thousand bbls of crude and 615 thousand Mcf of natural gas. This equates to $24 million in revenues. Over the first 360 days (using the true number of production days) it produced 240,036 bbls of crude. The month of December 2013, this well was shut in for the completion of an adjacent well. There was a return to production but no significant jump in production from pressure generated by the new locations. This well declined 42% over 12 months. This is much lower than estimates shown through other well models. The next year we see a 35% decline. 10 months later we see an additional decline of approximately 55%. The decline curve of a well is very specific to geology and well design. Keep in mind averages are just that, and do not provide specific data. These averages should not be used to evaluation acreage and operator as there are wide average swings. Also, averages are generally over a long time frame. Production in the Bakken began in 2004 (first horizontal well completed). Wells in 2004 produce nothing like wells today. Updated averages based on year (IP 360) are more useful. Riverview 100-3031H was part of a two well pad. A middle Bakken well was also completed.
Riverview 4-3031H began producing a month after Riverview 100-3031H. It was a 38 stage 9000 foot lateral. 4.3 million lbs of sand were used and 69000 bbls of fluids.
(click to enlarge) (Source: Welldatabase.com)
The Riverview and Hawkeye wells analyzed in this article were drilled in a southern fashion.
Date
Oil
Gas
BOE
7/1/2012
20,529.00
12,537.00
12537
8/1/2012
16,553.00
16,903.00
16903
9/1/2012
17,096.00
10,148.00
10148
10/1/2012
23,197.00
17,914.00
17914
11/1/2012
20,122.00
14,402.00
14402
12/1/2012
27,340.00
33,217.00
33217
1/1/2013
16,044.00
24,394.00
24394
2/1/2013
4,267.00
4,946.00
4946
3/1/2013
27,516.00
26,219.00
26219
4/1/2013
20,792.00
7,940.00
7940
5/1/2013
17,516.00
35,948.00
35948
6/1/2013
15,457.00
50,500.00
50500
7/1/2013
13,480.00
50,807.00
50807
8/1/2013
11,254.00
42,300.00
42300
9/1/2013
9,319.00
40,341.00
40341
10/1/2013
8,559.00
33,116.00
33116
11/1/2013
2,190.00
40
40
12/1/2013
0
0
0
1/1/2014
1,124.00
11
11
2/1/2014
5,271.00
81
81
3/1/2014
8,931.00
9,827.00
9827
4/1/2014
5,469.00
7,940.00
7940
5/1/2014
4,807.00
5,748.00
5748
6/1/2014
8,522.00
13,819.00
13819
7/1/2014
7,982.00
17,983.00
17983
8/1/2014
7,169.00
26,755.00
26755
9/1/2014
5,750.00
22,586.00
22586
10/1/2014
1,349.00
3,194.00
3194
11/1/2014
6,495.00
15,947.00
15947
12/1/2014
6,442.00
18,806.00
18806
1/1/2015
5,840.00
22,126.00
22126
2/1/2015
4,171.00
18,682.00
18682
3/1/2015
4,221.00
18,539.00
18539
4/1/2015
3,878.00
19,725.00
19725
(Source: Welldatabase.com)
Riverview 4-3031H has produced 361 thousand bbls of crude and 657 thousand Mcf of natural gas. It under produced Riverview 100-3031H, but this is consistent with well design. 360 day production totaled 237,735 bbls of oil. We do not know if the Three Forks is a better pay zone than the middle Bakken as the well design was not consistent. Most operators have reported better results from the middle Bakken. The Three Forks well used one more stage (less feet per stage should mean better fracturing). It also used significantly more sand and fluids. Either way both wells were good results. Riverview 4-3031H only declined approximately 36% in a comparison of the first month to month 12. This was 7% better than 100-3031H. It declined another 41% in year two on a month to month comparison. This was 6% greater. 56% was seen when compared to adjusted production for 5/15. The Three Forks well declines slower in later production than 4-3031H. This may be due to well design. The well with more stages, proppant and fluids continues to out produce the Bakken well. It is possible the source rock is better. There are many other variables to look at, but this data provides why EOG continues to push ahead with more complex locations.
In September of 2012, EOG drilled its next well in this area. Hawkeye 100-2501H is a 13700 foot lateral targeting the upper Three Forks. It is a 47 stage frac. 14 million pounds of sand were used with 158000 bbls of fluids.
(click to enlarge) (Source: Welldatabase.com)
Of the three pads, this well is located in the center. It was an interesting design, given the length of the lateral.
Date
Oil
Gas
BOE
9/1/2012
21,959.00
444
444
10/1/2012
54,927.00
155
155
11/1/2012
47,557.00
57,300.00
57300
12/1/2012
55,367.00
92,144.00
92144
1/1/2013
33,396.00
55,877.00
55877
2/1/2013
22,100.00
32,810.00
32810
3/1/2013
36,631.00
57,544.00
57544
4/1/2013
29,075.00
32,696.00
32696
5/1/2013
22,210.00
33,351.00
33351
6/1/2013
17,544.00
25,794.00
25794
7/1/2013
15,872.00
23,600.00
23600
8/1/2013
19,647.00
28,746.00
28746
9/1/2013
15,486.00
22,352.00
22352
10/1/2013
21,325.00
31,678.00
31678
11/1/2013
6,418.00
9,214.00
9214
12/1/2013
0
0
0
1/1/2014
0
0
0
2/1/2014
0
0
0
3/1/2014
29,699.00
23,822.00
23822
4/1/2014
39,782.00
32,696.00
32696
5/1/2014
35,267.00
61,543.00
61543
6/1/2014
27,554.00
49,551.00
49551
7/1/2014
7,229.00
12,565.00
12565
8/1/2014
31,155.00
98,086.00
98086
9/1/2014
12,617.00
32,742.00
32742
10/1/2014
2
4
4
11/1/2014
7,769.00
15,996.00
15996
12/1/2014
15,487.00
49,147.00
49147
1/1/2015
4,427.00
9,918.00
9918
2/1/2015
9,344.00
20,654.00
20654
3/1/2015
8,459.00
25,171.00
25171
4/1/2015
7,235.00
24,752.00
24752
(Source: Welldatabase.com)
Hawkeye 100-2501H had some excellent early production numbers. From that perspective, it is one of the best wells to date in the Bakken. It has already produced 655,000 bbls of crude and 960,000 Mcf of natural gas. It has revenues in excess of $42 million to date. This includes roughly four non-producing or unproductive months. Crude production over the first 360 days was 389,835 bbls. Over the first 12 months, this well produced crude revenues in excess of $23 million. Decline rates were higher, as the first full month of production declined 65% over the first year. This isn’t important as early production rates were some of the highest seen in North Dakota. It is important to note, decline rates are emphasized but higher pressured wells may deplete faster depending on choke and how quickly production is propelled up and out of the wellbore. Any well that produces very well initially will have higher decline rates, but this does not lessen the value of the well. This specific well is depleting faster, but no one is complaining about payback times well under a year. Decline rates decrease significantly in year two at 11%. This well saw a marked increase in production when adjacent wells were turned to sales. The additional pressure associated with well communication increased production from 20,000 bbls/month to 35,000 bbls/month on average. This occurred over a 6 month period.
(click to enlarge) (Source: Welldatabase.com)
Hawkeye 102-2501H was the fourth completion. This 14,000 foot 62 stage lateral targeted the upper Three Forks. It used 14.5 million pounds of sand and 164,000 bbls of fluids.
Date
Oil
Gas
BOE
1/1/2013
18,486.00
41
41
2/1/2013
27,120.00
8,705.00
8705
3/1/2013
39,702.00
15,748.00
15748
4/1/2013
17,714.00
30,501.00
30501
5/1/2013
41,368.00
57,489.00
57489
6/1/2013
26,602.00
34,399.00
34399
7/1/2013
0
0
0
8/1/2013
133
0
0
9/1/2013
0
0
0
10/1/2013
0
0
0
11/1/2013
0
0
0
12/1/2013
0
0
0
1/1/2014
5,163.00
6,403.00
6403
2/1/2014
41,917.00
74,353.00
74353
3/1/2014
36,439.00
18,111.00
18111
4/1/2014
19,477.00
30,501.00
30501
5/1/2014
26,388.00
43,071.00
43071
6/1/2014
27,480.00
49,456.00
49456
7/1/2014
14,529.00
33,072.00
33072
8/1/2014
24,542.00
62,753.00
62753
9/1/2014
17,613.00
53,460.00
53460
10/1/2014
17,451.00
66,544.00
66544
11/1/2014
9,634.00
33,366.00
33366
12/1/2014
16,338.00
76,547.00
76547
1/1/2015
11,450.00
65,277.00
65277
2/1/2015
8,971.00
50,919.00
50919
3/1/2015
3,177.00
14,820.00
14820
4/1/2015
6,495.00
13,616.00
13616
(Source: Welldatabase.com)
It has produced 458,000 bbls of crude and 839,000 Mcf to date. This equates to roughly $30 million over well life. 360 day production was 394,673 bbls of crude. Production was interesting as initial production was outstanding. The big production numbers were hindered as many of the early months had missed production days. We don’t know if there were production problems, but do know the well was shut when adjacent wells were turned to sales. Production was over 1000 bbls/d over the first six months. It was shut in for another six months. After this production jumped, but this is misleading. Given the fewer days of production per month, there wasn’t much of an increase when the new wells were turned to sales. The decline over the first year on a monthly basis is 20%. The second year is much greater at 80%. We have seen recent production decrease significantly, and is something to watch. Lower decline rates initially are more important. This is because production rates are higher. It equates to greater total production.
Hawkeye 01-2501H was completed in January of 2013.
(click to enlarge) (Source: Welldatabase.com)
It is a 64 stage, 15000 foot lateral targeting the middle Bakken. This well used 172,000 bbls of fluids and 15 million pounds of sand.
Date
Oil
Gas
BOE
1/1/2013
18,792.00
43
43
2/1/2013
30,211.00
13,879.00
13879
3/1/2013
42,037.00
17,648.00
17648
4/1/2013
17,433.00
36,881.00
36881
5/1/2013
38,754.00
63,501.00
63501
6/1/2013
28,602.00
48,817.00
48817
7/1/2013
0
0
0
8/1/2013
134
1
1
9/1/2013
0
0
0
10/1/2013
0
0
0
11/1/2013
0
0
0
12/1/2013
0
0
0
1/1/2014
6,311.00
7,186.00
7186
2/1/2014
43,713.00
74,099.00
74099
3/1/2014
39,156.00
18,492.00
18492
4/1/2014
23,408.00
36,881.00
36881
5/1/2014
21,681.00
33,498.00
33498
6/1/2014
28,502.00
51,543.00
51543
7/1/2014
18,795.00
45,017.00
45017
8/1/2014
25,512.00
58,837.00
58837
9/1/2014
20,522.00
60,662.00
60662
10/1/2014
19,137.00
68,576.00
68576
11/1/2014
12,093.00
37,043.00
37043
12/1/2014
16,587.00
45,980.00
45980
1/1/2015
14,246.00
62,819.00
62819
2/1/2015
9,220.00
35,931.00
35931
3/1/2015
3,617.00
6,634.00
6634
4/1/2015
13,702.00
42,551.00
42551
(Source: Welldatabase.com)
It has produced 492,170 bbls of crude and 866,520 Mcf of natural gas. 360 day production was 412,072 bbls of oil.
(click to enlarge) (Source: Welldatabase.com)
This is an excellent well, but the location of focus is Hawkeye 02-2501H. It was completed last in this group. This well provides the link between changes in well design to production improvements.
Date
Oil
Gas
BOE
12/1/2013
3,022.00
6,533.00
6533
1/1/2014
37,385.00
75,940.00
75940
2/1/2014
30,066.00
58,949.00
58949
3/1/2014
22,876.00
50,690.00
50690
4/1/2014
26,703.00
43,926.00
43926
5/1/2014
31,987.00
55,124.00
55124
6/1/2014
27,777.00
47,166.00
47166
7/1/2014
31,500.00
50,279.00
50279
8/1/2014
51,709.00
99,583.00
99583
9/1/2014
43,292.00
98,069.00
98069
10/1/2014
40,143.00
98,927.00
98927
11/1/2014
24,064.00
50,495.00
50495
12/1/2014
31,488.00
99,684.00
99684
1/1/2015
27,087.00
94,621.00
94621
2/1/2015
22,207.00
94,490.00
94490
3/1/2015
22,590.00
125,634.00
125634
4/1/2015
17,707.00
94,910.00
94910
(Source: Welldatabase.com)
The production numbers are significant. In less than a year and a half, it has produced 490,000 bbls of crude and 1.25 Bcf of natural gas. Revenues to date are $33.2 million. Its 360 day crude production was 427,663 bbls. The production is impressive but the decline curve is more important. This Hawkeye well has a steady production rate with only a slight decline. This is where the analysts may be getting it wrong, as decline curves change significantly by area and well design. What EOG has done is not only increased production significantly, but also flattened the curve. Initial production is interesting as we don’t see peak production until nine months. This means our best month is August of 2014, and not the first full month. When we analyze the production after one full year of production, there is no drop off.
This 12800 foot 69 stage lateral is a very good middle Bakken design. EOG decided to pull back some of the lateral length. There are several possible reasons for this. We think it is possible EOG has discovered it was having difficulty in getting proppant to the toe of the well. But this is why operators test the length. More importantly, the increase in stages in conjunction with a shorter lateral provides for shorter stages. This means the operator will probably do a better job of stimulating the source rock. This well also used massive volumes of fluids and sand. 460,000 bbls of fluids were used with over 27 million lbs of proppant. I don’t normally break down the types of sand, as it can be trivial to some but in this case I have as the design seems somewhat unique. This well used approximately 16 million lbs of 100 mesh sand, 7 million lbs of 30/70 and 4 million 40/70. The large volumes of mesh sand are interesting. It would seem EOG is trying to push the finest sand deep into the fractures to maintain deeper shale production.
Well
Date
Lateral Ft.
Stages
Proppant Lbs.
Fluids Bbls.
12 mo. Oil Production Bbls.
Production/Ft.
Riverview 100-3031H
6/12
9,000
39
5.7M
85,000
240,036
26.67
Riverview 4-3031H
7/12
9,000
38
4.3M
69,000
237,735
26.42
Hawkeye 100-2501H
9/12
13,700
47
14M
158,000
389,835
28.46
Hawkeye 102-2501H
1/13
14,000
62
14.5M
164,000
394,673
28.19
Hawkeye 01-2501H
1/13
15,000
64
15M
172,000
412,072
27.47
Hawkeye 02-2501H
12/13
12,800
69
27M
460,000
427,663
33.41
I completed the above table for several reasons. The first was to show well design’s effect on one year total production. We used 360 days as a base. We didn’t use 12 months as that will skew data, as some wells don’t produce every day of every month. Wells are shut in for service or more importantly when new production from adjacent locations are turned to sales. So these are a specific number of days and not estimates. We also broke down production per foot of lateral. This may be more important than any other factor. Production per well is important, but lateral length is a key as it shows how well the source rock was stimulated. In reality, production per foot matters more at longer lateral lengths. Many operators don’t like to do laterals longer than 10,000 feet, as production per foot decreases sharply. When looking at well production data, it is obvious that production per foot suffers as the toe of the lateral gets farther from the vertical.
There are several other ETFs that focus on U.S. and world crude prices:
iPath S&P Crude Oil Total Return Index ETN (NYSEARCA:OIL)
All six wells had fantastic results. The first two Riverview wells are still considered sand heavy fracs and produced almost a quarter of a million barrels of oil. This does not include natural gas in the estimates, but EURs for these wells are approximately 1200 MBo. We don’t put much emphasis on EURs other than an indicator of how good production is in comparison. Since locations will produce from 35 to 40 years, we are more inclined to emphasize one year production. Although the Hawkeye wells drilled on 9/12 and 1/13 didn’t show a large uptick in production per foot, it is still quite impressive considering the lateral length. Overall production uplift was exceptional, and these wells produce decent payback times at current oil price realizations.
There is no doubt this area has superior geology. It is definitely a core area, but may not be as good as Parshall field. Because of this, we know other areas would not produce as well, but still it provides a decent comparison for the upside to well design. Geology is still key and this is probably why EOG recently drilled a 15 well pad in the same general area. These wells are still in confidential status, so we do not know the outcome. Given the results in this area, these wells could be very interesting. The most important reason to focus on these Mega-Fracs is repeatability. If EOG can do this, so can other operators. Our expectations are many operators will be able to complete wells this good within the next 12 to 24 months. If this occurs we could see production maintained at much lower prices and fewer completions.
Recent oil crashes show you the hard floor for gauging value oil company equities.
Properly understood, the crashes lend an insight into the concept of Peak Oil.
All oil equity investors should understand the overarching upward trend on display here.
Note: ALL prices used in this article are using current 2015 dollars, inflation adjusted using the US BLS inflation calculator.
Generally, when I invest, I try to keep my thesis very simple. Find good companies, with good balance sheets and some kind of specific catalytic event on the horizon. But when one starts to concentrate their holdings in a sector, as I have recently in energy (see my recent articles on RMP Energy (OTCPK:OEXFF) and DeeThree Energy (OTCQX:DTHRF), you need to also get a good handle on the particular tail or headwinds that are affecting it. Sometimes a sector like oil (NYSEARCA:USO) can be subjected to such forces, like the recent oil price crash, where almost no company specific data mattered.
One of the biggest arguments, normally used by proponents of owning oil stocks as core holdings, in the energy sector is “Peak Oil.” For the unfamiliar, it is a theory forwarded first by M. King Hubbert in the 1950s regarding U.S. oil production. Essentially, the theory stated that the U.S. would reach a point where the oil reserves would become so depleted that it would be impossible to increase oil production further, or even maintain it at a given level, regardless of effort. This would inevitably lead to oil price rises of extreme magnitudes.
Since those early beginnings, the details have been argued over in an ever-evolving fashion. The argument has shifted with global events, technological developments, and grown to encompass nearly every basin in the world (even best-selling books have been written about peak oil like Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy by Matt Simmons about a decade ago) consuming endless bytes of the Internet in every kind of investment forum and medium of exchange.
In general, I believe that the term “peak oil” is a highly flawed one. Some picture peak oil in a Mad Max fashion, with oil supplies running out like a science fiction disaster movie. Others simply dismiss peak oil as having failed to predict these so-called peaks repeatedly (the world is producing a record amount of oil right now, so all previous absolute “Peak Oil” calls below these amounts are obviously wrong). But what people should be stating when they use these terms is a Peak OilPrice.
Using my own thinking and phrasing, I believe civilization has probably passed $25 Peak Oil. This means that if you set the oil price to $25 a barrel, there is no method available to humanity to provide enough oil to meet demand over any period of time that’s really relevant. I also believe we are in the middle of proving that we have also passed $50 Peak Oil. My final conjecture here is that we will prove in the near-term future to have reached $75 Peak Oil. I don’t believe we are quite at $100 Peak Oil.
Notice that in my formulation the term Peak Oil is always stated as a peak price. Oil is not consumed in a vacuum. The price affects the demand the world has for the product and simultaneously changes the ability of all sorts of entities (businesses and governments) to retrieve deposits of it. This is what I hope to prove in this article.
So what data could I bring to this crowded table?
Well we have one thing we now have that previous entrants into the Peak Oil melee didn’t, which is the recent price crash in oil. Peak oil is often falsely portrayed as a failed idea since it hasn’t resulted in a super squeeze to ultra high prices. These spike prices are viewed as the really critical element by energy investors since they are trying to find the best case. After all, who doesn’t want to own an oil producer if they can identify a spot in which oil prices will rise to some enormous number.
But that is the wrong way to go about it for your oil investments over the long haul. Because what $50 Peak Oil really provides is afloor. In a world where we have passed $25 Peak Oil, it should be impossible, without exogenous events of enormous magnitude (world war, etc.), to press the price of the product below that price. If you could do so, you would immediately disprove the thesis. You would then know the floor provided by whichever peak oil price level you selected was wrong. The same idea seems to hold true for $50 Peak Oil now.
To prove this “floor” we need to choose times of extreme stress in the oil markets, and look at those oil prices and see what the bottoms were. For these examples, let’s select WTI oil, whose weekly average prices are reported all the way back to 1986 by the EIA.
Let’s take the three big crashes in the oil markets. I will use a full year’s average to try to smooth out the various difficulties presented by weather, seasonal effects, or various one-off events (outages, etc.). The first crash I will use as a benchmark is The 1986 Oil Crash. The 1986 breakdown was a supply crash, caused by supply swamping demand. How big a disaster was it for the oil industry?
In 1986, the Saudis opened the spigot and sparked a four-month, 67 percent plunge that left oil just above $10 a barrel. The U.S. industry collapsed, triggering almost a quarter-century of production declines, and the Saudis regained their leading role in the world’s oil market.
This was quite a crash obviously. Triggering a 25 year decline? Not going to find a lot worse than this. So in inflation adjusted dollars what was WTI oil at for the year of 1986? It sold for around $32 a barrel. Now let’s note that at this time WTI crude was actually at a higher price vs. Brent and other world prices. On a Brent basis, crude would have been just around $25 for the year. This will prove to be an important point in a short while.
The next crash we will use to benchmark was the 2008 Financial Crisis. On this website, I should hope that this world crisis will need no introduction and little explanation. This crash in oil prices (and just about every other thing priced by human beings) was a demand crash. The financial disintegration across the world led to massive drops in demand, as jobs were lost across the world by the millions. So with this demand crash what was the average price of WTI crude in the year 2009? It sold in that year for a little over $60.
The last crash I will add is the current drop, starting sometime around October by my reckoning. I would find it hard to imagine any reader of this article is unfamiliar with the current situation in North America or the world regarding oil, at least in a headline sense. This seems to be a supply crash again, where North American-led tight oil drillers have caused an increase in production that the world’s demand couldn’t handle at the $100 price level. Since then, prices have dropped down to a level that suppresses the production of oil and enhances demand.
In the first four months of 2015, the North American oil rig count has already dropped by more than 50% as compared to last year and the demand for oil has begun to increase according to EIA statistics. The current price of WTI oil has been just over $49 as an average for the year 2015. However, let us note that WTI oil now sells for a large discount to world prices, and during the previous two crashes, WTI sold for a premium.
Now we have three data points. Each one is a fairly long period of time, not just a single week. We know that the world in 1986 nearly ended for the oil industry, yet in current dollars, WTI oil was unable to trade for a year below $30 a barrel. Then we had in 2008 and 2009 an economic crisis which was widely described as being the most dire financial disaster since WWII. In 2009, WTI oil still ended up trading well over the 1986 low. In fact it was nearly double that price. This shows just how hard it can be using almost any technique to push oil prices below a true peak number.
Now we have another supply led crunch. One that is widely described as the worst oil crash since 1986, a nearly 30 year time gap. We are attacking the oil price from the supply side instead of 2008’s demand side. Yet thus far, in 2015, oil is still trading more than 50%higher than the 1986 year average, inflation adjusted. In fact, WTI, when adjusted for its current discount to world prices, is trading close to its 2009 average price. Again, nearly double the price of the 1986 crash.
What does this all mean for investing? It means to me that $25 Peak Oil is behind us. You couldn’t really hit and maintain that number in the 1986 crash when many more virgin conventional reservoirs of oil were available. Despite the last three oil crises, not one of them could get WTI oil to $25 and keep it there. Now, using much more expensive oil resources (shale fracing, deep water drilling, arctic development, etc.), it doesn’t seem like the last two disasters have been able to press WTI oil much below $50 for a material length of time. In this recent crash, the $50 floor was able to be reached only with several years of hyper-investment made possible by the twin forces of sustained high prices and access to ultra-cheap capital. Both of these forces are no longer present in the oil markets.
Therefore, I think using a $50 Peak Oil number is a very reasonable hard floor to use when stress testing your oil stocks. It means that when I am choosing a stock that produces oil, it can survive both from supply and the demand led crashes using the worst the world can throw at it.
Some will say this reasoning is simplistic. One could claim any number of variables in the future (technology, peace in the Middle East, etc.) could change all the points I am relying on here. But we have throwneverything at the oil complex between 2008 and now; both from the supply side and the demand sides; breakdowns of the whole world economy, wars, sanctions, natural disasters, hugely stupid governmental policies, OPEC’s seeming fade to irrelevance, biofuels, periods of ultra-high prices, technological progress, electric cars, etc. Yet, here we stand with these numbers staring us in the face.
In conclusion, I feel these price points prove the reality of $50 Peak Oil (WTI). If WTI oil averages more than $50 in 2015 (which I strongly feel the data shows will happen), then it will confirm my thesis that no matter what happens in the world, human beings cannot seem to produce the amount of oil they require for less than that number. Therefore, one will know what the hard floor for petroleum is provided by the hugely complex interplay of geology, politics, economics, and technology by simply measuring those effects on one easy-to-measure point of data, namely price. This version of peak oil also means I have a minimum to test my selections on. I can buy companies that can at least deal with that floor, then make large profits as the prices rise from that hard floor. All oil fields deplete, and for the past twenty years, the solution has universally been to add more expensive technological solutions, exploit smaller or more physically difficult deposits, or use more expensive alternatives. The oil market does not have the same options available to it like it did 1986. Large, cheap conventional oil deposits are no longer available in sufficient supply, which is likely what the oil price is telling us by having higher Peak Floors during crashes. Without the magic of sustained ultra high prices, the investment levels that made this run at the $50 Peak Oil level will not exist going into the future. This means that the Peak Oil floor price should be creeping higher as a sector tailwind, giving a patient and selective investor a tremendous advantage for themselves.
The fall in U.S. rigs drilling for oil quickened a bit this week, data showed on Friday, suggesting a recent slowdown in the decline in drilling was temporary, after slumping oil prices caused energy companies to idle half the country’s rigs since October.
Drillers idled 31 oil rigs this week, leaving 703 rigs active, after taking 26 and 42 rigs out of service in the previous two weeks, oil services firm Baker Hughes Inc said in its closely watched report.
With the oil rig decline this week, the number of active rigs has fallen for a record 20 weeks in a row to the lowest since 2010, according to Baker Hughes data going back to 1987. Since the number of oil rigs peaked at 1,609 in October, energy producers have responded quickly to the steep 60 percent drop in oil prices since last summer by cutting spending, eliminating jobs and idling rigs.
After its precipitous drop since October, the U.S. oil rig count is nearing a pivotal level that experts say could dent production, bolster prices and even coax oil companies back to the well pad in the coming months.
Pioneer Natural Resources Co, a top oil producer in the Permian Basin of West Texas, said this week it will start adding rigs in June as long as market conditions are favorable. U.S. crude futures this week climbed to over $58 a barrel, the highest level this year, as a Saudi-led coalition continued bombings in Yemen.
That was up 38 percent from a six-year low near $42 set in mid March on oversupply concerns and lackluster demand, in part on expectations the lower rig count will start reducing U.S. oil output.
After rising mostly steadily since 2009, U.S. oil production has stalled near 9.4 million barrels a day since early March, the highest level since the early 1970s, according to government data.
The Permian Basin in West Texas and eastern New Mexico, the nation’s biggest and fastest-growing shale oil basin, lost the most oil rigs, down 13 to 242, the lowest on record, according to data going back to 2011.
Texas was the state with the biggest rig decline, down 19 to 392, the least since 2009. In Canada, active oil rigs fell by four to 16, the lowest since 2009.U.S. natural gas rigs, meanwhile, climbed by eight to 225, the same as two weeks ago.
Oil prices caused one-third of the job cuts that U.S.-based companies announced in the first quarter, according to a new report.March was the fourth month in a row to record a year-over-year increase in job cuts, Chicago-based outplacement consultancy Challenger, Gray & Christmas Inc. reports. And 47,610 of the 140,214 job cuts announced between January and March were directly attributed to falling oil prices.Not surprisingly, the energy sector accounted for 37,811 of the job cuts — up a staggering 3,900 percent from the same quarter a year earlier, when 940 energy jobs were cut.However, U.S. energy firms only announced 1,279 job cuts in March, down about 92 percent from the 16,339 announced in February and down nearly 94 percent from the 20,193 announced in January.The trend held true in Houston, where several energy employers announced job cuts in January and February, while fewer cuts were announced in March.Overall job-cut announcements are declining, as well. U.S. employers announced 36,594 job cuts in March, down 27.6 percent from the 50,579 announced in February and down 31 percent from the 53,041 announced in January. In December, 32,640 job cuts were announced.“Without these oil related cuts, we could have been looking one of lowest quarters for job-cutting since the mid-90s when three-month tallies totaled fewer than 100,000. However, the drop in the price of oil has taken a significant toll on oil field services, energy providers, pipelines, and related manufacturing this year,” John Challenger, CEO of Challenger, Gray & Christmas, said in a statement.
The U.S. Oil Boom Is Moving To A Level Not Seen In 45 Years
SAN FRANCISCO (MarketWatch) — U.S. oil production is on track to reach an annual all-time high by September of this year, according to Rystad Energy.If production does indeed top out, then supply levels may soon hit a peak as well. That, in turn, could lead to shrinking supplies.The oil-and-gas consulting-services firm estimates an average 2015 output of 9.65 million barrels a day will be reached in five months — topping the previous peak annual reading of 9.64 million barrels a day in 1970.Coincidentally, the nation’s crude inventories stand at a record 471.4 million barrels, based on data from U.S. Energy Information Administration, also going back to the 1970s.The staggering pace of production from shale drilling and hydraulic fracturing have been blamed for the 46% drop in crude prices CLK5, -1.08% last year. But reaching so-called peak production may translate into a return to higher oil prices as supplies begin to thin.
Rystad Energy’s estimate includes crude oil and lease condensate (liquid hydrocarbons that enter the crude-oil stream after production), and assumes an average price of $55 for West Texas Intermediate crude oil. May WTI crude settled at $49.14 a barrel on Friday.The forecast peak production level in September is also dependent on horizontal oil rig counts for Bakken, Eagle Ford and Permian shale plays stabilizing at 400 rigs, notes Per Magnus Nysveen, senior partner and head of analysis at Rystad.Of course, in this case, hitting peak production isn’t assured.“Some will be debating whether the U.S. has reached its peak production for the current boom, without addressing the question of what level will U.S. production climb to in any future booms,” said Charles Perry, head of energy consultant Perry Management. “So one might also say U.S. peak production is a moving target.”James Williams, an energy economist at WTRG Economics, said that by his calculations, peak production may have already happened or may occur this month, since the market has seen a decline in North Dakota production, with Texas expected to follow.
The number of rigs exploring for oil and natural gas in the Permian Basin decreased five this week to 285, according to the weekly rotary rig count released Thursday by Houston-based oilfield services company Baker Hughes.
The North American rig count was released a day early this week because of the Good Friday holiday, according to the Baker Hughes website.
District 8 — which includes Midland and Ector counties — shed four rigs, bringing the total to 180. The district’s rig count is down 42.68 percent on the year. The Permian Basin is down 46.23 percent.
At this time last year, the Permian Basin had 524 rigs.
TEXAS
Texas’ count fell six this week, leaving 456 rigs statewide.
In other major Texas basins, there were 137 rigs in the Eagle Ford, unchanged; 29 in the Haynesville, down three; 23 in the Granite Wash, down one; and six in the Barnett, unchanged.
Texas had 877 rigs a year ago this week.
UNITED STATES
The number of rigs in the U.S. decreased 20 this week, bringing the nationwide total to 1,028.
There were 802 oil rigs, down 11; 222 natural gas rigs, down 11; and four rigs listed as miscellaneous, up two.
By trajectory, there were 136 vertical rigs, down eight; 799 horizontal rigs, down 13; and 93 directional rigs, up one. The last time the horizontal rig count fell below 800 was the week ending June 4, 2010, when Baker Hughes reported 798 rigs.
There were 993 rigs on land, down 17; four in inland waters, unchanged; and 31 offshore, down three. There were 29 rigs in the Gulf of Mexico, down four.
The U.S. had 1,818 rigs at this time last year.
TOP 5s
The top five states by rig count this week were Texas; Oklahoma with 129, down four; North Dakota with 90, down six; Louisiana with 67, down five; and New Mexico with 51, unchanged.
The top five rig counts by basin were the Permian; the Eagle Ford; the Williston with 91, down six; the Marcellus with 70, unchanged; and the Cana Woodford and Mississippian with 40 each. The Mississippian idled three rigs, while the Cana Woodford was unchanged. The Cana Woodford shale play is located in central Oklahoma.
CANADA AND NORTH AMERICA
The number of rigs operating in Canada fell 20 this week to 100. There were 20 oil rigs, up two; 80 natural gas rigs, down 22; and zero rigs listed as miscellaneous, unchanged.
The last time Canada’s rig count dipped below 100 was the week ending May 29, 2009, when 90 rigs were reported.
Canada had 235 rigs at this time last year.
The total number of rigs in the North America region fell 40 this week to 1,128. North America had 2,083 rigs a year ago this week.
Back in early 2007, just as the first cracks of the bursting housing and credit bubble were becoming visible, one of the primary harbingers of impending doom was banks slowly but surely yanking availability (aka “dry powder”) under secured revolving credit facilities to companies across America. This also was the first snowflake in what would ultimately become the lack of liquidity avalanche that swept away Lehman and AIG and unleashed the biggest bailout of capitalism in history. Back then, analysts had a pet name for banks calling CFOs and telling them “so sorry, but your secured credit availability has been cut by 50%, 75% or worse” – revolver raids.Well, the infamous revolver raids are back. And unlike 7 years ago when they initially focused on retail companies as a result of the collapse in consumption burdened by trillions in debt, it should come as no surprise this time the sector hit first and foremost is energy, whose “borrowing availability” just went poof as a result of the very much collapse in oil prices.
As Bloomberg reports, “lenders are preparing to cut the credit lines to a group of junk-rated shale oil companies by as much as 30 percent in the coming days, dealing another blow as they struggle with a slump in crude prices, according to people familiar with the matter.
Sabine Oil & Gas Corp. became one of the first companies to warn investors that it faces a cash shortage from a reduced credit line, saying Tuesday that it raises “substantial doubt” about the company’s ability to continue as a going concern.
It’s going to get worse: “About 10 firms are having trouble finding backup financing, said the people familiar with the matter, who asked not to be named because the information hasn’t been announced.”
Why now? Bloomberg explains that “April is a crucial month for the industry because it’s when lenders are due to recalculate the value of properties that energy companies staked as loan collateral. With those assets in decline along with oil prices, banks are preparing to cut the amount they’re willing to lend. And that will only squeeze companies’ ability to produce more oil.
Those loans are typically reset in April and October based on the average price of oil over the previous 12 months. That measure has dropped to about $80, down from $99 when credit lines were last reset.
That represents billions of dollars in reduced funding for dozens of companies that relied on debt to fund drilling operations in U.S. shale basins, according to data compiled by Bloomberg.
“If they can’t drill, they can’t make money,” said Kristen Campana, a New York-based partner in Bracewell & Giuliani LLP’s finance and financial restructuring groups. “It’s a downward spiral.”
As warned here months ago, now that shale companies having exhausted their ZIRP reserves which are largely unsecured funding, it means that once the secured capital crunch arrives – as it now has – it is truly game over, and it is just a matter of months if not weeks before the current stakeholders hand over the keys to the building, or oil well as the case may be, over to either the secured lenders or bondholders.
The good news is that unlike almost a decade ago, this time the news of impending corporate doom will come nearly in real time: “Publicly traded firms are required to disclose such news to investors within four business days, under U.S. Securities and Exchange Commission rules. Some of the companies facing liquidity shortfalls will also disclose that they have fully drawn down their revolving credit lines like Sabine, according to one of the people.”
Speaking of Sabine, its day of reckoning has arrived
Sabine, the Houston-based exploration and production company that merged with Forest Oil Corp. last year, told investors Tuesday that it’s at risk of defaulting on $2 billion of loans and other debt if its banks don’t grant a waiver.
Another company is Samson Resource, which said in a filing on Tuesday that it might have to file for a Chapter 11 bankruptcy protection if the company is unable to refinance its debt obligations. And unless oil soars in the coming days, it won’t.
Its borrowing base may be reduced due to weak oil and gas prices, requiring the company to repay a portion of its credit line, according to a regulatory filing on Tuesday. That could “result in an event of default,” Tulsa, Oklahoma-based Samson said in the filing.
Indicatively, Samson Resources, which was acquired in a $7.2-billion deal in 2011 by a team of investors led by KKR & Co, had a total debt of $3.9 billion as of Dec. 31. It is unlikely that its sponsors will agree to throw in more good money after bad in hopes of delaying the inevitable.
The revolver raids explain the surge in equity and bond issuance seen in recent weeks:
Many producers have been raising money in recent weeks in anticipation of the credit squeeze, selling shares or raising longer-term debt in the form of junk bonds or loans.
Energy companies issued more than $11 billion in stock in the first quarter, more than 10 times the amount from the first three months of last year, Bloomberg data show. That’s the fastest pace in more than a decade.
Breitburn Energy Partners LP announced a $1 billion deal with EIG Global Energy Partners earlier this week to help repay borrowings on its credit line. EIG, an energy-focused private equity investor in Washington, agreed to buy $350 million of Breitburn’s convertible preferred equity and $650 million of notes, Breitburn said in a March 29 statement.
Unfortunately, absent an increase in the all important price of oil, at this point any incremental dollar thrown at US shale companies is a dollar that will never be repaid.
The shale oil revolutionaries are retreating in disarray, and cheap foreign oil may banish them to the margins of the market.
As oil and natural gas move into a period of low prices, new data shows that North American drillers may not have the wherewithal to keep producing shale wells, which make up 90 percent of new drilling. In fact, if prices remain low for years to come, which is a real possibility, then investors may never see a return on the money spent to drill shale wells in the first place.
The full cost of producing oil and natural gas at a representative sample of U.S. companies, including capital spent to build the company and buy assets, is about $80 per barrel of oil equivalent, according to a study from the Bureau of Economic Geology’s Center for Energy Economics at the University of Texas.
The analysis of 2014 corporate financial data from 15 of the top publicly traded producers, which I got an exclusive look at before it’s published this week, determined that companies will have a hard time recovering the capital spent that year and maintaining production unless prices rise above $80 a barrel.
The price for West Texas Intermediate has spent most of the year below $50 a barrel.
Low prices, though, won’t mean that producers will shut in existing wells. Many of these same companies can keep pumping to keep cash coming into the company, and they can still collect a 10 percent return above the well’s operating costs at $50 a barrel of oil. They just won’t make enough money to invest in new wells or recover the capital already spent.
This harsh reality of what it will take to keep the shale revolution going shows how vulnerable it is to competition from cheap overseas oil.
“Everyone walks around thinking that they know how much this stuff costs because they see published information on what people spend to just drill wells,” explained Michelle Foss, who leads the Houston-based research center. “That is not what it takes for a company to build these businesses, to recover your capital and to make money.” The bureau was founded in 1909 and functions as the state geological agency.
Low oil prices will also exacerbate the economic impact of low natural gas prices. For years natural gas has kept flowing despite prices below $4 for a million British thermal units because about 50 percent of wells produced both gas and liquids, such as crude oil and condensate.
True natural gas costs
High oil prices have helped companies subsidize natural gas wells, but lower oil prices mean natural gas wells that don’t produce liquids will need to stand on their own economics.
The center’s analysis found that among the sample companies focused primarily on gas, prices will need to top $6 a million BTUs just to cover full costs and rise above $12 a million BTUs to recover the capital expended to develop the wells.
“We have important resources, but people have to be realistic about the challenges of developing them,” Foss told me. “There will have to be higher prices.”
Everyone predicts prices will rise again. The only questions are how quickly and to what price. Some experts predict WTI prices will reach $70 a barrel by the end of 2015, while others see $60. The soonest most expect to see $80 a barrel oil is in 2017. Saudi Arabian officials have said they believe the price has stabilized and don’t see oil returning to $100 a barrel for the next five years.
High prices and shale
The Saudi opinion is particularly important because that nation can produce oil cheaper than any other country and can produce more oil than any other country. As the informal leader of the Organization of the Petroleum Exporting Countries, Saudi Arabia kept the price of oil inside a band between $80 and $100 a barrel for years. Now, the Saudis appear ready to keep the price low.
That’s because high prices inspired the shale revolution, where American companies figured out how to economically drill horizontally into tight rocks and then hydraulically fracture them to release oil and natural gas. Since OPEC countries rely on high oil prices to finance their governments, everyone assumed OPEC would cut production and keep revenues high.
Arab leaders, though, were more concerned about holding on to market share and allowed prices to fall below levels that make most shale wells economic. Foss, who recently returned from meetings in the United Arab Emirates, said OPEC is unlikely to change course because developing countries are seeking alternatives to oil and reducing demand.
“The Saudis and their partners see pressures on oil use everywhere they look, and what they want is their production, in particular their share of the global supply pie, to be as competitive as it can be to ensure they’ve got revenue coming into the kingdom for future generations,” she said.
OPEC is afraid rich countries like the U.S. are losing their addiction to oil, and by lowering prices hope to keep us hooked. And OPEC has plenty of product.
“There’s 9 million barrels a day in current and potential production capacity in Iraq and Iran that is tied up by political conflicts, and if you sort that out enough, that’s a flood of cheap oil onto the market,” Foss said.
On the losing end
If prices remain low, the big losers will be the bond holders and shareholders of indebted, small and medium-size companies that drill primarily in North America. Since these companies are not getting high enough prices to pay off capital expenditures through higher share prices or interest payments , they are in serious trouble.
The inability of Denver-based Whiting Petroleum to sell itself is an example. The board of the North Dakota-focused company was forced to issue new shares, reducing the company’s value by 20 percent, and take on more expensive debt. Quicksilver Resources, based in Fort Worth, filed for Chapter 11 bankruptcy on March 17 because it couldn’t make the interest payments on its debt and no one was willing to invest more capital.
Until one of these companies is bought, we won’t know the true value of the shale producers at the current oil and natural gas prices.
But as more data reaches the market, there is a real danger that these companies are worth even less than investors fear, even though they may have high-quality assets.
Oil production continues to eclipse record highs on a weekly basis despite the oil rig count declining 49% since October.
A single oil-well declines exponentially up to 75% in its first year of production. However, in a process known as Convolution, older wells buffer the rapid decline from new rigs.
This article provides a comprehensive analysis of principles behind oil drilling and production, applies it to the current crude oil climate, and predicts future production, rig counts, and oil price.
Based on my analysis, I remain short-term bearish but long-term bullish on the commodity. My trading strategy based on this analysis is discussed in detail.
On Friday, March 20, Baker Hughes (NYSE:BHI) reported that the crude oil rig count had fallen an additional 41 rigs to 825 active rigs. This was the 15th straight week and 25th out of 26 weeks that the rig count has declined. Active oil rigs are now at the lowest level since the week ending March 18th, 2011 and total drilling rigs (oil + natural gas) are the fewest since October 2009. Overall, the oil rig count is down 49% in the 23 weeks since peaking in October. Nevertheless, in its weekly Petroleum Report, the EIA announced last Wednesday that domestic oil production set yet another record high of 9.42 million barrels per day. Since the rig count peaked the week of October 10, 2014 and began its subsequent collapse, oil production has climbed 460,000 barrels per day, or 5.2%. This continued increase in production in the face of a plummeting rig count has confounded journalists, flummoxed investors, and inflated supplies to record highs leading to a continued slump in oil prices.
The two main questions on traders’ minds are 1) why is oil production still at record highs five months after the rig count started dropping? And 2) when, if at all, will oil production begin to fall and how far will it fall? This article provides a comprehensive analysis of the principles behind the relationship between oil drilling and production, applies it to the current crude oil climate, and predicts where both production and the rig count will go in the coming year.
Before we discuss the real-world oil production and drilling situation – an extremely complex picture with over 1 million rigs producing oil – let’s look at a simple, hypothetical situation. The first key point is that once an oil well is drilled, its production is not constant. In fact, production not only begins to decline almost immediately, it does so in an exponential fashion. After analyzing production curves from multiple wells, I will be estimating weekly oil production from a single oil well by the following equation:
Equation 1:
Daily Oil Production From Single Well = (Initial Daily Production)/(1+ (Week # from start of production*K)
Where K is a constant equal to 0.06
When graphed using a well that initially produces 1000 barrels of oil per week this equation is represented by Figure 1 below:
Figure 1: Crude oil production curve of single, hypothetical well showing exponential decay.
There are two take home points to note from this chart. First, initial decay is very rapid, with weekly production declining by about 75% after 1 year. Second, after the initial rapid decay, production declines much slower and becomes approximately linear with decay rates of 5-10% per year. Although this graph ends after 2 years or 104 weeks, production continues slowly and steadily beyond 5 years.
Figure 1 represents production from a single well. What happens when we add multiple wells over a period of time? The process by which multiple functions – in this case, oil wells – are added over time is known as Convolution. As noted before, even after an oil well has been active for many years, it is still producing a small volume of oil, a fraction of its initial output. However, there are a LOT of these old, low-output rigs – over 1.1 million in fact. When the number of drilling rigs decreases – thus reducing the number of new wells that come into the service – the old, stable wells plus the production from the declining number of new wells is initially enough to buffer the decline in rig count and net output will continue to rise.
Let’s illustrate this with a simple example. Imagine a new oil field monopolized with a single company that owns 30 oil rigs. The company adds five new rigs each month. Each rig is able to drill 1 new well per month. After six months, the company has deployed all of its rigs to the field. Unfortunately, shortly thereafter the company encounters financial difficulties and is forced to withdraw rigs at a rate of 5 per month until zero remain drilling. Figure 2 below compares active drilling rigs and total wells in this field.
Figure 2: Rig count and total well count of hypothetical oil field
Note that after the rig count peaks and begins to decline, total wells continue to increase before ultimately peaking at 180, where it remains for the remainder of the 20-month period.
Each well initially produces 200 barrels of oil per day and declines according to Equation 1 and the chart in Figure 1. Figure 3 below shows total oil field production overlaid with the total rig count of the field.
Figure 3: Oil Production from hypothetical oil field illustrating how crude oil production can continue to climb despite a sharp reduction in the rig count due to convolution.
Oil production initially climbs rapidly as more rigs are added to the field, reaching 500,000 barrels per month by the time the rig count peaks after 6 months. However, even though the rig count declines to zero six months later, total production continues to increase and peaks at 770,000 barrels per month in month 10 – 4 months after the rig count peaked. Production then begins to decline, but slowly. Even by month 20 after the rig count has been at zero for eight months, production has only declined by 33%.
This is obviously a simply, insular example, but it illustrates several important points. First, there is a delay between when the rig count peaks and when production begins to decline as the combination of old, accumulated oil wells and the continued addition of new wells by the declining rigs is sufficient to coast production higher initially. Second, even when production begins to decline, it is blunted, with production declining a fraction of the actual reduction in rig count. For those interested, the Following Article delves into these principles further and provides useful insight.
Let’s now apply these principles to actual domestic oil production. Before we can set up the model, there are three baseline metrics that need to be established: 1) Rate that rigs drill a well, 2) Time between initial spudding of a well and when it begins production, and 3) Initial production rate of new oil wells.
The EIA has released well counts on a quarterly basis for the past two years. Their data shows that the ratio of new wells to rigs has increased slowly from around 4.75 per quarter in 2012 to 5.3 per quarter in 2014. This equates to about 0.4 wells per week per rig presently. For the model, I used a linear reduction in drilling efficiency with drilling rates down to 0.3 wells per week per rig in 2006.
It takes 15-30 days to drill a new oil well. Once the hole is dug, the well must be completed. It typically takes another week for the rig to be removed and new equipment to be set up. A further week is devoted to hydraulic fracturing. Initial flow back and priming of production takes place over the next 3-4 days. Over the final week, the well is primed for continuous production including installation of tank batteries, the pump jack, and assorted power connections. The well is then connected to the pipeline and permanent production begins. Thus, it takes roughly two months from initial spudding of the well to when it begins production. However, once a well is completed it does not always begin to produce immediately and may not do so for up to six months.
Initial oil production rates have increased markedly over the past decade as drilling technology has improved. The EIA released the chart shown below in Figure 4 showing yearly initial production rates in the Eagleford Shale.
Figure 4: Yearly production rates in Eagleford Shale Formation showing rapidly increased initial rates of production 2009-2014. (Source:EIA)
Initial rates increased from less than 50 barrels per day (or 350 per week) in 2009 to nearly 400 barrels per day (or 2800 per week) in 2014. Note that the decay rate has also increased such that by 2-3 years, all wells are approaching the same output despite the significant differences in increased production. This is a relatively new oil formation and older formations produced more oil initially prior to 2010. For my model, I assumed initial production of 2625 barrels of oil per well per week in 2014-2015 with initial production declining to 1400 barrels per well per week in 2006.
Using this data and the methodology discussed in the example above, a modeled projection of U.S. oil production is created dating back to 2006. This data is shown in Figure 5 below and is compared to actual oil production, calculated on a weekly basis. My preferred unit of time is 1 week as this is the frequency that both the rig count and oil production numbers are released.
Figure 5: Projected oil production based on my model vs. observed crude oil production vs. Baker Hughes Rig Count [Sources: Baker Hughes, EIA]
Overall, this model accurately projects oil production based on active drilling rigs. Between 2006 and 2015, the average error was 88,000 barrels per day, or 1.2%. Over the past six months, this error has averaged just 44,000 barrels per day. The model correctly shows production continuing to increase despite the sharp reduction in active drilling rigs. It is interesting to note that the largest deviation between projected oil production and observed production occurred in late 2009 and early 2010, or shortly after the rig count bottomed out from the previous oil price collapse. The model predicted that oil production would decline somewhat while actual production actually just leveled off before beginning a new rally once the rig count rebounded later in 2010.
This model can be used to project how oil production might behave heading into the future. To do so, we must make assumptions about how the rig count might behave heading into the future. First, let’s pretend that the rig count stays unchanged at 825 active oil rigs for the next 1 year. Figure 6 below projects crude oil production to 1 year.
Figure 6:Projected oil production based the rig count remaining unchanged at 825 [Sources: Baker Hughes, EIA]
Using this projection, crude oil production will peak during the week ending April 10 at 9.51 million barrels per day and then begin declining. By next March 2016, production will have declined to 8.68 million barrels per day, down 9.5% from the projected peak. Again, this goes to show the buffering capacity of older rigs, given that a sustained 50% reduction in the rig count results in a comparatively small <10% decrease in output.
Two qualifying notes are necessary. This model shows a relatively short period of time between production plateauing and production beginning its decline. 1) Given that this model assumes all completed wells are producing oil within 3 months of spudding, it is certainly possible that the production curve may flatten out for a longer period of time due to additional completed wells that have been idle are slowly hooked up to pipelines over the next several months. 2) This model also makes the assumption that all rigs produce oil equally. If rigs drilling less-productive oil fields have been selectively retired while those drilling richer fields have remained active, the rate of decline will similarly be slower and less than projected.
The most recent historical comparison to the events currently unfolding took place in 2008-2009 following the collapse of oil from record highs during the great recession from a high of $146/barrel to near $30/barrel. The rig count during that event was likewise slashed by 50% before rapidly recovering when prices rebounded. However, this is not an apples-to-apples comparison since drilling technology has changed substantially – decline rates are much more rapid, initial production is nearly double that in 2008, etc – and inferences cannot necessarily be made about the future of production. However, let’s assume that the current rig count follows a similar trend. If so, the rig count will slow its descent and bottom out in roughly six weeks near 760-780. If the rig count follows the trend seen in 2009, the count will then rapidly rise and will reach 1330 by this time next year. Production will again peak during the week of April 10, before declining. Production will bottom out in late October near 8.9 million barrels per day, down just 6.3% from its peak before again increasing late in the year.
However, the decline in oil in 2008-2009 was based more on the combination of a bubble bursting and a slumping economy than fundamental forces while the current slump is predicated on a supply/demand mismatch. I expect this will keep prices and rigs down significantly longer than in 2008-2009. Let’s amplify the 2008-2009 rig count curve and project instead that rigs bottom out near 730-750 and that the rate of recovery is roughly half that of 2008-2009 with total rigs at just 950 this time next year. Using this model, production will continue to slowly decline through the New Year and flatten out near 8.7 million barrels per day by March 2016, down 8.4% from the peak. I believe that this is a more realistic model for crude oil production. This projection is shown below in Figure 7.
Figure 7:Projected oil production based on 2008-2009 rig count [Sources: Baker Hughes, EIA]
What does this mean for the supply/demand situation? As I have discussed in my previous articles, crude oil supply and demand are severely mismatched. This has led to oil inventories skyrocketing to a record high of 458 million barrels, a huge 98.7 million barrels above the five-year mean for March. Applying the projected production curve shown in Figure 7 to crude oil storage yields some surprising results. Even with just an 8.7% reduction in supply, the inventory surplus will narrow markedly. These results are shown below in Figure 8, which compares the five-year average storage level and current and projected storage levels. Note: These projections assume that total imports will remain flat and that total demand will follow the five-year average.
Figure 8: Projected crude oil storage based on projected oil production data vs. 5-year average [Source: EIA]
While the rig count continues to climb and then plateaus, I expect that the storage surplus will continue to widen with total inventories approaching 500 million barrels by early May. However, as production drops off, the inventory surplus begins to decline. By the last week of 2015, total supply has declined by 4.7 million barrels per week and projected inventory levels cross the five-year average for the first time since October 2014. Should the rig count begin the slow rise that is projected, by March of 2016, total storage levels will be 50 million barrels BELOW the five-year average. Even if the two qualifying statements discussed above verify or the rig count rises more rapidly than projected, I expect that, based on the drop in rig count already, crude oil inventories will be at or below average this time next year.
What does this mean for crude oil prices? There is a chicken and egg situation going on here. This article makes references to the rebound in rig count after bottoming out in the next month or two. This, of course, is predicated on a rise in price to make drilling again profitable. Without a rally, the count will continue to fall or, at the very least NOT rise, putting further pressure on supply and down-shifting the projected production curve further, making it more likely that prices will THEN rally. Until they finally do. One way or another, I do not see how crude oil can remain priced at under $45/barrel for longer than a few months. Something has to give. Drilling technology is simply not yet to the point where this is a profitable price range for the majority of companies.
Given that these projections show production increasing through early April, I would not be surprised to see continued short-term pressure on oil prices. As I discussed in My Article Last Week, storage at Cushing, the closely watched oil pipeline hub, continues to fill rapidly and threatens to reach capacity by early May. I would welcome such an event, as crude oil would likely drop under $40/barrel presenting an even better buying opportunity. I therefore maintain a short-term bearish, long-term bullish stance on oil.
My favorite way to play a rally in oil is to short the VelocityShares 3x Inverse Crude Oil ETN (NYSEARCA:DWTI) to gain long exposure. This takes advantage of leverage-induced decay to at least partially negate the impact of contango on the ETF. The United States Oil ETF USO), on the other hand, is intended to track 1x the price of oil and leaves an investor directly exposed to contango, which is now 15% over the next six months. The same applies to the VelocityShares 3x Long Crude Oil ETN (NYSEARCA:UWTI), except that exposure to contango is now tripled to 45%.
The advantage to USO is in its safety. A short position in DWTI theoretically leaves an investor open to infinite losses should the price of oil continue to drop. Further, shares must be borrowed to short, which can cost 3-5% annually depending on the broker. And if, once a trader has a position, these shares are no longer available, the position can be forcibly closed at an inopportune time. A slightly less risky position would be the ProShares UltraShort Bloomberg Crude Oil ETF (NYSEARCA:SCO) that is more liquid and less volatile.
For this reason, I started a small position in USO on Thursday at $16.05 when oil erased its post-Fed Remarks gains from Wednesday. This position is equal to just 2% of my portfolio. I will add to my USO position once oil breaks $45/barrel and then again should the commodity break $42/barrel for a total exposure of 6% of my portfolio. Should oil continue to decline to under $40/barrel, I will begin to sell short DWTI at what I assume to be a safer entry point until 10% of my portfolio is allocated to oil ETFs.
Should oil rebound, I will look to take profits. Once the rig count bottoms, I will begin taking profits once oil reaches $50/barrel. I will selectively sell USO initially. I prefer to close out the position most exposed to contango initially in the event that oil reverses and I would otherwise be stuck holding it for an extended period of time. I will then close out DWTI if and when crude oil again reaches $60/barrel. While I believe that oil may ultimately see higher prices, I am concerned at the speed at which rigs may be re-deployed once drilling again becomes profitable. I believe that this will keep oil under $70/barrel for the foreseeable future and will look to exit prior to this level.
In conclusion, an oil production model based on 9 years of domestic production and rig count data is used to project oil production for the past 1 year. This model suggests that oil will bottom around the week ending April 10. However, this is just a modeled projection and the actual peak in production will depend on nuances in drilling discussed above. Nevertheless, I believe that the peak in oil production will represent a significant psychological inflection point and that crude oil is poised for a rally once production begins to roll over.
On the face of it, the oil price appears to be stabilizing. What a precarious balance it is, however.
Behind the facade of stability, the re-balancing triggered by the price collapse has yet to run its course, and it might be overly optimistic to expect it to proceed smoothly. Steep drops in the US rig count have been a key driver of the price rebound. Yet US supply so far shows precious little sign of slowing down. Quite to the contrary, it continues to defy expectations.
So said the International Energy Agency in its Oil Market Report on Friday. West Texas Intermediate plunged over 4% to $45 a barrel.
The boom in US oil production will continue “to defy expectations” and wreak havoc on the price of oil until the power behind the boom dries up: money borrowed from yield-chasing investors driven to near insanity by the Fed’s interest rate repression. But that money isn’t drying up yet – except at the margins.
Companies have raked in 14% more money from high-grade bond sales so far this year than over the same period in 2014, according to LCD. And in 2014 at this time, they were 27% ahead of the same period in 2013. You get the idea.
Even energy companies got to top off their money reservoirs. Among high-grade issuers over just the last few days were BP Capital, Valero Energy, Sempra Energy, Noble, and Helmerich & Payne. They’re all furiously bringing in liquidity before it gets more expensive.
In the junk-bond market, bond-fund managers are chasing yield with gusto. Last week alone, pro-forma junk bond issuance “ballooned to $16.48 billion, the largest weekly tally in two years,” the LCD HY Weekly reported. Year-to-date, $79.2 billion in junk bonds have been sold, 36% more than in the same period last year.
But despite this drunken investor enthusiasm, the bottom of the energy sector – junk-rated smaller companies – is falling out.
Standard & Poor’s rates 170 bond issuers that are engaged in oil and gas exploration & production, oil field services, and contract drilling. Of them, 81% are junk rated – many of them deep junk. The oil bust is now picking off the smaller junk-rated companies, one after the other, three of them so far in March.
On March 3, offshore oil-and-gas contractor CalDive that in 2013 still had 1,550 employees filed for bankruptcy. It’s focused on maintaining offshore production platforms. But some projects were suspended last year, and lenders shut off the spigot.
On March 8, Dune Energy filed for bankruptcy in Austin, TX, after its merger with Eos Petro collapsed. It listed $144 million in debt. Dune said that it received $10 million Debtor in Possession financing, on the condition that the company puts itself up for auction.
On March 9, BPZ Resources traipsed to the courthouse in Houston to file for bankruptcy, four days after I’d written about its travails; it had skipped a $60 million payment to its bondholders [read… “Default Monday”: Oil & Gas Companies Face Their Creditors].
And more companies are “in the pipeline to be restructured,” LCD reported. They all face the same issues: low oil and gas prices, newly skittish bond investors, and banks that have their eyes riveted on the revolving lines of credit with which these companies fund their capital expenditures. Being forever cash-flow negative, these companies periodically issue bonds and use the proceeds to pay down their revolver when it approaches the limit. In many cases, the bank uses the value of the company’s oil and gas reserves to determine that limit.
If the prices of oil and gas are high, those reserves have a high value. It those prices plunge, the borrowing base for their revolving lines of credit plunges. S&P Capital IQ explained it this way in its report, “Waiting for the Spring… Will it Recoil”:
Typically, banks do their credit facility redeterminations in April and November with one random redetermination if needed. With oil prices plummeting, we expect banks to lower their price decks, which will then lead to lower reserves and thus, reduced borrowing-base availability.
April is coming up soon. These companies would then have to issue bonds to pay down their credit lines. But with bond fund managers losing their appetite for junk-rated oil & gas bonds, and with shares nearly worthless, these companies are blocked from the capital markets and can neither pay back the banks nor fund their cash-flow negative operations. For many companies, according to S&P Capital IQ, these redeterminations of their credit facilities could lead to a “liquidity death spiral.”
Alan Holtz, Managing Director in AlixPartners’ Turnaround and Restructuring group told LCD in an interview:
We are already starting to see companies that on the one hand are trying to work out their operational problems and are looking for financing or a way out through the capital markets, while on the other hand are preparing for the events of contingency planning or bankruptcy.
Look at BPZ Resources. It wasn’t able to raise more money and ended up filing for bankruptcy. “I think that is going to be a pattern for many other companies out there as well,” Holtz said.
When it trickled out on Tuesday that Hercules Offshore, which I last wrote about on March 3, had retained Lazard to explore options for its capital structure, its bonds plunged as low as 28 cents on the dollar. By Friday, its stock closed at $0.41 a share.
When Midstates Petroleum announced that it had hired an interim CEO and put a restructuring specialist on its board of directors, its bonds got knocked down, and its shares plummeted 33% during the week, closing at $0.77 a share on Friday.
When news emerged that Walter Energy hired legal counsel Paul Weiss to explore restructuring options, its first-lien notes – whose investors thought they’d see a reasonable recovery in case of bankruptcy – dropped to 64.5 cents on the dollar by Thursday. Its stock plunged 63% during the week to close at $0.33 a share on Friday.
Numerous other oil and gas companies are heading down that path as the oil bust is working its way from smaller more vulnerable companies to larger ones. In the process, stockholders get wiped out. Bondholders get to fight with other creditors over the scraps. But restructuring firms are licking their chops, after a Fed-induced dry spell that had lasted for years.
Investors Crushed as US Natural Gas Drillers Blow Up
The Fed speaks, the dollar crashes. The dollar was ripe. The entire world had been bullish on it. Down nearly 3% against the euro, before recovering some. The biggest drop since March 2009. Everything else jumped. Stocks, Treasuries, gold, even oil.
West Texas Intermediate had been experiencing its biggest weekly plunge since January, trading at just above $42 a barrel, a new low in the current oil bust. When the Fed released its magic words, WTI soared to $45.34 a barrel before re-sagging some. Even natural gas rose 1.8%. Energy related bonds had been drowning in red ink; they too rose when oil roared higher. It was one heck of a party.
But it was too late for some players mired in the oil and gas bust where the series of Chapter 11 bankruptcy filings continues. Next in line was Quicksilver Resources.
It had focused on producing natural gas. Natural gas was where the fracking boom got started. Fracking has a special characteristic. After a well is fracked, it produces a terrific surge of hydrocarbons during first few months, and particularly on the first day. Many drillers used the first-day production numbers, which some of them enhanced in various ways, in their investor materials. Investors drooled and threw more money at these companies that then drilled this money into the ground.
But the impressive initial production soon declines sharply. Two years later, only a fraction is coming out of the ground. So these companies had to drill more just to cover up the decline rates, and in order to drill more, they needed to borrow more money, and it triggered a junk-rated energy boom on Wall Street.
At the time, the price of natural gas was soaring. It hit $13 per million Btu at the Henry Hub in June 2008. About 1,600 rigs were drilling for gas. It was the game in town. And Wall Street firms were greasing it with other people’s money. Production soared. And the US became the largest gas producer in the world.
But then the price began to plunge. It recovered a little after the Financial Crisis but re-plunged during the gas “glut.” By April 2012, natural gas had crashed 85% from June 2008, to $1.92/mmBtu. With the exception of a few short periods, it has remained below $4/mmBtu – trading at $2.91/mmBtu today.
Throughout, gas drillers had to go back to Wall Street to borrow more money to feed the fracking orgy. They were cash-flow negative. They lost money on wells that produced mostly dry gas. Yet they kept up the charade. They aced investor presentations with fancy charts. They raved about new technologies that were performing miracles and bringing down costs. The theme was that they would make their investors rich at these gas prices.
The saving grace was that oil and natural-gas liquids, which were selling for much higher prices, also occur in many shale plays along with dry gas. So drillers began to emphasize that they were drilling for liquids, not dry gas, and they tried to switch production to liquids-rich plays. In that vein, Quicksilver ventured into the oil-rich Permian Basin in Texas. But it was too little, too late for the amount of borrowed money it had already burned through over the years by fracking for gas below cost.
During the terrible years of 2011 and 2012, drillers began reclassifying gas rigs as rigs drilling for oil. It was a judgement call, since most wells produce both. The gas rig count plummeted further, and the oil rig count skyrocketed by about the same amount. But gas production has continued to rise since, even as the gas rig count has continued to drop. On Friday, the rig count was down to 257 gas rigs, the lowest since March 1993, down 84% from its peak in 2008.
Quicksilver’s bankruptcy is a consequence of this fracking environment. It listed $2.35 billion in debts. That’s what is left from its borrowing binge that covered its negative cash flows. It listed only $1.21 billion in assets. The rest has gone up in smoke.
Its shares are worthless. Stockholders got wiped out. Creditors get to fight over the scraps.
Its leveraged loan was holding up better: the $625 million covenant-lite second-lien term loan traded at 56 cents on the dollar this morning, according to S&P Capital IQ LCD. But its junk bonds have gotten eviscerated over time. Its 9.125% senior notes due 2019 traded at 17.6 cents on the dollar; its 7.125% subordinated notes due 2016 traded at around 2 cents on the dollar.
Among its creditors, according to the Star Telegram: the Wilmington Trust National Association ($361.6 million), Delaware Trust Co. ($332.6 million), US Bank National Association ($312.7 million), and several pipeline companies, including Oasis Pipeline and Energy Transfer Fuel.
Last year, it hired restructuring advisers. On February 17, it announced that it would not make a $13.6 million interest payment on its senior notes and invoked the possibility of filing for Chapter 11. It said it would use its 30-day grace period to haggle with its creditors over the “company’s options.”
Now, those 30 days are up. But there were no other “viable options,” the company said in the statement. Its Canadian subsidiary was not included in the bankruptcy filing; it reached a forbearance agreement with its first lien secured lenders and has some breathing room until June 16.
Quicksilver isn’t alone in its travails. Samson Resources and other natural gas drillers are stuck neck-deep in the same frack mud.
A group of private equity firms, led by KKR, had acquired Samson in 2011 for $7.2 billion. Since then, Samson has lost $3 billion. It too hired restructuring advisers to deal with its $3.75 billion in debt. On March 2, Moody’s downgraded Samson to Caa3, pointing at “chronically low natural gas prices,” “suddenly weaker crude oil prices,” the “stressed liquidity position,” and delays in asset sales. It invoked the possibility of “a debt restructuring” and “a high risk of default.”
But maybe not just yet. The New York Post reported today that, according to sources, a JPMorgan-led group, which holds a $1 billion revolving line of credit, is granting Samson a waiver for an expected covenant breach. This would avert default for the moment. Under the deal, the group will reduce the size of the revolver. Last year, the same JPMorgan-led group already reduced the credit line from $1.8 billion to $1 billion and waived a covenant breach.
By curtailing access to funding, they’re driving Samson deeper into what S&P Capital IQ called the “liquidity death spiral.” According to the New York Post’s sources, in August the company has to make an interest payment to its more junior creditors, “and may run out of money later this year.”
Industry soothsayers claimed vociferously over the years that natural gas drillers can make money at these prices due to new technologies and efficiencies. They said this to attract more money. But Quicksilver along with Samson Resources and others are proof that these drillers had been drilling below the cost of production for years. And they’d been bleeding every step along the way. A business model that lasts only as long as new investors are willing to bail out old investors.
But it was the crash in the price of “liquids” that made investors finally squeamish, and they began to look beyond the hype. In doing so, they’re triggering the very bloodletting amongst each other that ever more new money had delayed for years. Only now, it’s a lot more expensive for them than it would have been three years ago. While the companies will get through it in restructured form, investors get crushed.
“People need to kinda settle in for a while.” That’s what Exxon Mobil CEO Rex Tillerson said about the low price of oil at the company’s investor conference. “I see a lot of supply out there.”
So Exxon is going to do its darnedest to add to this supply: 16 new production projects will start pumping oil and gas through 2017. Production will rise from 4 million barrels per day to 4.3 million. But it will spend less money to get there, largely because suppliers have had to cut their prices.
That’s the global oil story. In the US, a similar scenario is playing out. Drillers are laying some people off, not massive numbers yet. Like Exxon, they’re shoving big price cuts down the throats of their suppliers. They’re cutting back on drilling by idling the least efficient rigs in the least productive plays – and they’re not kidding about that.
In the latest week, they idled a 64 rigs drilling for oil, according to Baker Hughes, which publishes the data every Friday. Only 922 rigs were still active, down 42.7% from October, when they’d peaked. Within 21 weeks, they’ve taken out 687 rigs, the most terrific, vertigo-inducing oil-rig nose dive in the data series, and possibly in history:
As Exxon and other drillers are overeager to explain: just because we’re cutting capex, and just because the rig count plunges, doesn’t mean our production is going down. And it may not for a long time. Drillers, loaded up with debt, must have the cash flow from production to survive.
But with demand languishing, US crude oil inventories are building up further. Excluding the Strategic Petroleum Reserve, crude oil stocks rose by another 10.3 million barrels to 444.4 million barrels as of March 4, the highest level in the data series going back to 1982, according to the Energy Information Administration. Crude oil stocks were 22% (80.6 million barrels) higher than at the same time last year.
“When you have that much storage out there, it takes a long time to work that off,” said BP CEO Bob Dudley, possibly with one eye on this chart:
So now there is a lot of discussion when exactly storage facilities will be full, or nearly full, or full in some regions. In theory, once overproduction hits used-up storage capacity, the price of oil will plummet to whatever level short sellers envision in their wildest dreams. Because: what are you going to do with all this oil coming out of the ground with no place to go?
A couple of days ago, the EIA estimated that crude oil stock levels nationwide on February 20 (when they were a lot lower than today) used up 60% of the “working storage capacity,” up from 48% last year at that time. It varied by region:
Capacity is about 67% full in Cushing, Oklahoma (the delivery point for West Texas Intermediate futures contracts), compared with 50% at this point last year. Working capacity in Cushing alone is about 71 million barrels, or … about 14% of the national total.
As of September 2014, storage capacity in the US was 521 million barrels. So if weekly increases amount to an average of 6 million barrels, it would take about 13 weeks to fill the 77 million barrels of remaining capacity. Then all kinds of operational issues would arise. Along with a dizzying plunge in price.
In early 2012, when natural gas hit a decade low of $1.92 per million Btu, they predicted the same: storage would be full, and excess production would have to be flared, that is burned, because there would be no takers, and what else are you going to do with it? So its price would drop to zero.
They actually proffered that, and the media picked it up, and regular folks began shorting natural gas like crazy and got burned themselves, because it didn’t take long for the price to jump 50% and then 100%.
Oil is a different animal. The driving season will start soon. American SUVs and pickups are designed to burn fuel in prodigious quantities. People will be eager to drive them a little more, now that gas is cheaper, and they’ll get busy shortly and fix that inventory problem, at least for this year. But if production continues to rise at this rate, all bets are off for next year.
Natural gas, though it refused to go to zero, nevertheless got re-crushed, and the price remains below the cost of production at most wells. Drilling activity has dwindled. Drillers idled 12 gas rigs in the latest week. Now only 268 rigs are drilling for gas, the lowest since April 1993, and down 83.4% from its peak in 2008! This is what the natural gas fracking boom-and-bust cycle looks like:
Yet production has continued to rise. Over the last 12 months, it soared about 9%, which is why the price got re-crushed.
Producing gas at a loss year after year has consequences. For the longest time, drillers were able to paper over their losses on natural gas wells with a variety of means and go back to the big trough and feed on more money that investors were throwing at them, because money is what fracking drills into the ground.
But that trough is no longer being refilled for some companies. And they’re running out. “Restructuring” and “bankruptcy” are suddenly the operative terms.
Debt funded the fracking boom. Now oil and gas prices have collapsed, and so has the ability to service that debt. The oil bust of the 1980s took down 700 banks, including 9 of the 10 largest in Texas. But this time, it’s different. This time, bondholders are on the hook.
And these bonds – they’re called “junk bonds” for a reason – are already cracking. Busts start with small companies and proceed to larger ones. “Bankruptcy” and “restructuring” are the terms that wipe out stockholders and leave bondholders and other creditors to tussle over the scraps.
Early January, WBH Energy, a fracking outfit in Texas, kicked off the series by filing for bankruptcy protection. It listed assets and liabilities of $10 million to $50 million. Small fry.
A week later, GASFRAC filed for bankruptcy in Alberta, where it’s based, and in Texas – under Chapter 15 for cross-border bankruptcies. Not long ago, it was a highly touted IPO, whose “waterless fracking” technology would change a parched world. Instead of water, the system pumps liquid propane gel (similar to Napalm) into the ground; much of it can be recaptured, in theory.
Ironically, it went bankrupt for other reasons: operating losses, “reduced industry activity,” the inability to find a buyer that would have paid enough to bail out its creditors, and “limited access to capital markets.” The endless source of money without which fracking doesn’t work had dried up.
On February 17, Quicksilver Resources announced that it would not make a $13.6 million interest payment on its senior notes due in 2019. It invoked the possibility of filing for Chapter 11 bankruptcy to “restructure its capital structure.” Stockholders don’t have much to lose; the stock is already worthless. The question is what the creditors will get.
It has hired Houlihan Lokey Capital, Deloitte Transactions and Business Analytics, “and other advisors.” During its 30-day grace period before this turns into an outright default, it will haggle with its creditors over the “company’s options.”
On February 27, Hercules Offshore had its share-price target slashed to zero, from $4 a share, at Deutsche Bank, which finally downgraded the stock to “sell.” If you wait till Deutsche Bank tells you to sell, you’re ruined!
When I wrote about Hercules on October 15, HERO was trading at $1.47 a share, down 81% since July. Those who followed the hype to “buy the most hated stocks” that day lost another 44% by the time I wrote about it on January 16, when HERO was at $0.82 a share. Wednesday, shares closed at $0.60.
Deutsche Bank was right, if late. HERO is headed for zero (what a trip to have a stock symbol that rhymes with zero). It’s going to restructure its junk debt. Stockholders will end up holding the bag.
On Monday, due to “chronically low natural gas prices exacerbated by suddenly weaker crude oil prices,” Moody’s downgraded gas-driller Samson Resources, to Caa3, invoking “a high risk of default.”
It was the second time in three months that Moody’s downgraded the company. The tempo is picking up. Moody’s:
The company’s stressed liquidity position, delays in reaching agreements on potential asset sales and its retention of restructuring advisors increases the possibility that the company may pursue a debt restructuring that Moody’s would view as a default.
Moody’s was late to the party. On February 26, it was leaked that Samson had hired restructuring advisers Kirkland & Ellis and Blackstone’s restructuring group to figure out how to deal with its $3.75 billion in debt. A group of private equity firms, led by KKR, had acquired Samson in 2011 for $7.2 billion. Since then, Samson has lost $3 billion. KKR has written down its equity investment to 5 cents on the dollar.
This is no longer small fry.
Also on Monday, oil-and-gas exploration and production company BPZ Resources announced that it would not pay $62 million in principal and interest on convertible notes that were due on March 1. It will use its grace period of 10 days on the principal and of 30 days on the interest to figure out how to approach the rest of its existence. It invoked Chapter 11 bankruptcy as one of the options.
If it fails to make the payments within the grace period, it would also automatically be in default of its 2017 convertible bonds, which would push the default to $229 million.
BPZ tried to refinance the 2015 convertible notes in October and get some extra cash. Fracking devours prodigious amounts of cash. But there’d been no takers for the $150 million offering. Even bond fund managers, driven to sheer madness by the Fed’s policies, had lost their appetite. And its stock is worthless.
Also on Monday – it was “default Monday” or something – American Eagle Energy announced that it would not make a $9.8 million interest payment on $175 million in bonds due that day. It will use its 30-day grace period to hash out its future with its creditors. And it hired two additional advisory firms.
One thing we know already: after years in the desert, restructuring advisers are licking their chops.
The company has $13.6 million in negative working capital, only $25.9 million in cash, and its $60 million revolving credit line has been maxed out.
But here is the thing: the company sold these bonds last August! And this was supposed to be its first interest payment.
That’s what a real credit bubble looks like. In the Fed’s environment of near-zero yield on reasonable investments, bond fund managers are roving the land chasing whatever yield they can discern. And they’re holding their nose while they pick up this stuff to jam it into bond funds that other folks have in their retirement portfolio.
Not even a single interest payment!
Borrowed money fueled the fracking boom. The old money has been drilled into the ground. The new money is starting to dry up. Fracked wells, due to their horrendous decline rates, produce most of their oil and gas over the first two years. And if prices are low during that time, producers will never recuperate their investment in those wells, even if prices shoot up afterwards. And they’ll never be able to pay off the debt from the cash flow of those wells. A chilling scenario that creditors were blind to before, but are now increasingly forced to contemplate.
The Fed should reject its inclination to raise rates, according to Jeffrey Gundlach. It’s rare that he agrees with Larry Summers, but in this case the two believe that the fundamentals in the U.S. economy do not justify higher interest rates.
Gundlach, the founder and chief investment officer of Los Angeles-based Doubleline Capital, spoke to investors in a conference call on February 17. The call was focused on the release of the new DoubleLine Long Duration Fund, but Gundlach also discussed a number of developments in the economy and the bond market.
Signals of an impending rate increase have come from comments by Fed governors that the word “patient” should be dropped from the Fed meeting notes, according to Gundlach. That word has taken on special significance, he explained, since Janet Yellen attached a two-month time horizon to it.
“If they drop that word,” Gundlach said, “it would be a strong signal that rates would rise in the following two months.”
The Fed seems “philosophically” inclined to raise rates, Gundlach said, even though the fundamentals do not justify such a move. Strong disinflationary pressure coming from the collapse in oil prices should caution the Fed against raising rates, he said.
Gundlach was asked about comments by Gary Shilling that oil prices might go as low at $10/barrel. “We better all hope we don’t get $10,” he said, “because something very deflationary would be happening in this world.” If that is the case, Gundlach said investors should flock to long-term Treasury bonds.
“I’d like to think that the world is not in that kind of deflationary precipice,” he said.
Oil will break below its previous $44 low, Gundlach said. But he did not put a price target on oil.
Gundlach warned that by mid-year, if the Fed does raise rates, “the sinister side of low oil may raise its head.” At that time, lack of hiring or layoffs in the fracking industry could cripple the economy, according to Gundlach.
In the short term, Gundlach said that the recent rise in interest rates is a signal that the “huge deflationary scare” –which was partly because of Greece – has dissipated. Investors should monitor Spanish and Italian yields, he said. If they remain low, it is a signal that Greece is not leaving the Eurozone or that, if it does, “it is not a big deal.”
Current government regulations imposed by the Bureau of Land Management are harming energy production and holding back the U.S. economy, a new study reveals.
“While federally owned lands are also full of energy potential, a bureaucratic regulatory regime has mismanaged land use for decades,” write The Heritage Foundation’s Katie Tubb and Nicolas Loris.
The report focuses on the Federal Lands Freedom Act, introduced by Rep. Diane Black, R-Tenn., and Sen. James Inhofe, R-Okla. It is designed to empower states to regain control of their lands from the federal government in order to pursue their own energy goals. That is a challenge in an oil-rich state like Colorado.
“We need to streamline the process as there are very real consequences to poor [or nonexistent] management,” Tubb, a Heritage research associate, told The Daily Signal.
“Empowering the states is the best solution. The people who benefit have a say and can share in the benefits. If there are consequences, they can address them locally with state and local governments that are much more responsive to elections and budgets than the federal government.”
Emphasizing the need to streamline the process, Tubb pointed to the findings in the new report.
“The Bureau of Land Management estimates that it took an average of 227 days simply to complete a drill application,” Tubb said.
That’s more than the average of 154 days in 2005 and more than seven times the state average of 30 days, according to the report.
The report blames this increase in the application process on the drop in drilling on federal lands.
“Since 2009,” Tubb and Loris write, “oil production on federal lands has fallen by nine percent, even as production on state and private lands has increased by 61 percent over the same period.”
Despite almost “43 percent of crude oil coming from federal lands,” government-owned lands have seen a 13-point drop in oil production, from 36 percent to 23 percent.
The report also examines the recent oil-related job boom.
“Job creation in the oil and gas industry bucked the slow economic recovery and grew by 40 percent from 2007 to 2012, in comparison to one percent in the private sector over the same period,” according to the report.
That boom has had a big impact on jobs.
“Energy-abundant states like Colorado and Alaska would stand to benefit tremendously. We’ve seen oil and natural gas production increase substantially in Colorado over the past eight years, bringing jobs and economic activity to the state,” said Loris, an economist who is Heritage’s Herbert and Joyce Morgan fellow.
Tubb cautioned that any change will happen slowly. “The federal government likely will not release the land that easily.”
Loris agreed, noting the long-running debate about the Arctic National Wildlife Refuge.
“It was no surprise that the Alaskan delegation was up in arms when the administration proposed to permanently put ANWR off limits to energy exploration,” Loris told The Daily Signal. “Many in the Alaskan delegation and Alaskan natives, including village of Kaktovik—the only town in the coastal plain of ANWR, support energy development.”
“We are putting power to the people,” Tubb concluded.
OPEC is supposedly out to beat, or at least curtail the growth of American shale oil production.
For a host of reasons, especially the much shorter capex cycle for shale, they will not succeed unless they are willing to accept permanent low oil prices.
But, permanent low oil prices will do too much damage to OPEC economies for this to be a credible threat.
We’re sure by now you are familiar with the main narrative behind the oil price crash. First, while oil production outside of North America is basically stagnant since 2005.
The shale revolution has dramatically increased supply in America.
(click to enlarge)
The resulting oversupply has threatened OPEC and the de-facto leader Saudi Arabia has chosen a confrontational strategy not to make way for the new kid on the block, but instead trying to crush, or at least contain it. Can they achieve this aim, provided it indeed is their aim?
Breakeven price At first, one is inclined to say yes, for the simple reason that Saudi (and most OPEC) oil is significantly cheaper to get out of the ground.
(click to enlarge)
This suggests that all OPEC has to do is to keep output high and sooner or later the oversupply will work itself off the market, and expensive oil is more likely to see cutbacks than cheaper oil, although this critically depends on incentives facing individual producers.
Capex decline It is therefore no wonder that we’ve seen significant declines in rig counts and numerous companies have announced considerable capex declines. While this needs time to work out into supply cutbacks, these will eventually come.
For instance BP (NYSE:BP) cutting capex from $22.9B in 2014 to $20B in 2015, or Conoco (NYSE:COP) reducing expenditures by more than 30% to $11.5B this year on drilling projects from Colorado to Indonesia. There are even companies, like SandRidge (NYSE:SD), that are shutting 75% of their rigs.
Leverage It is often argued that the significant leverage of many American shale companies could accelerate the decline, although it doesn’t necessarily have to be like that.
While many leveraged companies will make sharp cutbacks in spending, which has a relatively rapid effect on production (see below), others have strong incentives to generate as much income as possible, so they might keep producing.
Even the companies that go belly up under a weight of leverage will be forced to relinquish their licenses or sell them off at pennies to the dollar, significantly lowering the fixed cost for new producers to take their place.
Hedging Many shale companies have actually hedged much of their production, so they are shielded from much of the downside (at a cost) at least for some time. And they keep doing this:
Rather than wait for their price insurance to run out, many companies are racing to revamp their policies, cashing in well-placed hedges to increase the number of future barrels hedged, according to industry consultants, bankers and analysts familiar with the deals. [Reuters]
Economics Being expensive is not necessarily a sufficient reason for being first in line for production cuts. For instance, we know that oil from the Canadian tar sands is at the high end of cost, but simple economics can explain why production cuts are unlikely for quite some time to come.
The tar sands involve a much higher fraction as fixed cost:
Oil-sands projects are multibillion-dollar investments made upfront to allow many years of output, unlike competing U.S. shale wells that require constant injections of capital. It’s future expansion that’s at risk. “Once you start a project it’s like a freight train: you can’t stop it,” said Laura Lau, a Toronto-based portfolio manager at Brompton Funds. Current oil prices will have producers considering “whether they want to sanction a new one.” [Worldoil]
So, once these up-front costs are made, these are basically sunk, and production will only decline if price falls below marginal cost. As long as the oil price stays above that, companies can still recoup part of their fixed (sunk) cost and they have no incentive to cut back production.
But, of course, you have tar sand companies that have not yet invested all required up-front capital and new capex expenditures will be discouraged with low oil prices. So, there is still the usual economic upward sloping supply curve operative here.
Swing producer The funny thing is American shale oil is at the opposite end of this fixed (and sunk) cost universe, apart from acquiring the licenses. As wells have steep decline curves, production needs constant injection of capital for developing new wells.
Production can therefore be wound down pretty quickly should the economics require, and it can also be wound back up relatively quickly, which we think is enough reason why American shale is becoming the new (passive) swing producer. This has very important implications:
The relevant oil price to look at isn’t necessarily the spot price, but the 12-24 months future price, the time frame between capex and production.
OPEC will not only need to produce a low oil price today, that price needs to be low for a prolonged period of time in order to see cutbacks in production of American shale oil. Basically, OPEC needs the present oil price to continue indefinitely, as soon as it allows the price to rise again, shale oil capex will rebound and production will increase fairly soon afterwards.
So basically, shale is the proverbial toy duck which OPEC needs to submerge in the bathtub, but as soon as it releases the pressure, the duck will emerge again.
Declining cost curves The shale revolution caught many by surprise, especially the speed of the increase in production. While technology and learning curves are still improving, witness how production cost curves have been pushed out in the last years:
There is little reason this advancement will come to a sudden halt, even if capex is winding down. In fact, some observers are arguing that producers shift production from marginal fields to fields with better production economics, and the relatively steep production decline curves allow them to make this shift pretty rapidly.
Others point out that even the rapid decline in rig count will not have an immediate impact on production, as the proportion of horizontal wells and platforms where multiple wells are drilled from the same location are increasing, all of which is increasing output per rig.
Another shift that is going on is to re-frack existing wells, instead of new wells. The first is significantly cheaper:
Beset by falling prices, the oil industry is looking at about 50,000 existing wells in the U.S. that may be candidates for a second wave of fracking, using techniques that didn’t exist when they were first drilled. New wells can cost as much as $8 million, while re-fracking costs about $2 million, significant savings when the price of crude is hovering close to $50 a barrel, according to Halliburton Co., the world’s biggest provider of hydraulic fracturing services. [Bloomberg]
Production cuts will take time The hedging and shift to fields with better economics is only a few of the reasons why so far there has been little in the way of actual production cuts in American shale production, the overall oil market still remains close to record oversupply. The International Energy Agency (IEA) argues:
It is not unusual in a market correction for such a gap to emerge between market expectations and current trends. Such is the cyclical nature of the oil market that the full physical impact of demand and supply responses can take months, if not years, to be felt [CNBC].
In fact, the IEA also has explicit expectations for American shale oil itself:
The United States will remain the world’s top source of oil supply growth up to 2020, even after the recent collapse in prices, the International Energy Agency said, defying expectations of a more dramatic slowdown in shale growth [Yahoo].
OPEC vulnerable itself Basically, the picture we’re painting above is that American shale will be remarkably resilient. Yes, individual companies will struggle, sharp cutbacks in capex are already underway, and some companies will go under, but the basic fact is that as quick as capex and production can fall, they can rise as quickly again when the oil price recovers.
How much of OPEC can the storm of the oil price crash, very much remains to be seen. There is pain all around, which isn’t surprising as one considers that most OPEC countries have budgeted for much higher oil prices for their public finances.
(click to enlarge) You’ll notice that these prices are all significantly, sometimes dramatically, higher than what’s needed to balance their budgets. Now, many of these countries also have very generous energy subsidies on domestic oil use, supposedly to share the benefits of their resource wealth (and/or provide industry with a cost advantage).
So, there is a buffer as these subsidies can be wound down relatively painless. Some of these countries also have other buffers, like sovereign wealth funds or foreign currency reserves. And there is often no immediate reason for public budgets to be balanced.
But to suggest, as this article is doing, that OPEC is winning the war is short-sighted.
Conclusion While doing damage to individual American shale oil producers and limiting its expansion, the simple reality is that for a host of reasons discussed above, OPEC can’t beat American shale oil production unless it is willing to accept $40 oil indefinitely. While some OPEC countries might still produce profitably at these levels, the damage to all OPEC economies will be immense, so, we can’t really see this as a realistic scenario in any way.
February 4th, 2015: Crude oil had rallied 20% in three days, with West Texas Intermediate jumping $9 a barrel since Friday morning, from $44.51 a barrel to $53.56 at its peak on Tuesday. “Bull market” was what we read Tuesday night. The trigger had been the Baker Hughes report of active rigs drilling for oil in the US, which had plummeted by the most ever during the latest week. It caused a bout of short covering that accelerated the gains. It was a truly phenomenal rally!
But the weekly rig count hasn’t dropped nearly enough to make a dent into production. It’s down 24% from its peak in October. During the last oil bust, it had dropped 60%. It’s way too soon to tell what impact it will have because for now, production of oil is still rising.
And that phenomenal three-day 20% rally imploded today when it came in contact with another reality: rising production, slack demand, and soaring crude oil inventories in the US.
The Energy Information Administration reported that these inventories (excluding the Strategic Petroleum Reserve) rose by another 6.3 million barrels last week to 413.1 million barrels – the highest level in the weekly data going back to 1982. Note the increasingly scary upward trajectory that is making a mockery of the 5-year range and seasonal fluctuations:
And there is still no respite in sight.
Oil production in the US is still increasing and now runs at a multi-decade high of 9.2 million barrels a day. But demand for petroleum products, such as gasoline, dropped last week, according to the EIA, and so gasoline inventories jumped by 2.3 million barrels. Disappointed analysts, who’d hoped for a drop of 300,000 barrels, blamed the winter weather in the East that had kept people from driving (though in California, the weather has been gorgeous). And inventories of distillate, such as heating oil and diesel, rose by 1.8 million barrels. Analysts had hoped for a drop of 2.2 million barrels.
In response to this ugly data, WTI plunged $4.50 per barrel, or 8.5%, to $48.54 as I’m writing this. It gave up half of the phenomenal three-day rally in a single day.
In our experience, oil markets rarely exhibit V-shaped recoveries and we would be surprised if an oversupply situation as severe as the current one was resolved this soon. In fact, our balances indicate the absolute oversupply is set to become more severe heading into 2Q15.
Those hoping for a quick end to the oil glut in the US, and elsewhere in the world, may be disappointed because there is another principle at work – and that principle has already kicked in.
As the price has crashed, oil companies aren’t going to just exit the industry. Producing oil is what they do, and they’re not going to switch to selling diapers online. They’re going to continue to produce oil, and in order to survive in this brutal pricing environment, they have to adjust in a myriad ways.
“Efficiency and innovation, when price falls, it accelerates, because necessity is the mother of invention,” Michael Masters, CEO of Masters Capital Management, explained to FT Alphaville on Monday, in the middle of the three-day rally. “Even if the investment only spits out quarters, or even nickels, you don’t turn it off.”
Crude has been overvalued for over five years, he said. “Whenever the return on capital is in the high double digits, that’s not sustainable in nature.” And the industry has gotten fat during those years.
Now, the fat is getting trimmed off. To survive, companies are cutting operating costs and capital expenditures, and they’re shifting the remaining funds to the most productive plays, and they’re pushing 20% or even 30% price concessions on their suppliers, and the damage spreads in all directions, but they’ll keep producing oil, maybe more of it than before, but more efficiently.
This is where American firms excel: using ingenuity to survive. The exploration and production sector has been through this before. And those whose debts overwhelm them – and there will be a slew of them – will default and restructure, wiping out stockholders and perhaps junior debt holders, and those who hold the senior debt will own the company, minus much of the debt. The groundwork is already being done, as private equity firms and hedge funds offer credit to teetering oil companies at exorbitant rates, with an eye on the assets in case of default.
And these restructured companies will continue to produce oil, even if the price drops further.
So Masters said that, “in our view, production will not decrease but increase,” and that increased production “will be around a lot longer than people are forecasting right now.”
After the industry goes through its adjustment process, focused on running highly efficient operations, it can still scrape by with oil at $45 a barrel, he estimated, which would keep production flowing and the glut intact. And the market has to appreciate that possibility.
Rigs Down By 21% Since Start Of 2015 Permian Basin loses 37 rigs first week in February
The number of rigs exploring for oil and natural gas in the Permian Basin fell 37 this week to 417, according to the weekly rotary rig count released Friday by Houston-based oilfield service company Baker Hughes.
This week’s count marked the ninth-consecutive decrease for the Permian Basin. The last time Baker Hughes reported a positive rig-count change was Dec. 5, when 568 rigs were reported. Since then, the Permian Basin has shed 151 rigs, a decrease of 26.58 percent.
For the year, the Permian Basin has shed 113 rigs, or 21.32 percent.
In District 8, which includes Midland and Ector counties, the rig count fell 19 this week to 256. District 8 has shed 58 rigs, 18.47 percent, this year.
Texas lost 41 rigs this week for a statewide total of 654. The Lone Star State has 186 fewer rigs since the beginning of the year, a decrease of 22.14 percent.
In other major Texas basins, there were 168 rigs in the Eagle Ford, down 10; 43 in the Haynesville, unchanged; 39 in the Granite Wash, down one; and 19 in the Barnett, unchanged.
The Haynesville shale is the only major play in Texas to have added rigs this year. The East Texas play started 2015 with 40 rigs.
At this time last year, there were 483 rigs in the Permian Basin and 845 in Texas.
In the U.S., there were 1,456 rigs this week, a decrease of 87. There were 1,140 oil rigs, down 83; 314 natural gas rigs, down five; and two rigs listed as miscellaneous, up one.
By trajectory, there were 233 vertical drilling rigs, down two; 1,088 horizontal drilling rigs, down 80; and 135 directional drilling rigs, down five.
The top five states by rig count this week were Texas; Oklahoma with 176, down seven; North Dakota with 132, down 11; Louisiana with 107, down one; and New Mexico with 78, down nine.
The top five basins were the Permian; the Eagle Ford; the Williston with 137, down 11; the Marcellus with 71, down four; and the Mississippian with 53, down one.
In the U.S., there were 1,397 rigs on land, down 85; nine in inland waters, down three; and 50 offshore, up one. There were 48 rigs in the Gulf of Mexico, up one.
Canada’s rig count fell 13 this week to 381. There were 184 oil rigs, down 16; 197 natural gas rigs, up three; and zero rigs listed as miscellaneous, unchanged. Canada had 621 rigs a year ago this week, a difference of 240 rigs compared to this week’s count.
The number of rigs exploring for oil and natural gas in the North America region, which includes the U.S. and Canada, fell 100 this week to 1,837. There were 2,392 rigs in North America last year.
Rigs worldwide
On Friday, Baker Hughes released its monthly international rig count for January. The worldwide total was 3,309 rigs. The U.S. ended January with 1,683 rigs, just more than half of all rigs worldwide.
The following are January’s rig counts by region, with the top three nations in each region in parentheses:
The oil boom that lifted home prices in Texas, Oklahoma and Louisiana is coming to an end.
Crude oil prices have crashed since June, falling by more than 54 percent to less than $50 a barrel. That swift drop has started to cripple job growth in oil country, creating a slow wave that in the years ahead may devastate what has been a thriving real estate market, according to new analysis by the real estate firm Trulia.
“Oil prices won’t tank home prices immediately,” Trulia chief economist Jed Kolko explained. “Rather, falling oil prices in the second half of 2014 might not have their biggest impact on home prices until late 2015 or in 2016.”
History shows it takes time for home prices in oil country to change course.
Kolko looked at the 100 largest housing markets where the oil industry accounted for at least 2 percent of all jobs. Asking prices in those cities rose 10.5 percent over the past year, compared with an average of 7.7 percent around the country.
Prices climbed 13.4 percent in Houston, where 5.6 percent of all jobs are in oil-related industries. The city is headquarters to energy heavyweights such as Phillips 66, Halliburton and Marathon Oil. Asking prices surged 10.2 percent in Fort Worth and 10.1 percent in Tulsa, Oklahoma. In some smaller markets, oil is overwhelmingly dominant — responsible for more than 30 percent of the jobs in Midland for instance.
The closest parallel to the Texas housing market might have occurred in the mid-1980s, when CBS was airing the prime-time soap opera “Dallas” about a family of oil tycoons.
In the first half of 1986, oil prices plunged more than 50 percent, to about $12 a barrel, according to a report by the Brookings Institution, a Washington-based think tank.
Job losses mounted in late 1986 around Houston. The loss of salaries eventually caused home prices to fall in the second half of 1987.
That led Kolko to conclude that since 1980, it takes roughly two years for changes in oil prices to hit home prices.
Of course, there is positive news for people living outside oil country, Kolko notes.
Falling oil prices lead to cheaper gasoline costs that reduce family expenses, freeing up more cash to spend.
“In the Northeast and Midwest especially, home prices tend to rise after oil prices fall,” he writes in the analysis.
Oilfield worker on a rig Active pumping rig located on Highway 385 south of Odessa, photographed Tuesday, Sept. 24, 2014. James Durbin/Reporter-Telegram. Source: MRT.com
MIDLAND — With oil prices plummeting by more than 50 percent since June, the gleeful mood of recent years has turned glum here in West Texas as the frenzy of shale oil drilling has come to a screeching halt.
Every day, oil companies are decommissioning rigs and announcing layoffs. Small firms that lease equipment have fallen behind in their payments.
In response, businesses and workers are getting ready for the worst. A Mexican restaurant has started a Sunday brunch to expand its revenues beyond dinner. A Mercedes dealer, anticipating reduced demand, is prepared to emphasize repairs and sales of used cars. And people are cutting back at home, rethinking their vacation plans and cutting the hours of their housemaids and gardeners.
Dexter Allred, the general manager of a local oil field service company, began farming alfalfa hay on the side some years ago in the event that oil prices declined and work dried up. He was taking a cue from his grandfather, Homer Alf Swinson, an oil field mechanic, who opened a coin-operated carwash in 1968 — just in case.
“We all have backup plans,” Allfred said with a laugh. “You can be sure oil will go up and down, the only question is when.”
Indeed, to residents here in the heart of the oil patch, booms and busts go with the territory.
“This is Midland and it’s just a way of life,” said David Cristiani, owner of a downtown jewelry store, who keeps a graph charting oil prices since the late 1990s on his desk to remind him that the good times do not last forever. “We are always prepared for slowdowns. We just hunker down. They wrote off the Permian Basin in 1984, but the oil will always be here.”
It is at times like these that Midland residents recall the wild swings of the 1980s, a decade that began with parties where people drank Dom Pérignon out of their cowboy boots. Rolls-Royce opened a dealership, and the local airport had trouble finding space to park all the private jets.
By the end of the decade, the Rolls-Royce dealership was shut and replaced by a tortilla factory, and three banks had failed.
There has been nothing like that kind of excess over the past five years, despite the frenzy of drilling across the Permian Basin, the granddaddy of U.S. oil fields. Set in a forsaken desert where tumbleweed drifts through long-forgotten towns, the region has undergone a renaissance in the last four years, with horizontal drilling and fracking reaching through multiple layers of shale stacked one over the other like a birthday cake.
But since the Permian Basin rig count peaked at around 570 last September, it has fallen to below 490, and local oil executives say the count will probably go down to as low as 300 by April unless prices rebound.
The last time the rig count declined as rapidly was in late 2008 and early 2009, when the price of oil fell from more than $140 to under $40 a barrel because of the financial crisis.
Unlike traditional oil wells, which cannot be turned on and off so easily, shale production can be cut back quickly, and so the field’s output should slow considerably by the end of the year.
The Dallas Federal Reserve recently estimated that the falling oil prices and other factors will reduce job growth in Texas overall from 3.6 percent in 2014 to as low as 2 percent this year, or a reduction of about 149,000 jobs created.
Midland’s recent good fortune is plain to see. The city has grown in population from 108,000 in 2010 to 140,000 today, and there has been an explosion of hotel and apartment construction. Companies like Chevron and Occidental are building new local headquarters. Real estate values have roughly doubled during the past five years, according to Mayor Jerry Morales.
The city has built a new fire station and recruited new police officers with the infusion of new tax receipts, which increased by 19 percent from 2013 to 2014 alone. A new $14 million court building is scheduled to break ground next month.
But the city has also put away $39 million in a rainy-day fund for the inevitable oil bust.
“This is just a cooling-off period,” Morales said. “We will prevail again.”
Expensive restaurants are still full and traffic around the city can be brutal. Still, everyone seems to sense that the pain is coming, and they are preparing for it.
“We are responding to survive, so that we may once again thrive when we come out the other side,” said Steven H. Pruett, president and chief executive of Elevation Resources, a Midland-based oil exploration and production company. “Six months ago there was a swagger in Midland and now that swagger is gone.”
Pruett’s company had six rigs running in early December but now has only three. It will go down to one by the end of the month, even though he must continue to pay a service company for two of the rigs because of a long-term contract.
The other day Pruett drove to a rig outside of Odessa he feels compelled to park to save cash, and he expressed concern that as many as 50 service workers could eventually lose their jobs.
But the workers themselves seemed stoic about their fortunes, if not upbeat.
“It’s always in the back of your mind — being laid off and not having the security of a regular job,” said Randy Perry, a tool-pusher who makes $115,000 a year, plus bonuses, managing the rig crews. But Perry said he always has a backup plan because layoffs are so common — even inevitable.
Since graduating from high school a decade ago, he has bought several houses in East Texas and fixed them up, doing the plumbing and electrical work himself. At age 29 with a wife and three children, he currently has three houses, and if he is let go, he says he could sell one for a profit he estimates at $50,000 to $100,000.
Just a few weeks ago, he and other employees received a note from Trent Latshaw, the head of his company, Latshaw Drilling, saying that layoffs may be necessary this year.
“The people of the older generation tell the young guys to save and invest the money you make and have cash flow just in case,” Perry said during a work break. “I feel like everything is going to be OK. This is not going to last forever.”
The most nervous people in Midland seem to be the oil executives who say busts may be inevitable, but how long they last is anybody’s guess.
Over a lavish buffet lunch recently at the Petroleum Club of Midland, the talk was woeful and full of conspiracy theories about how the Saudis were refusing to cut supplies to vanquish the surging U.S. oil industry.
“At $45 a barrel, it shuts down nearly every project,” Steve J. McCoy, Latshaw Drilling’s director of business development, told Pruett and his guests. “The Saudis understand and they are killing us.”
Pruett nodded in agreement, adding, “They are trash-talking the price of oil down.”
“Everyone has been saying ‘Happy New Year,’” Pruett continued. “Yeah, some happy new year.”
NEW YORK (Reuters) – DoubleLine Capital’s Jeffrey Gundlach said on Tuesday there is a possibility of a “true collapse” in U.S. capital expenditures and hiring if the price of oil stays at its current level.
Gundlach, who correctly predicted government bond yields would plunge in 2014, said on his annual outlook webcast that 35 percent of Standard & Poor’s capital expenditures comes from the energy sector and if oil remains around the $45-plus level or drops further, growth in capital expenditures could likely “fall to zero.”
Gundlach, the co-founder of Los Angeles-based DoubleLine, which oversees $64 billion in assets, noted that “all of the job growth in the (economic) recovery can be attributed to the shale renaissance.” He added that if low oil prices remain, the U.S. could see a wave of bankruptcies from some leveraged energy companies.
Brent crude approached a near six-year low on Tuesday as the United Arab Emirates defended OPEC’s decision not to cut output and traders wondered when a six-month price rout might end.
Brent has fallen as low as just above $45 a barrel, near a six-year low, having averaged $110 between 2011 and 2013.
Gundlach said oil prices have to stop going down so “don’t be bottom-fishing in oil” stocks and bonds. “There is no hurry here.”
Energy bonds, for example, have been beaten up and appear attractive on a risk-reward basis, but investors need to hedge them by purchasing “a lot, lot of long-term Treasuries. I’m in no hurry to do it.”
High-yield junk bonds have also been under severe selling pressure. Gundlach said his firm bought some junk in November but warned that investors need to “go slow” and pointed out “we are still underweight.”
Gundlach said U.S. stocks could outperform other countries’ equities as the economic recovery looks stronger than its counterparts, though double-digit gains cannot be repeated.
He also reiterated that it’s possible yields on the benchmark 10-year Treasury note could drop to 1 percent in 2015. The 10-year yield traded around 1.91 percent on Tuesday, little changed from late on Monday after hitting 20-month low of 1.8640 percent.
“The 10-year Treasury could join the Europeans and go to 1 percent. Why not?” Gundlach told Reuters last month. “If oil goes to $40, then the 10-year could be going to 1 percent.”
The yield on 10-year German Bunds stood at 0.47 percent on Tuesday.
This is the title of the latest webcast from DoubleLine Capital’s Jeffrey Gundlach, who just wrapped up a webcast giving his outlook for 2015.
We last heard from Gundlach in December when he held a presentation called “This Time It’s Different,” in which he talked about the oil markets, the dollar, and how the 10-year Treasury bond could get to 1%.
Among the things Gundlach believes 2015 has in store for the market is more volatility, lower Treasury yields, and a Federal Reserve rate hike, “just to see if they can do it.”
Gundlach spent a good chunk of his open talking about the effects that the decline in oil will have on jobs growth and capital investment in the US, noting that 35% of capital investment from the S&P 500 is related to the energy sector.
The bull case for the US in 2015, Gundlach said, is predicated primarily on the strength of the US labor market. Meanwhile the chart of the year so far is the US 10-year yield against other major economies, with the US clearly having space to converge towards the super-low yields seen on 10-year bonds in Japan, Germany, and Switzerland.
We’ve broken out a number of Gundlach’s slides below and added commentary taken as he spoke live on Tuesday.
Gundlach says of the title that it stands for the fifth year that he’s being these webcasts, but also has a market theme. “Most risk markets have gone into a V since about June.”
Says that the “touchdown” part of the drop in oil is that consumers get more money in their pocket. “I think that’s one of the reasons, rightly, that people view the oil decline as somewhat positive.”
Gundlach says that there is a sinister side to the oil decline, which is potential impacts on employment in the US, particularly in the energy space.
Gundlach says “all of the job growth” from the recession until today can be attributed to the shale oil boom.
“It wasn’t the US of A in 2014, but the US of Only.”
US stocks were the only really strong equity markets among major developed economies. Chinese and Indian stocks were big winners among emerging markets.
Gundlach says he’s been positive on the US dollar since 2011. This was a huge consensus trade in 2014, and Gundlach says sometimes the consensus is right.
“It looks to me like the dollar is headed higher.”
Gundlach says he knows long dollar is a crowded trade, but the fundamentals bolstering a strong dollar remain in tact.
Additionally, Gundlach thinks the Fed will raise rates with a few more months of strong payrolls gains, which will only make the dollar stronger.
Oil prices have been correlated with GDP growth 18 months forward.
And so this chart implies 3+% global growth going forward.
“On balance this should be viewed as an encouraging indicator.”
Gundlach doesn’t think, however that global growth is going to be upgraded in 2015, and like the last several years will be downgraded as the year goes along.
Gundlach says US outperformance “isn’t really a great sign.” But says US is probably the preferred place to invest against the rest of the world, however.
“It’s almost impossible for the gains from June 2014 to now to be repeated this year.”
“I’ll bet you dollars to donuts the red line goes down.”
Gundlach says that oil just can’t stop going down. Last year, Treasury yields couldn’t stop going down, and this year oil can’t seem to stop going down.
Adds that contrarianism is dagnerous in commodities and stocks, says that contrarian investing is tempting, but oil is just a dangerous trade right now.
Gundlach says that once oil broke $70, it would create acceptance that oil isn’t going back to $95, causing producers to increase production because they need the revenue, not cut production to boost prices.
Gundlach says the bond chart of the year is part of the argument about why oil at $40, weighing on inflation, could bring the 10-year below its 2012 lows.
Gundlach says that with online sales at 9% of retail sales coming online, it seems low. But consider that you can’t buy gasoline online, you don’t really buy groceries online.
“I think of all the car companies, Tesla is less of a car company than any other.”
“I’m surprised that anyone would change their car buying habits based on the six-month price of oil. Tesla isn’t so much a play on cars being sold, but on batteries being transformative in many phases of life.”
Gundlach again talking about potential for Tesla’s batteries to get homes entirely off the grid.
“Tesla has as good a chance as anybody to develop a battery that can change the world.”
Says that the stock is hugely overvalued if you just look at the auto sales.
For the second straight month, Midland showed the nation’s largest over-the-year percentage gain in employment, according to figures released last week by the Bureau of Labor Statistics.
Midland reported a 6.2 percent increase in employment during the month of November. The number of employed increased from 95,200 to 96,000. Odessa (a drilling town next door to Midland) was second in the nation with a growth rate of 4.7 percent.
Midland also bettered its position among the metropolitan statistical areas with the lowest unemployment rates. In October, Midland was tied for fifth with a 2.5 percent jobless rate. In November, with the rate dropping to 2.3 percent, Midland was ranked fourth. Lincoln, Nebraska, took home the top spot with a 2.1 percent rate. Makato, Minnesota, and Fargo, North Dakota, tied for second at 2.2 percent.
There were 14 MSAs with unemployment rates at or below 3 percent during the month of November, including Odessa at 2.8 percent. There were 34 MSAs at 3.5 percent or below.
The following are the lowest unemployment rates in the nation during the month of November, according to the Bureau of Labor Statistics:
Lincoln, Nebraska, 2.1
Mankato, Minnesota, 2.2
Fargo, North Dakota, 2.2
Midland 2.3
Bismarck, North Dakota, 2.5
Ames, Iowa, 2.5
Logan, Utah, 2.5
Iowa City, Iowa, 2.6
Rochester, Minnesota, 2.6
Grand Forks, North Dakota, 2.7
Sioux Falls, South Dakota, 2.7
Odessa 2.8
Minneapolis, St. Paul, 3.0
Omaha, Nebraska, 3.0
Lowest rates from October:
Bismarck, North Dakota, 2.0; Fargo, North Dakota, 2.2; Lincoln, Nebraska, 2.3. Also: Midland 2.5
Lowest rates from September:
Bismarck, North Dakota 2.1; Fargo, North Dakota 2.3; Midland 2.6
Lowest rates from August:
Bismarck, North Dakota 2.2, Fargo North Dakota 2.4; Midland 2.8.
Lowest rates from July:
Bismarck, North Dakota, 2.4; Sioux Falls, South Dakota, 2.7; Fargo, North Dakota, 2.8; Midland 2.9.
Lowest rates from June:
Bismarck, North Dakota, 2.6, Midland 2.9, Fargo, North Dakota, 3.0.
Lowest rates from May:
Bismarck, North Dakota, 2.2, Fargo, North Dakota, 2.5, Logan, Utah, 2.5, Midland 2.6.
Oil consumption remains strong and is likely to increase thanks to cheaper prices.
Historically oil rebounds quite quickly, especially when the U.S. and global economy are growing.
Investors are overly negative on oil ever since the OPEC meeting, but production cuts could still be on the way.
Ever since the November 27th OPEC meeting the price of oil has plunged by about 20% and many stocks are off by much, much more. The doomsayers and shorts are out in force now, emboldened by the weakness in this sector. There is a tremendous amount of negative sentiment towards oil now. But this extreme level of negativity appears to be very overdone. It also seems to be based on psychology, forced margin call selling, panic selling and tax-loss selling. With all these factors, it’s been a perfect storm that has brought some small-cap oil stocks back to levels not seen since the depths of the financial crisis. Back in 2009, oil plunged to the $40 range, but the U.S. and the global economy were in free fall and oil consumption was also falling. The factors that drove oil to collapse in 2009 like bank failures, financial system imploding, home prices collapsing, massive layoffs, and other negatives that just do not exist today. That is why it does not make sense to be expecting oil to plunge back towards the lows seen in 2009. Furthermore, it is really important to realize that even when oil plunged in 2009, it rebounded very, very quickly (in spite of all the doomsayers back then). That is another big factor to consider because since the global economy is significantly stronger now, it could rebound sooner than most investors realize. Here are a few more reasons why this is a buying opportunity as oil is not likely to go down much more and why it is not likely to stay down for very long:
Reason #1: Energy company insiders are calling the recent plunge in stocks a “fire sale” and they are buying at a pace that has not been seen in years. Oil industry insiders have seen the ups and downs in oil prices and have experienced market pullbacks before. If oil company insiders are buying en masse now, there is a good chance that they see bargains and a strong future for oil. This supports the idea that there is a disconnect between the current market price of many oil stocks and the longer-term fundamentals of this industry. Citigroup (NYSE:C) recently made a strong case that indicates there is a disconnect between asset prices in the oil industry and the fundamentals. A Bloomberg article details some of the recent insider activity, it states:
“This is an absolute fire sale,” he said. “It’s an overreaction and the result is it’s oversold.” With valuations at a decade low, oil executives such as Rochford and Chesapeake Energy Corp.’s (NYSE:CHK) Archie Dunham are driving the biggest wave of insider buying since 2012, data compiled by the Washington Service and Bloomberg show. They’re snapping up stocks after more than $300 billion was erased from share values as crude slipped below $70 for the first time since 2010.”
Reason #2: Just because OPEC did not act at the November 27th meeting, it does not mean they won’t act. OPEC is scheduled to meet again in 2015, but there is always the possibility for an emergency meeting at any time. Even a statement from OPEC discussing the willingness to cut production or to address “cheating” by some members who are producing more than their quota allows could cause a significant short-covering rebound in the oil sector. A CNBC article points out that some industry watchers believe OPEC could act soon with an extraordinary or “emergency” meeting, it states:
“We see the possibility they call an extraordinary meeting sometime next year,” said Dominic Haywood, crude and products analyst with Energy Aspects. “We think they’re going to address countries not living within their quota.” OPEC has a quota of 30 million barrels a day, but it has been producing more.
On December 2, a Saudi Prince stated that his country would cut production if other countries would also participate. This seems the first “olive branch” since the OPEC meeting and it appears to be in response to the slide in oil since that meeting took place.
Reason #3: The perceived “glut” of oil is much smaller than most people realize. Furthermore, that excess supply could be taken out rather rapidly because cheaper oil is likely to lead to more demand and consumption. Toyota (NYSE:TM) just reported that sales of its 4Runner sport utility vehicle just jumped by 53% in November and sales of the Prius fell by 14% in the same period. This is just one example of how quickly demand for oil can rise and if you multiply even slight increases in global oil consumption because of much lower prices the numbers get quite large. Urban Carmel (a former McKinsey consultant and President of UBS Securities in Asia) believes that oil is going back to $80 per barrel and a recent article he wrote explains why the perceived glut is not going to last long, he states:
“Excess oil supply (over demand) is presently about 1 mbd. That would be a problem for oil prices except for one thing: existing fields lose about 6% of their production capacity each year, equal to about 5.5 mbd. That means that even if demand is flat, at least 4.5 mbd in new production is needed. Opec has spare capacity of only about 3 mbd. The remainder must come from new investment. New deep water and oil sand projects have a breakeven cost of about $80-90. There will be little incentive to make these investments unless the price of oil is at least $80. If the price stays lower than $80, supply will be insufficient for demand. It’s exactly under those circumstances that spikes higher in oil prices have occurred in the past.”
Reason #4: Oil can be very volatile, but it historically rebounds very quickly because it is used in very large quantities every day. The chart below shows that oil has reached a level that is giving investors a buy signal. Also, it is worth noting that prior oil price slides typically lasted about 20 weeks and the current slide is on week 25 which is another sign a rebound is way overdue. Oil and most oil stocks are extremely oversold now and that means a powerful relief and short covering rally could be coming soon. Some “smart money” investors are recognizing the buying opportunity at hand. Hedge funds are starting to position for a rebound in oil as there is a growing belief that the oil slide has run its course and is now due for a rally.
Oil is already down by about 40%, and the global economy is not in a current state that would support drastically lower prices as some are predicting. It is worth noting that most analysts and economists have a terrible track record when it comes to forecasting oil prices. If you had told anyone that oil was going to surge to over $100 within a couple years of the financial crisis you would have been ridiculed. I believe that the inaction at the OPEC meeting triggered margin call selling, and as we know, selling begets selling especially at this time of year when tax-loss selling fuels even more downside pressure. Some investors are making too much of the oil price decline by trying to connect the dots which should not be connected. I don’t believe that oil’s decline is a major sign of global economic weakness, I believe it is partially because supplies are temporarily a bit higher than needed, the dollar has been strong, and because too many speculators held futures contracts that were suddenly liquidated after the OPEC meeting sparked a sell-off. This has created bargains, especially in small-cap oil stocks. I have been primarily focusing my buying on companies that have no direct exposure to the price of oil and significant contract backlogs. This has led me to buy stocks like McDermott International (NYSE:MDR) which is now incredibly cheap at less than $3 per share. This company is an engineering and construction firm that specializes in the energy industry. It has a $4 billion contract backlog and it has about $900 million in cash and (incredibly) a market cap of just $584 million. That means that this company could buy all the outstanding shares and still have over $300 million left in cash on the balance sheet. McDermott shares are also trading for less than half of the stated book value which is $6.30 per share. On November 14, David Trice (a director) bought 20,000 shares at $4.16, which was about $83,000 worth of stock. But, due to immensely negative sentiment in the oil sector, panic selling, margin call selling, and tax-loss selling, this stock is down by about 40% just from when this insider bought, even though this company has no direct exposure to oil prices and enough business (with the $4 billion+ contract backlog) to keep it busy for the next two years. It also does projects for the natural gas industry and investors seem to have overlooked that natural gas prices have remained solid.
I also see opportunity in Willbros Group (NYSE:WG) which trades for just over $4 now (down from a high of about $13 this year). It specializes in pipeline projects for the energy industry which includes oil and gas, petrochemicals, refining as well as electric power. This stock took a hit several weeks ago when the company announced it would restate earnings due to a charge on a pipeline project that was estimated to reverse about $8 million in previously reported pre-tax income. This caused the company to be delayed in filing the latest financial report and the market overreacted by knocking off about $160 million in market cap in just a few days after the restatement issue was announced. Willbros Group has a strong balance sheet and a $1.7 billion backlog which absolutely dwarfs the restatement numbers and the market cap of just about $215 million. It also recently announced plans for an asset sale that is estimated to generate up to $125 million. For more details, read my recent article on Willbros Group.
I expect that small cap stocks like McDermott and Willbros will rebound as tax-loss selling should fade by December 19th which is the Friday before the holiday season. This causes most traders and investors to have completed their tax planning issues before taking off for the holidays and that often leads to a significant “Santa Claus” and “January Effect” rally in beaten-down small caps.
Keep An Eye On Futures
Oil Futures Structure Seen as Encouraging Traders to Store Crude.
Brent oil in a contango will encourage traders to take delivery of crude and wait for higher prices, according to U.S. economist Dennis Gartman.
Brent for February delivery is $6.10 a barrel cheaper than the February 2016 contract. February Oman oil traded on the Dubai Mercantile Exchange is $8.30 cheaper than the year later contract after being $6 more expensive about six months ago.
“Not enough people pay attention to the importance of term structure,” Dennis Gartman, author of the Suffolk, Virginia-based Gartman Letter, said yesterday in a phone interview. “The market is saying it will pay traders to go into storage.”
Gartman said contango arbitrage is easier to trade on the broader benchmarks than the Oman contract because banks prefer to provide financing for markets that are more heavily traded. Investors can earn a “nearly riskless return” of 8 percent by selling crude futures and storing oil at current prices, Gartman said.
The cost of warehousing and lending has hindered popularity of the trade, Gartman said. Shipbroker Charles R. Weber said this month that oil tanker rates are too high to spur floating storage. There are 28.8 million barrels of oil being stored at Cushing, Oklahoma, about three million barrels above the 2014 average.
The United States is now the world’s largest and fastest-growing producer of hydrocarbons. It has surpassed Saudi Arabia in combined oil and natural gas liquids output and has now surpassed Russia, formerly the top producer, in natural gas. [ZH: that’s about to change]
The increased production of domestic hydrocarbons not only employs people directly but also radically reduces the drag on growth and job formation associated with America’s trade deficit.
As the White House Council of Economic Advisers noted this past summer: “Every barrel of oil or cubic foot of gas that we produce at home instead of importing abroad means more jobs, faster growth, and a lower trade deficit.” [the focus now is not on the oil produced at home, which is set to plunge, but the consumer “tax cut” from plunging oil prices]
Since 2003, more than 400,000 jobs have been created in the direct production of oil & gas and some 2 million more in indirect employment in industries such as transportation, construction, and information services associated with finding, transporting, and storing fuels from the new shale bounty.
All told, about 10 million Americans are employed directly and indirectly in a broad range of businesses associated with hydrocarbons.
There are 16 states with more than 150,000 people employed in hydrocarbon-related activities. Even New York, which continues to ban the production of shale oil & gas, is seeing job benefits in a range of support and service industries associated with shale development in adjacent Pennsylvania.
Direct employment in the oil & gas industry had been declining for 30 years but has recently reversed course, with the availability of new technologies to develop shale fields. Nearly 300,000 direct oil & gas jobs have been created following the 2003 nadir in that sector’s direct employment.
The five super-major oil companies—Exxon, BP, Chevron, Shell, Conoco—that operate in the U.S. account for only 10 percent of Americans working directly in the oil & gas business.
Meanwhile, more than 20,000 other firms are directly involved in the oil & gas industry, and they produce over 75 percent of America’s oil & gas output. The median independent oil & gas firm has fewer than 15 employees. (Note that these data exclude gasoline stations, which employ nearly 1 million people and are overwhelmingly owned by individuals or small businesses.)
As in the oil & gas industry, most Americans are employed by firms with fewer than 500 employees. Small businesses not only employ half of all American workers but also generate nearly half the nation’s economic output. Young firms tend to be small firms; and young firms tend to emerge disproportionately in areas of rapid growth or new opportunities—such as in and around America’s shale fields.
A broad array of small and midsize oil & gas companies are propelling record economic and jobs gains—not just in the oil fields but across the economy. The enormous expansion in employment, exports, and tax revenues from the domestic oil & gas revolution is largely attributable to a core and defining feature of America: small businesses.
The oil & gas sector boom creates “induced” and energy-related jobs. For every direct job, there are, on average, three jobs created in industries such as housing, retail, education, health care, food services, manufacturing, and construction.
In the 10 states at the epicenter of oil & gas growth, overall statewide employment gains have greatly outpaced the national average. There we see the ripple-out effect on overall (not just oil & gas) employment. The shale boom’s broad jobs benefits are most visible in North Dakota and Texas, of course, where overall state employment growth in all sectors has vastly outpaced U.S. job recovery. Similarly, in the other states that have experienced recent growth in hydrocarbon production—notably, Pennsylvania, Colorado, Louisiana, Oklahoma, Wyoming—statewide overall (again, not just oil & gas) employment growth has also outpaced the U.S. recovery.
In addition to the direct and induced jobs, America is beginning to see the economic and jobs impact of a renaissance in energy-intensive parts of the manufacturing sector, from plastics and chemicals to fertilizers. Examples include an Egyptian firm planning a $1 billion fertilizer plant in Iowa and a South Korean tire company with an $800 million plan for a Tennessee plant. Germany’s BASF recently announced expansion of its American investments, including production and research. BASF calculated that its German operations’ energy bill would be $700 million a year lower if it could pay American prices for energy
The Marcellus shale fields in Pennsylvania were responsible for enabling statewide double-digit job growth in 2010 and 2011 and now account for more than one-fifth of that state’s manufacturing jobs. For every $1 that the Marcellus industry spends in the state, $1.90 of total economic output is generated.
The typical wage effect of the oil & gas revolution is most clearly visible in Texas. In the 23 counties atop the Eagle Ford shale, average wages for all citizens have grown by 14.6 percent annually since 2005, compared with the 6.8 and 6.3 percent average for Texas and the U.S., respectively, over the same period. The top five counties in the Eagle Ford shale have experienced an average 63 percent annual rate of wage growth. These are the kinds of wage effects sought in every state and by every worker.
Given the persistent, slow job recovery from the Great Recession, there could not be a more important time in modern history to find ways to foster more small businesses of all kinds, given that they are not only the core engine for growth but also frequently grow rapidly.
Punchline #1:
The $300–$400 billion overall annual economic gain from the oil & gas boom has been greater than the average annual GDP growth of $200–$300 billion in recent years—in other words, the economy would have continued in recession if it were not for the unplanned expansion of the oil & gas sector.
Punchline #2:
Hydrocarbon jobs have provided a greater single boost to the U.S. economy than any other sector, without requiring any special taxpayer subsidies—instead generating tax receipts from individual incomes and business growth.
And the final punchline:
The National Association of Manufacturers estimated that the shale revolution will lead to 1 million manufacturing jobs over the coming decade. Manufacturing jobs pay nearly 30 percent more than the industrial average and generate $1.48 of economic activity for every $1 spent, making manufacturing the highest economic multiplier of all industrial sectors.
Sorry, not anymore.
Now, thanks to John Kerry’s “secret pact“, and America’s close “ally” in the middle-east, Saudi Arabia whose “mission” it no longer to bankrupt Russia but to crush America’s shale industry, the only question surround the only bright spot for America’s economy over the past 6 years is how long before most of the marginal producers file Chapter 11, or 7.
The precipitous drop in global oil prices has created a domino effect that led to a new decline in lower mortgage rates, according to a report by Chris Flanagan, a mortgage rate specialist at Bank of America Merrill Lynch.
“The oil collapse of 2014 appears to have been a key driver [in declining mortgage rates],” stated Flanagan in his report, which was obtained by CBS Moneywatch. “Further oil price declines could lead the way to sub-3.5 percent mortgage rates.”
Flanagan applauded this development, noting that the reversal of mortgage rates might propel housing to a stronger recovery.
“We have maintained the view that 4 percent mortgage rates are too high to allow for sustainable recovery in housing,” he wrote. Flanagan also theorized that if rates fell into 3.25 percent to 3.5 percent range, it would boost “supply from both refinancing and purchase mortgage channels.”
Flanagan’s report echoes the sentiments expressed by Frank Nothaft, Freddie Mac’s chief economist, who earlier this week identified the link between oil prices and housing.
“The recent drop in oil prices has been an unexpected boon for consumers’ pocketbooks and most businesses,” Nothaft stated. “Economic growth has picked up over the final nine months of 2014 and lower energy costs are expected to support growth of about 3 percent for the U.S. in 2015. Therefore we expect the housing market to continue to strengthen with home sales rising to their best sales pace in eight years, national house price indexes up, and rental markets continuing to display low vacancy rates and the highest level of new apartment completions in 25 years.”
But not everyone is expected to benefit from this development. A report issued last week by the Houston Association of Realtors forecast a 10 percent to 12 percent drop in home sales over the next year, owing to a potential slowdown in job growth for the Houston market’s energy industry if oil prices continue to plummet.
Many investors are still skeptical that Saudi Arabia will hold firm on oil production.
Increased global consumption due to falling prices is unlikely to offset North American production.
US consumption is in a secular, structural decline due to increased efficiency and demographic changes. That’s unlikely to change any time soon.
The floor may not be where the Saudis think it is.
Investors are slowly waking up to the fact that Saudi Arabia is willing to take OPEC hostage to defend its market share, with Oil Minister Ali Al-Naimi declaring that –
In a situation like this, it is difficult, if not impossible, that the kingdom or OPEC would carry out any action that may result in a reduction of its share in market and an increase of others’ shares.
Alas, rather than embrace the cheap petroleum paradigm that has dominated most of the 20th century, many investors continue to cling to old shibboleths. Case in point: Brian Hicks, a portfolio manager at US Global Investors, recently noted that –
The theme going into 2015 is mean reversion. Oil prices are below where they should be (emphasis mine), and hopefully they will start gravitating back to the equilibrium price of between $US80 and $US85 a barrel.
I emphasize the words “below where they should be” because the notion that oil (NYSEARCA:USO) prices belong somewhere – and it’s always higher, somehow – is the linchpin of the bullish thesis. But the question of why a high price regime should prevail over a low price regime is never satisfactorily explained.
Higher extraction costs? A sizable chunk of those costs are sunk costs that can simply be ignored in production decisions and lowering the effective breakeven price. A tighter focus on already drilled wells in areas with mature infrastructure could lower costs even further. Moreover, service sector costs fall as rigs are idled. Depleted reserves? Most resource-producing basins are experiencing an increasing yield over time despite the rapid depletion of individual wells. A lot of that is due to extraction efficiency, which is increasing at a phenomenal rate; in fact, one rig today brings on four times the amount of gas in the Barnett Shale than it did in 2006. Drill times in the Bakken are also falling, while new well production per rig is steadily rising since 2011.
Drill Times (Spud to Rig) 2004-2013
(SOURCE: ITG Research)
Technically oversold? Good luck catching that knife. Traders have been pounding the table on “oversold conditions” since $80. Proponents of the Oversold Hypothesis who like to point historical examples of oil’s extreme short-term volatility for validation are conveniently ignoring the vast number of counter-examples like this TIME Magazine headline from June, 1981, which almost reads as if it could have been written yesterday:
(Source: TIME Archives)
1981 is an intriguing date for another reason: It marked the first time in over a decade that Non-OPEC nations countries outproduced OPEC. Despite repeated cuts by OPEC, it took five years for capitulation to set in. Nor are lower prices guaranteed to lead to cuts. Indeed, when oil prices plummeted from $4/bbl to 35 cents in 1862, the Cleveland wildcatters didn’t idle their pumps; they pumped faster to pay the interest on their debt.
Don’t Iran and Venezuela require higher oil prices in order to balance their budgets and head off domestic upheaval? Please. The Saudis don’t care about Iran’s budget problems. Venezuela is a non-entity despite it’s immense reserves. In fact, Venezuela’s hell-in-a-handbasket status was one of the major reasons for Cuba’s recent defection to the US.
Asian stimulus? The only reason that Japanese consumers know that oil prices are lower is from Western news headlines. The share of a day’s wages to buy a single gallon of gas in Japan is 5.59% vs. 2.45% in the US. Nevertheless, the Japanese are riding high compared to the BRICS: In Brazil, it’s 17.62%; in Russia, 7.95%; in India it’s 114.92%; in China it’s 23.54%. Not the most fertile ground for a demand-side revolution; especially since oil is priced in dollars rather than yen, reals, rubles, or rupees.
What about the US? Won’t lower prices lead to higher consumption? Despite what you read about our “insatiable thirst” for oil, Americans don’t actually drink the stuff. Our machines do, and those machines are becoming more and more efficient due to CAFE standards and new transportation technologies, especially NGVs. Demographic changes are also leading a secular decline in consumption. Fig. 2 below highlights the steady march down for miles traveled per capita as the Baby Boomers retire to slower paced lives.
(Source: Citigroup, Census, CIRA)
The reality is that there’s little that an uptick in demand can do to offset oil’s continuing price collapse if the Saudis aren’t prepared to cut to the bone. The wildcatters certainly aren’t going to; on the contrary, they have every incentive (and no real alternative at this point) to pump like crazy to pay down debt and break OPEC’s back. Most doom and gloom prognostications for North American shale use full-cycle breakeven estimates like the ones presented in Figure 2.
Full-Cycle Breakeven Costs by Resource (Assuming Zero Efficiency Gains)
Unfortunately for the bulls, all-in sustaining cost (full-cycle capex) is a totally irrelevant metric for establishing a floor on commodity prices. Commodities prices are based on the marginal cost of production of the most prolific producers, not the full-cycle costs of marginal, high cost producers lopped in with the market leaders. As Seth Kleinman’s group at Citi has pointed out –
…what counts at this stage is half-cycle costs, which are in the significantly lower band of $37 to $45 a barrel. This means that the floor is falling and may not be nearly as firm as the Saudi view assume(s).
Oil swooned again on Wednesday, with the benchmark West Texas Intermediate closing at $60.94. And on Thursday, WTI dropped below $60, currently trading at $59.18. It’s down 43% since June.
Yesterday, OPEC forecast that demand for its oil would further decline to 28.9 million barrels a day next year, after having decided over Thanksgiving to stick to its 30 million barrel a day production ceiling, rather than cutting it. It thus forecast that there would be on OPEC’s side alone 1.1 million barrels a day in excess supply.
Hours later, the US Energy Information Administration reported that oil inventories in the US had risen by 1.5 million barrels in the latest week, while analysts had expected a decline of about 3 million barrels.
So the bloodletting continues: the Energy Select Sector ETF (XLE) is down 26% since June; S&P International Energy Sector ETF (IPW) is down 34% since July; and the Oil & Gas Equipment & Services ETF (XES) is down 46% since July.
Goodrich Petroleum, in its desperation, announced it is exploring strategic options for its Eagle Ford Shale assets in the first half next year. It would also slash capital expenditures to less than $200 million for 2015, from $375 million for 2014. Liquidity for Goodrich is drying up. Its stock is down 88% since June.
They all got hit. And in the junk-bond market, investors are grappling with the real meaning of “junk.”
Sabine Oil & Gas’ $350 million in junk bonds still traded above par in September before going into an epic collapse starting on November 25 that culminated on Wednesday, when they lost nearly a third of their remaining value to land at 49 cents on the dollar.
In early May, when the price of oil could still only rise, Sabine agreed to acquire troubled Forest Oil Corporation, now a penny stock. The deal is expected to close in December. But just before Thanksgiving, when no one in the US was supposed to pay attention, Sabine’s bonds began to collapse as it seeped out that Wells Fargo and Barclays could lose a big chunk of money on a $850-million “bridge loan” they’d issued to Sabine to help fund the merger.
A bridge loan to nowhere: investors interested in buying it have evaporated. The banks are either stuck with this thing, or they’ll have to take a huge loss selling it. Bankers have told the Financial Times that the loan might sell for 60 cents on the dollar. But that was back in November before the bottom fell out entirely.
As so many times in these deals, there is a private equity angle to the story: PE firm First Reserve owns nearly all of Sabine and leveraged it up to the hilt.
The same week, a $220-million bridge loan, put together by UBS and Goldman Sachs for PE firm Apollo Group’s acquisition of oilfield-services provider Express Energy, was supposed to be sold. But investors balked. As of December 2, the loan was still being marketed, “according to two people with knowledge of the deal,” Bloomberg reported. If it can be sold at all, it appears UBS and Goldman will end up with a loss.
Six years of the Fed’s easy money policies purposefully forced even conservative investors to either lose money to inflation or venture way out on the risk curve. So they ventured out, many of them without knowing it because it happened out of view inside their bond funds. And they funded the fracking boom and the offshore drilling boom, and the entire oil revolution in America, no questions asked.
Energy junk bonds now account for a phenomenal 15.7% of the $1.3 trillion junk-bond market. Alas, last week, JPMorgan warned that up to 40% of them could default over the next few years if oil stays below $65 a barrel. Bond expert Marty Fridson, CIO at LLF Advisors, figured that of the 180 “distressed” bonds in the BofA Merrill Lynch high-yield index, 52 were issued by energy companies. And Bloomberg reported that the yield spread between energy junk bonds and Treasuries has more than doubled since September to 942 basis points (9.42 percentage points).
The toxicity of energy junk bonds is spreading to the broader junk-bond market. The iShares iBoxx High Yield Corporate Bond ETF fell 1.2% to $88.43 on Thursday, the lowest since June 2012. And at the riskiest end of the junk-bond market, it’s getting ugly: the effective yield index for bonds rated CCC or lower jumped from 7.9% in late June to 11.4% on Wednesday.
After not finding any visible yield in the classic spots, thanks to the Fed’s policies, institutional investors – the folks that run your mutual fund or pension fund – took big risks just to get a tiny bit of extra yield. And to grab a yield of 5% in June, they bought energy junk debt so risky that it now has lost a painfully large part of its value, and some of it might default.
Oil and gas are inseparable from Wall Street. Over the years, as companies took advantage of the Fed’s policies and issued this enormous amount of risky debt at a super-low cost, and as they raised money by spinning off subsidiaries into over-priced IPOs that flew off the shelf in one of the most inflated markets in history, and as they spun off other assets into white-hot MLPs, and as banks put now iffy bridge loans together, and as mergers and acquisitions were funded, at each step along the way, Wall Street extracted its fees.
Now the boom is turning into a bust, and the contagion is spreading from the oil patch to Wall Street. Energy companies are cutting back. BP, Chevron, Goodrich…. They’re not cutting back production by turning a valve. They’ll keep the oil and gas flowing to generate cash to stay alive, and it will contribute to the glut.
Instead, they’re cutting back on exploration and drilling projects. It will hit local economies in the oil patch and ripple beyond them. As energy companies slash their capex and their stock buybacks, they’ll borrow less, those that can still borrow at all, and there won’t be many energy IPOs, and there may not be a lot of spinoffs into MLPs or any of the other financial maneuvers that Wall Street got so fat on during the fracking and offshore drilling boom. The fees will dry up. And some of the losses will come home to roost on bank balance sheets.
The contagion is already visible on Wall Street. Susquehanna Financial Group downgraded Goldman Sachs to neutral on Wednesday, citing the mayhem in the oil markets and the impact it has on junk bonds and leveraged loans and the other financial mechanism by which Goldman’s investment and lending divisions sucked fees out of the oil patch and its investors. And this is just the beginning.
“Our biggest worry is the end of the liquidity cycle. The Fed is done. The reach for yield that we have seen since 2009 is going into reverse”, said Bank of America.
The OPEC oil cartel no longer exists in any meaningful sense and crude prices will slump to $50 a barrel over the coming months as market forces shake out the weakest producers, Bank of America has warned.
Revolutionary changes sweeping the world’s energy industry will drive down the price of liquefied natural gas (LNG), creating a “multi-year” glut and a much cheaper source of gas for Europe.
Francisco Blanch, the bank’s commodity chief, said OPEC is “effectively dissolved” after it failed to stabilize prices at its last meeting. “The consequences are profound and long-lasting,“ he said.
The free market will now set the global cost of oil, leading to a new era of wild price swings and disorderly trading that benefits only the Mid-East petro-states with deepest pockets such as Saudi Arabia. If so, the weaker peripheral members such as Venezuela and Nigeria are being thrown to the wolves.
The bank said in its year-end report that at least 15pc of US shale producers are losing money at current prices, and more than half will be under water if US crude falls below $55. The high-cost producers in the Permian basin will be the first to “feel the pain” and may soon have to cut back on production.
The claims pit Bank of America against its arch-rival Citigroup, which insists that the US shale industry is far more resilient than widely supposed, with marginal costs for existing rigs nearer $40, and much of its output hedged on the futures markets.
Bank of America said the current slump will choke off shale projects in Argentina and Mexico, and will force retrenchment in Canadian oil sands and some of Russia’s remote fields. The major oil companies will have to cut back on projects with a break-even cost below $80 for Brent crude.
It will take six months or so to whittle away the 1m barrels a day of excess oil on the market – with US crude falling to $50 – given that supply and demand are both “inelastic” in the short-run. That will create the beginnings of the next shortage. “We expect a pretty sharp rebound to the high $80s or even $90 in the second half of next year,” said Sabine Schels, the bank’s energy expert.
Mrs Schels said the global market for (LNG) will “change drastically” in 2015, going into a “bear market” lasting years as a surge of supply from Australia compounds the global effects of the US gas saga.
If the forecast is correct, the LNG flood could have powerful political effects, giving Europe a source of mass supply that can undercut pipeline gas from Russia. The EU already has enough LNG terminals to cover most of its gas needs. It has not been able to use this asset as a geostrategic bargaining chip with the Kremlin because LGN itself has been in scarce supply, mostly diverted to Japan and Korea. Much of Europe may not need Russian gas at all within a couple of years.
Bank of America said the oil price crash is worth $1 trillion of stimulus for the global economy, equal to a $730bn “tax cut” in 2015. Yet the effects are complex, with winners and losers. The benefits diminish the further it falls. Academic studies suggest that oil crashes can ultimately turn negative if they trigger systemic financial crises in commodity states.
Barnaby Martin, the bank’s European credit chief, said world asset markets may face a stress test as the US Federal Reserve starts to tighten afters year of largesse. “Our biggest worry is the end of the liquidity cycle. The Fed is done and it is preparing to raise rates. The reach for yield that we have seen since 2009 is going into reverse”, he said.
Mr Martin flagged warnings by William Dudley, the head of the New York Fed, that the US authorities had tightened too gently in 2004 and might do better to adopt the strategy of 1994 when they raised rates fast and hard, sending tremors through global bond markets.
Bank of America said quantitative easing in Europe and Japan will cover just 35pc of the global stimulus lost as the Fed pulls back, creating a treacherous hiatus for markets. It warned that the full effect of Fed tapering had yet to be felt. From now on the markets cannot expect to be rescued every time there is a squall. “The threshold for the Fed to return to QE will be high. This is why we believe we are entering a phase in which bad news will be bad news and volatility will likely rise,” it said.
What is clear is that the world has become addicted to central bank stimulus. Bank of America said 56pc of global GDP is currently supported by zero interest rates, and so are 83pc of the free-floating equities on global bourses. Half of all government bonds in the world yield less that 1pc. Roughly 1.4bn people are experiencing negative rates in one form or another.
These are astonishing figures, evidence of a 1930s-style depression, albeit one that is still contained. Nobody knows what will happen as the Fed tries to break out of the stimulus trap, including Fed officials themselves.
The oil markets have hit multi-year lows on unsubstantiated theories about a supply glut and fears of cooling demand.
Meanwhile, the geopolitical risks around the world have oddly disappeared in H2 2015.
Nevertheless, the facts prove that the real thing is way too far from evaporating geopolitical risks or a material deterioration of the global supply-demand fundamentals that can justify a slump.
The unprecedented downward pressure on oil prices is a headline-driven and sentiment-driven event.
The oil price will definitely rise significantly in 2015.
Introduction
The stock market will always give the investors a chance to make a blunder, especially for those who allow emotions to overrule facts and factual thinking. The emotional blunders are part of the game in the stock market. And if you run your portfolio based on lame-thinking and emotion, you will most likely follow the herd mentality and sell at the wrong time, because lame-thinking and emotion will always cloud your judgment.
Things get worse for your portfolio when you allow the analysts and the opinion makers who show up daily on CNBC and Bloomberg, to tell you what is really going on with a sector. To me, many of these guys are not just incompetent. To me, they are dangerous because their advice can ruin your wealth in a record time. It is easy to throw out statements without backing them up with any math, and it is easy to make overly simplistic interpretations of the global supply/demand dynamics. “So easy even a caveman can do it,” as GEICO’s commercial states.
And as clearly illustrated by the following charts, insanity and panic are currently hovering over the oil markets, due to the fact that many incompetent oil prognosticators have flooded the media with their lame opinions over the last months. For instance, the charts for the bullish ETFs (NYSEARCA:USO), (NYSEARCA:DBO) and (NYSEARCA:OIL) that track WTI are below:
(click to enlarge)
and below:
(click to enlarge)
and below:
(click to enlarge)
This is the chart for the bullish ETF (NYSEARCA:BNO) that tracks Brent:
(click to enlarge)
And the charts for the leveraged bullish ETFs (NYSEARCA:UCO) and (NYSEARCA:UWTI) are below:
(click to enlarge)
and below:
(click to enlarge)
All these bullish ETFs have returned back to their 2010 levels amid irrational fears for oversupply. But, these fears are completely unsubstantiated and they do not justify at all the sentiment-driven slump in the oil price over the last 4 months.
Andre Kostolany and The Oil Price
Obviously, all these sellers ignore Andre Kostolany who has said that:
“Imagine a man walking, one step at a time, on a country lane for a mile or so. He is accompanied by his dog, which follows the man like a dog follows his master: one step forward, one step backward. While the man is walking slowly, his dog is jumping around back and forth. There will be times when the man is ahead; he will wait for the dog and then there will be times when the dog is ahead and the dog will wait. In this example, the man represents the economy, and the dog the stock market.”
And for those who do not know Andre Kostolany, Kostolany is a stock market legend. Kostolany’s great quote describes what is going on with the oil price these days. The dog (oil price) currently is behind the man (oil supply/demand dynamics) and will catch him sooner rather than later.
In other words, I am a strong believer that Brent is not going to stay below $75/barrel for long, and the dubious Thomas are welcome to read the facts that will propel Brent higher than its current levels by early 2015.
What They Were Telling You In 2013 AndH1 2014
Back in 2013 and H1 2014, when Brent was trading around $110/bbl, the analysts and several other opinion makers were calling for oil to hit $150 per barrel. Let’s see some more details and the reasons behind these calls:
1) In H1 2013, the U.S. Department of Energy reported that China overtook the U.S. as the world’s largest net oil importer. That was the time when a report from the Paris-based OECD (Organization for Economic Co-Operation and Development) came out and noted:
“Based on plausible demand and supply equations, there is a risk that prices could go up to anywhere between $150 and $270 per barrel in real terms by 2020, depending on the responsiveness of oil demand and supply and on the size of the temporary risk premium embedded in current prices due to fears about future supply shortages.”
OECD also noted in that report:
“There is a strong price increase needed despite this new oil production coming on stream.”
2) In H1 2013, Energy Aspects, an energy research consultancy, noted as linked above “All estimates point to Asian demand propelling growth.” It also said that the implications of the U.S. shale-oil boom could be overstated for the rest of the world if demand from Asia keeps up.
3) In H1 2013, some analysts from Goldman Sachs wrote that Brent crude oil prices could rise to $150 per barrel in H2 2013 because:
“Despite the boom in U.S. shale gas, the oil price remains high, which he attributed primarily to sanction-related supply disruptions in Iran. Trying to compensate for this, Saudi Arabia has already increased its oil production to a 30-year high this year.”
Mr. Currie added that:
“While global oil demand has increased at a slower pace, it is still higher than the production increases in non-OPEC countries. Upside risks for oil prices include low inventory levels, limited OPEC spare capacity, and geopolitical risks which are likely near an all-time high with production in a very large number of countries at risk, including Egypt, Iran, Iraq, Libya, Nigeria, Sudan, Syria and Venezuela. Europe still faces economic and policy headwinds, China just experienced a significant food inflation surprise (and the livestock impacts from last year’s agriculture price spike will only be felt this year) and the US still faces risks from the debt ceiling debate, the automatic spending cuts (or “sequestration”) and impending tax increases.”
4) In H2 2013, when Brent was still around $115/bbl, the French bank Societe Generale said:
“Brent crude is likely to rise towards $125 a barrel if the West launches airstrikes against Syria, and could go even higher if the conflict spills over into the rest of the Middle East.”
5) As linked above, another report from JBC Energy in Vienna said in H2 2013:
“Current developments such as low spare capacity in Saudi Arabia, stockpiles falling in the U.S., disappointing supply developments around the world and signs of an improving global economy are pointing to tighter markets.”
“Average oil price was $112 per barrel in 2012. The average price of crude oil is forecast at $105 per barrel in 2013, $101 per barrel in 2014 and $100 per barrel in 2015. The base case is for oil prices to soften mildly, but remain close to $100 per barrel through 2018. Thereafter, prices rise by a few dollars each year in this scenario.”
“If Iraq, accounting for 3.7% of the world’s total oil production, suffers a serious disruption to its oil supplies, we will see a sharp upswing in oil prices as the OPEC effective spare capacity buffer is low, making the global oil market highly sensitive to further supply disturbances. If Iraqi oil production would fall back to the low levels seen during the invasion of Iraq in 2003, oil prices could easily rise by up to $30 a barrel as this would push the global spare capacity back to the lows when oil prices reached $150 a barrel in July 2008. High oil prices would put the world economic recovery at risk.”
B) This is from PVM Oil Associates:
“The deteriorating situation in Iraq could be the source of an oil price and therefore a financial shock should be sending economic-growth forecasters back to the drawing board. There can be no doubt that if Iraq’s southern oil operations are impacted Brent could reach $125 a barrel and beyond. Saudi Arabia may have 2 million barrels a day of capacity it can turn on reasonably quickly but that leaves no spare capacity margin.”
“It is hard to imagine that the oil production in northern Iraq will return to the market in the foreseeable future. So far, oil production in the south of Iraq, which accounts for 90% of Iraq’s oil exports, has been unaffected by the fighting in the north and center of the country. However, the sharp price rise in the last two days shows that this oil supply is no longer viewed as secure, either. Without the oil production from the south of Iraq, the market would be stripped of an estimated 2.5 million barrels per day.”
D) This is from the research consultancy Energy Aspects:
“Look at any forecast, they are calling for Iraqi production to be around 7-8 million barrels a day by 2018/2020 for oil prices to not rise substantially. And I think that’s the key, because that’s not going to happen. If this is contained within Iraq that’s one thing, but there’s a very different implication if it becomes a bigger regional conflict. That’s the biggest problem. Iraq’s at the heart of this big oil-producing region.”
What They Are Telling You In H2 2014
Let’s see now what the analysts and several other oil experts have been telling you lately:
1) In October 2014, Goldman Sachs slashed its 2015 oil price forecast. Goldman sees Q1 2015 WTI crude at $75/bbl versus $90/bbl previously and Q1 2015 Brent at $85/bbl versus $100/bbl previously. The U.S. investment bank said rising production will outstrip demand, joining other oil analysts who predict consumption will be dented by slower global economic growth and lead to a supply glut.
2) Other analysts who joined the bearish party lately, predict that the bear market in crude will continue with prices falling as low as $50 a barrel, in part because the global economy is slowing, pushing supply levels higher.
3) In late October 2014, fellow newsletter editor Dennis Gartman showed up and implied that oil could go to $40-$50 per barrel because among others, Lockheed Martin (NYSE:LMT) was working on a compact fusion reactor that could be ready within 10 years. He said:
“Fusion is going to be the great nuclear power of the next 150 years. And finally, we are driving less and less. We are using so much less gasoline than we ever have, in global terms, in national terms, in per capital terms. All of those things, I think, are going to be weighing heavily on crude oil. And where could it go? A lot lower, a lot lower.”
So within ten years from now, we will fit a nuclear fusion reactor on the back of our cars dumping our gas tanks. Let Star Trek come to life! Obviously, Gartman’s thesis also implies that Star Trek’s high-tech, innovative and game-changing tools will be on clearance, so all the people from China and India to Africa and America will not afford to overlook this irrationally cheap nuclear fusion reactor. I don’t even understand why an investor can take Gartman’s approach on oil seriously.
4) The technical traders also showed up a few weeks ago calling for $40/bbl, based on the following chart:
(click to enlarge)
2013/H1 2014 vs. H2 2014: No Major Fundamental Change While Geopolitical Risks Deteriorate
As also shown in the previous paragraph, the calls in 2013 and H1 2014 for $150/bbl were based on the geopolitical tensions in the Middle East and the expectations about global growth with a focus on demand from the growing Asian markets, which are high in the list with the world’s biggest oil consumers.
And the facts below prove that nothing has changed over the last six months to justify a drop of 35% in the oil price that has occurred lately. In contrast, the geopolitical risks in the Middle East have deteriorated, and the security situation both in Iraq and in Libya has worsened recently. Even International Monetary Fund [IMF] admits that the geopolitical risks have worsened since H1 2014, according to its latest report.
Also, the world’s biggest oil consumers are growing at rates that either are in line with 2013 rates or exceed expectations. There is nothing to indicate that global supply and demand imbalance has fundamentally changed in the past six months. There is just too much speculation, emotion, panic and short-term lame thinking that have been used to determine the value of the oil price lately, and this slump in oil prices is clearly a result of sentiment and emotion.
Let’s proceed now with the facts:
1)Geopolitical risks deteriorate primarily due toISIS, Iran and Libya: The extremist Islamic State of Iraq and Syria (ISIS) is still there, and the U.S. military and its allies hit ISIS forces with 15 air strikes in Iraq and Syria during a three-day period, The U.S. Central Command revealed a couple of days ago. Thirteen attacks were carried out in Iraq since last Wednesday and two more targeted Islamic State in Syria.
Meanwhile, ISIS keeps advancing in Iraq and Syria, after seizing Iraq’s second largest city Mosul on June 10th. The attacks have been escalating since 2013 and H1 2014, while American, British and Syrian soldiers were beheaded in October 2014 and November 2014, which is confirmed by Obama Administration. Apparently, there is no improvement compared to the situation in 2013 or H1 2014.
Furthermore, world powers failed to reach a nuclear agreement with Iran last week and extended talks for seven months. This means that the Western economic sanctions are not going to be lifted anytime soon, freezing the ability of Iranian banks to conduct international transactions while Iran’s daily oil export restrictions will remain too. This also means that Iran will continue working on its nuclear program by the summer of 2015, impacting negatively the destabilization risk in the region. And there is obviously no improvement compared to the situation in 2013 or H1 2014.
Also, there is no risk improvement in Libya compared to the situation in 2013 or H1 2014. In late August 2014, Libya’s ambassador to the United Nations warned of “full-blown civil war,” if the chaos and division in the North African country continue.
Libya currently has two competing parliaments and governments. The first government and elected House of Representatives relocated to Tobruk a few months ago after an armed group from the western city of Misrata seized the capital Tripoli and most government institutions, as well as the eastern city of Benghazi. The rival previous parliament remains in Tripoli and is backed by militias.
And just a couple of weeks ago, Libya’s political strife intensified as the rival government that has seized the capital took control of Libya’s largest oilfield (El Sharara), according to Reuters. Libya’s oil production rose above 900,000 bopd in September 2014, sharply above lows of 100,000 bopd in June 2014, but it has already fallen to around 500,000 bopd at most, as a recovery in Libya has faltered so far, according to Reuters. This translates into a material drop of approximately 400,000 bopd from Libya only.
2) GDP Growth Rates: Let’s take a look now at the GDP growth rates of the world’s biggest oil consumers:
A) United States: According to the latest news of September 2014, the U.S. economy grew 4.6% in Q2 2014, exceeding earlier estimates. And according to the latest news of November 2014, the U.S. economy grew 3.9% in Q3 2014, exceeding once again the consensus estimate of 3.3%, as illustrated below:
(click to enlarge)
B) China: China grew 7.6% in 2013 and grows 7.4% (on average) to date, as shown below:
(click to enlarge)
Also, China’s GDP per capita continues growing in 2014 at the same pace it has been growing over the last couple of years, as illustrated below:
(click to enlarge)
On top of that, the Chinese central bank initiated an easing cycle just a few weeks ago. How can a serious investor ignore this initiative that will have material effects on China’s future growth and China’s oil consumption of course?
C) Japan: The Japanese economy grew in Q1 2014 and contracted in Q2 and Q3 2014, as illustrated below:
Additionally, Japan’s GDP per capita continues growing in 2014 compared to 2013, as illustrated below:
(click to enlarge)
D) India: As shown below, the Indian economy grew 4.5% in 2013:
(click to enlarge)
That was the time when the analysts were saying that these GDP numbers were below their expectations. Please see some analysts’ and officials’ statements about India’s GDP growth from late 2013:
i) “There is no light at the end of the tunnel visible in India’s GDP release.”
ii) “It was slightly below expectations but I feel the overall growth rate of 4.9% would be achieved this year (2014)” said C. Rangarajan, Chairman of the Prime Minister’s Economic Advisory Council.
iii) “These numbers clearly show that attaining a growth rate of 4.9% in 2014 is not possible.”
That was also the time when Brent was around $110/bbl and all the oil prognosticators were projecting $150/bbl, as shown in the previous paragraph.
However, the Indian economy picked up steam and rebounded to a 5.7% rate in Q2 2014 from 4.6% in Q1 2014, led by a sharp recovery in industrial growth and gradual improvement in services.
And under the Modi government and thanks to a series of fundamental economic reforms, the Indian economy continued its growth and grew 5.3% in Q3 2014, as illustrated below:
(click to enlarge)
Needless to mention that these GDP rates in Q2 2014 and Q3 2014 were well above the analysts’ expectations.
Additionally, India’s GDP per capita continues rising in 2014 compared to 2013, as illustrated below:
(click to enlarge)
And according to yesterday’s news from Reuters, Indian factory activity expanded at its fastest pace in nearly two years in November 2014. The HSBC Manufacturing Purchasing Managers’ Index (PMI) rose to 53.3 in November 2014 from 51.6 in October 2014, its highest since February 2013, and the thirteenth consecutive month of expansion in activity. The analysts had expected manufacturing activity to lose some steam and predicted the index would fall to 51.2.
On top of that, India overtook Japan as the world’s third-biggest crude oil importer in 2013 and the U.S. Energy Information Administration [EIA] projects that India will become the world’s largest oil importer by 2020.
E) Europe: Europe continues growing in 2014 albeit in a slow rate, as illustrated below:
(click to enlarge)
But the current slow growth in Europe was there in 2013 too. In fact, Europe has been limping forward for years and this is nothing new, as clearly illustrated at the previous chart.
The Half-Truths And The Peak Oil
Given the fact that neither the geopolitical risks have declined since H1 2014 nor the average GDP growth rates in the world’s biggest oil consumers have dropped compared to 2013, the oil bears had to discover something else to strengthen their lame approach to oil and the supposedly supply glut.
Therefore, it does not surprise me the fact that I have seen the chart below more than 20 times in numerous online articles over the last weeks, given also that there are always willing authors who behave like parrots repeating what they hear:
The thing is that this chart itself tells you half-truths for the following three reasons that you will not find all together in any of the recent bearish articles about oil:
1) This chart above compares apple to oranges. It compares Saudi’s conventional production with U.S. oil production which is primarily a result of drilling unconventional shale wells that peter out quickly. The gap between the extraction cost in Saudi Arabia and the U.S. is approximately $60/bbl. Extracting oil from shale costs $60 to $100 a barrel, compared with $25 a barrel on average for conventional supplies from the Middle East, according to the International Energy Agency [IEA].
In other words, new oil is not cheap and the rising oil production in the U.S. over the last couple of years has been conditional upon the high oil price. Most of the wave of the U.S. production is currently unprofitable and the current low oil price discourages new drilling.
2) The U.S. shale players are on a steep rate treadmill because of the high decline rates of the unconventional wells, and an investor must be in denial to not see it.
3) The sweet spots and the spots with high productivity in the main oil basins in the U.S. (Williston, EF, Permian) cover a finite amount of land and eventually the number of the wells at the sweet spots is not infinite. The shale producers say that they have reserves [RLI] for approximately 10 years but this does not mean that their drilling locations are sweet spots.
The shale producers have already drilled in many of the best areas, or sweet spots. Once those areas have been drilled out completely, operators will have to move to more-marginal locations and well productivity will fall precipitously. Meanwhile, the advances in technology cannot make wonders to boost the recovery rates overnight.
As such, it is imperative to keep in mind that the peak oil in the U.S. is not a myth. At the current oil price, the supply of the unconventional oil production in the U.S. will quickly prove self-correcting. Both the oil production and the crude inventories in the U.S. will stall soon and will go into a permanent decline effective H1 2015 as a result of the ongoing reduction in drilling activity, the high depletion rates of the unconventional wells and the finite number of the sweet spots.
In fact, the rapid decline has already started. First, the Energy Information Administration said yesterday U.S. crude-oil supplies declined 3.7 million barrels on the week ended Nov. 28. Analysts surveyed by Platts had expected crude inventories to increase by 380,000 barrels on the week.
According also to today’s news from Seeking Alpha, new permits, which outline what drilling rigs will be doing 60-90 days in the future, showed heavy declines for the first time this year across the top three U.S. onshore fields: the Permian Basin, Eagle Ford and Bakken shale. Specifically, there is an almost 40% decline in new well permits issued across the U.S. in November 2014, with only 4,520 new well permits approved last month, down from 7,227 in October 2014.
These numbers indicate a sizable dent in U.S. production in the not too distant future. Most of that dent will come from the highly leverage players holding lower quality land.
The Oil Sector In 2015 And The Real Estate Analog
The ETFs (NYSEARCA:IYR) and (NYSEARCA:VNQ) measure the performance of the real estate sector of the U.S. equity market and include large-, mid- or small-capitalization companies known as real estate investment trusts (“REITs”). Their charts over the last couple of years are illustrated below:
(click to enlarge)
and below:
(click to enlarge)
All the investors know the fundamental problems behind the slump of the real estate sector in the U.S. a few years ago. Given that no fundamental improvement can take place overnight, it took the real estate sector in the U.S. a few years to recover from its lows in 2009.
I am sure now that many readers wonder why I talk about the real estate sector in an oil-related article. What is the relation between the real estate sector and the oil markets?
I mention this example because I strongly believe that the oil price will recover like the real estate sector has recovered from its bottom over the last three years. But, there is also a big difference here. The recovery of the oil price will be much quicker than the recovery of the real estate sector, given that this slump of the oil price has been driven by lame thinking, arbitrary speculation and sentiment, while having nothing to do with evaporating geopolitical risks around the world or a material deterioration of the global supply-demand fundamentals.
On top of that, there are some additional geopolitical clouds on the horizon that can make oil jump by H1 2015. For instance, the current low oil price has brought many OPEC members to their knees, while the holders of those countries’ sovereign debt are toast as long as oil stays at the current levels. Iran, Iraq, Libya, Algeria and Venezuela are not prepared to withstand low oil prices for long and they are now in serious danger of political upheaval at current prices. According to yesterday’s news from CNBC, the first signs of an escalating social unrest in Venezuela are already there, and things will definitely get worse over the next weeks.
Furthermore, Russia and Saudi Arabia will be anxiously watching the rapid depletion of their sovereign wealth funds, which will make the political situation in these two countries dicey over the next months.
In other words, I obviously agree with Andrew John Hall, who is known as the God of Crude Oil Trading. Although many investors and readers do not know this oil legend, Hall is secure in his view that the price of oil is destined to rise sooner rather than later, mocking those who are convinced that a U.S. shale boom will mean long-term cheap, abundant energy.
My Takeaway
Fellow investors, please educate yourselves for your own benefit. Everyone talks about buying low and selling high, but he often does the opposite. The typical investor often buys high because he feels good. And he sells low because of panic and lame thinking.
Therefore, this is the essence of my investment thesis. This oil price fall is a sentiment-driven slump. This is short term and sentiment-driven noise in the big picture story. Right now, oil has come to the point where it is unloved, which is exactly when you have to expose yourself to the sector. This oil downturn cannot last long and oil will bounce back by early 2015.
On the supply side, there are not any “elephant” conventional discoveries over the last years, and this is why the conventional oil production from the U.S., the North Sea, Mexico, North Africa and the Middle East has been falling over the last years. Cheap and easy oil is gone forever, and the global marginal barrel currently is in the $80 to $90 range.
Due to the current low oil price, oil supplies will become critically tight by early 2015, largely because production leader Saudi Arabia is not able to pump as much extra oil as many people believe. In fact, Saudi oil production has peaked at approximately 10 million bopd over the last years, as illustrated below:
On the demand side, the investors must not ignore that world population keep growing at a satisfactory rate in an energy intensive world, as witnessed by the GDP growth rates and the GDP per capita for the world’s biggest oil consumers mentioned above. As a result, global oil demand continues growing unabated at average of 1 million barrels per year.
Meanwhile, the geopolitical tensions are escalating and the crude oil price is best proxy for geopolitical risk.
After all, how can the investors weather this temporary storm and benefit from this oil price shock? Well, big fortunes will be made to those with the patience and foresight to pick right and hold tight. Just pick quality oil stocks with low key metrics (i.e. EV/EBITDA, EV/Production, EV/Reserves), sit tight, and you are going to do very well given that the strong players will remain and the weak ones will vanish.
For instance, stay far from the heavily indebted companies with a high Net Debt to EBITDA ratio, because many highly leveraged U.S. shale producers will go broke over the next couple of years. The rising tide will not lift all boats. Even if WTI jumps at $85/bbl tomorrow, several U.S. shale oil producers will not avoid bankruptcy while others will be sold for pennies on the dollar. Beggars cannot be choosers.
And now you know why I sent out last Thursday a Market Update to the subscribers of “Nathan’s Bulletin,” urging them to load specific quality picks. And when Brent crests that $90 mark again, they will be glad they did.
I would be obvious to a garden gnome that any rise in the price of Brendt crude above $115 causes a recession. This has been true ever since 2007. The US cannot afford $4 gasoline.
The reason oil stayed as high as it did was the fact that India and China subsidized it. The fact that China passed the US in imports misses the point. China uses 36mm boe in coal every year. They manufacture 700 million tons of steel versus 40 in the US. This is due largely to $5 trillion in QE. In the process of this absurd borrowing, they have wiped out most of their neighbors.
Earnest and Young estimates that there is 300 million tons of excess steel capacity in the world and China is STILL building new capacity. That 300 million tons is assuming China continues to use 640 million tons internally. Once countries start to protect their steel producers, China is going to collapse. Steel requires 11 BOE of energy per ton. 300 million tons is the equivalent of 10 million BOE of energy per day. If there’s a recession, you could see total energy use drop by 15-20 million BOE per day.
Demand isn’t what people want, demand is what they can pay for. Once the wold starts defaulting on this junk corporate debt, petroleum demand is going to collapse. The last time we went through a shock like this was 1982 and 6 million BPD of demand came of the market. This one is going to be far far worse. You could easily see oil go to $50 and stay there for a decade. According to Evans-Ambrose Prichard, Jim Chanos and Kyle Bass, China is going to collapse.
Excellent write up, as usual! Your excerpt below says it all:
” The recovery of the oil price will be much quicker than the recovery of the real estate sector, given that this slump of the oil price has been driven by lame thinking, arbitrary speculation and sentiment, while having nothing to do with evaporating geopolitical risks around the world or a material deterioration of the global supply-demand fundamentals”.
and this one:
” In fact, the rapid decline has already started. First, the Energy Information Administration said yesterday U.S. crude-oil supplies declined 3.7 million barrels on the week ended Nov. 28. Analysts surveyed by Platts had expected crude inventories to increase by 380,000 barrels on the week.
According also to today’s news from Seeking Alpha, new permits, which outline what drilling rigs will be doing 60-90 days in the future, showed heavy declines for the first time this year across the top three U.S. onshore fields: the Permian Basin, Eagle Ford and Bakken shale. Specifically, there is an almost 40% decline in new well permits issued across the U.S. in November 2014, with only 4,520 new well permits approved last month, down from 7,227 in October 2014. “
I did not actually expect such big declines so soon. Both declines really surprised me. How long can an investor remain in denial?
GI, if those numbers for well permits are not seasonally adjusted, then it’s possible that a big part of that drop is caused by seasonal factors related to weather. It could be that many drillers do not start new wells after November in places like the Bakken play and the DJ Basin, and thus the latest month that they get permits could be October. So those permit number have to be seasonally adjusted to be meaningful.
Nonetheless, I don’t buy some of the talk I’m reading on the internet that “the US shale drillers will keep right on going with oil at $65”. That idea is just totally ridiculous. The operating cash flow generated by US shale producers will decline dramatically if oil stays below $80 and they won’t be able to raise nearly as much capital because of lower stock prices and substantially higher yields required to sell bonds. So US shale drillers will be forced to cut back on drilling activity because of a simple lack of capital and cash flow to pay for horizontal drilling, which is expensive. This big drop in drilling activity, which will happen for sure if oil stays below $80, should cause US oil production growth to drop sharply in the first half of next year and that drop will probably cause the oil market to correct back up into the 80s by the second half of next year.
I’ve been surprised that the Saudis have been willing to let oil prices fall all the way below $70. I’m starting to wonder if anyone really knows what oil price they need to balance their national budget. Same thing with the Russians–it’s difficult to get good credible information from the Middle East, South America, and Russia about national budgets and other subjects like what kind of oil production technology they’re using today and what their marginal cost of production is today. Do Wall Street analysts and those sleepy international agencies in Europe really know what’s going on in the Middle East and Russia? I’m starting to wonder.
Oil and coal are not fungible and they are not used primarily for the same purposes. BOE is nice if you’re assessing overall energy consumption, but it’s not a good way to think about consumption across all energy sources. If steel production drops, how will that affect the people driving vehicles in Beijing or other metropolitan areas? If coal producers in the US close mines, how will that affect oil prices and consumption? Not as much as you might propose just by looking at BOE. People don’t fuel cars with coal, and power companies are building NG fueled power plants because NG is cheaper and cleaner. So if coal production drops in the US, it’s not going to directly cause gasoline prices to rise. My point in these examples is not to argue whether oil or NG prices will rise or fall, but simply to illustrate the lack of connection between markets and demand.
Thank you for your compliments. The huge divergence between the reality and the market perception is more than apparent in the oil markets now.
The geopolitical risks have worsened compared to 2013 and H1 2014, the GDP growth rates in 2014 are at or above expectations in the world’s largest oil consumers compared to 2013, while the crude inventories and the new permits have already started to drop rapidly. We talk for a 40% decline here.
To me, this is the definition of: THEATER OF THE ABSURD.
Let’s see how long this THEATER OF THE ABSURD will go on.
Re: “I don’t buy some of the talk I’m reading on the internet that “the US shale drillers will keep right on going with oil at $65″. That idea is just totally ridiculous. The operating cash flow generated by US shale producers will decline dramatically if oil stays below $80 and they won’t be able to raise nearly as much capital because of lower stock prices and substantially higher yields required to sell bonds”
If oil price keeps going down, and I’m a shale driller with sunk cost already, wouldn’t I want to try to keep pumping MUCH, MUCH more first to try to keep my fixed costs even lower, to try my best to survive, before the inevitable happens? In other words, I think we might just be seeing the beginning of the price fall … sure, 6-12 months down the road, we’ll see some real bust happening (not all producers have enough liquidity to last 6-12 months), but the time from today to the next 3-6 months could be really painful for longs … before they cut production, I think, they’ll try to produce a heck of a lot more to try to survive, before the financial constraints starts to work – remember, financials have many avenues, some will still pump more, borrow from banks to suvive, etc. i.e. we could be looking at 6-12 months pain before recovery, before the banks finally say enough is enough, before capital markets starts to rate the bonds as junk, etc. These process could last a long time, and until then, we might be seeing continued increased weekly production which will keep depressing crude oil prices …
Originally, I plan to go long on crude oil stocks, but I’m now thinking of holding back my longs until I see a real bottom in prices. I like to see US production slows down for 2 to 3 weeks in a row, and right now, we are just not seeing this happening at all – US producers keep producing more oil every week, and with Saudis not cutting down, the supply of oil on a weekly basis keeps going up, and prices inevitably must come down … I have a feeling, $65 will not be the immediate bottom yet … but let’s see …
It will take a few months for drilling activity to decline. The OPEC meeting was only a week ago. Oil producers are not going to stop drilling any wells that they’ve already started, and I would think they have some contracts for a few months that can only be canceled in extreme dire situations. By March 2015 we should start seeing a substantial decline in oil rig counts. Production growth will then start declining quickly and US production could even start dropping by mid-summer.
Very funny! Yet sadly correct, and getting worse. We are raising a generation of Electronic Gamers. They live in another world instead of the real world.
Interesting article…lots of good data points, particularly how well you call out the “analysts” and hold them accountable for their calls. These people truly are nothing but weathervanes….at least the vast majority of them.
I do think there is a temporary glut of supply that triggered the decline, coupled with the obligatory unwinding of long positions…crude prices may capitulate further, but they won’t stay down for long. The tricky part is staying patient and waiting for a tradeable bottom, and separating the long term winners from the ones with excess leverage and poor fundamentals. We know the hedge funds are herd animals so expect more piling on of short positions to drive crude lower.
I am getting sick when I see how quickly all these highly paid “gurus” change their mind depending on which way the wind blows, while ignoring the facts. And they behave like parrots repeating the words and imitating the actions of another.
This is why, I felt the need to write this factual article that clearly demonstrates what these “gurus” were telling us in 2013 and H1 2014, and what could drive prices at $150/bbl.
Also, separating the wheat from the chaff is something that ALL the investors must do now. They must NOT make the mistake to load the heavily indebted energy companies because it will be a “dead cat bounce”, if these companies ever bounce back.
Value Digger,
I greatly value your research, time and effort put into you articles.
However, timing is everything. This piece feels desperate. I have read a lot of details on the subject of late and there were many signs of this slump in prices coming that were not accounted for by those who only see oil prices as going up.
Prices go up and they go down. I don’t see the compelling evidence that it will suddenly go up soon.
Duago,
Just pull up the price charts of crude oil over the past 20 years.
You’ll see this current price drop is the 2nd longest drop over that period.
The only time when crude had a bigger drop was back in 2008, from a peak of $147, down to a low of $33, near the 200 month MA. Today, we are near the 200 month MA as well which is currently around $60-$65 … we can’t time it precisely, but over the next few months, I feel we are close to the current bottom, and it makes sense to pick good quality issues relating to crude oil, and slowly work your way inside. Never go on margin, this is really Value Investing at its finest, and if you are not scared, you are not doing Value Investing properly – I won’t bat an eyelid if the purchases made this week drops by 50% more at the bottom, because history has shown that they will rise much, much more. I’m looking at +100% gains over the next 1-3 years at the least …
Demand for oil in the six segments that simply cannot stop are impervious to economic slowdown (plastics, oceangoing freight, train freight, fertilizer, aviation, modern armies). Regardless of consumer slowdowns, these six segments represent 80% of oil and net gas consumed around the world. When economies slow down, the food, freight, aviation and military segments do not, they continue on. A recession in Europe or China would only slow the rise in demand, not reverse it. Look at the demand trend of the past year and understand that even if demand only rises at one half the slope is has followed from 2004 until now, it will still outstrip current expected global production for Q1 2015. Oil price strip is highly elastic to tiny percentage changes in the supply-demand balance. Current situation is creating the coiled spring and that coiled spring WILL unwind before the end of 2015.
We just hope it is a measured controlled unwind throughout the year, otherwise we will have the $140 spike we saw in 2008 for a month or two before settling down to something in the $90 – $100 brent range.
Set your DCF and NAV models for $90 brent / $85 WTI. This is going to get ugly before the weather gets cold again in 2015. I’m willing to go out on a limb and say you can quote me on this one.
Here is the reality when Brent is $70/bbl for more than one or two months…
1. Venezuela is cash flow negative and cannot make coupon payments on its foreign debt. Venezuela WILL default on its debt before end of 2015 in this price regime.
2. Iran cannot feed its army at this price. The mullahs depend on the support of their army to maintain power. Kicking this leg out from under the government stool makes their continued existence precarious. Martial law kind of precarious.
3. The government in Tripoli cannot feed their guard at these prices. If the government in Tripoli cannot do this, they cannot protect the pipes that carry crude to their northern port. When that happens the other government in the west breaks through and shuts the pipe down to prevent revenue from reaching the Tripoli government and thereby trying to strangle it. 800,000 bbl/day go off stream.
4. Saudi Arabia is burning $2b/month from their sovereign wealth fund. At that burn rate, the ENTIRE sovereign wealth fund runs dry in 60 months. They need to turn the boat around long before that happens because if they burn through more than about 25% of it, angry men with beards and automatic rifles start to hang around the palace gates. Not a stable internal situation. Riyadh has made major financial promises to its citizens in return for peace and their support. And in Saudi Arabia, the citizens do not have peaceful protest marches when they are aggrieved.
5. Russia is burning $2.5b/month form their sovereign wealth fund. At that burn rate, the ENTIRE sovereign wealth fund runs dry in 48 months. They will tighten their belts, suffer, freeze, grit their teeth and tough it out. BUT! (and this is a big one) understand that at the back of the mind of every strategist in the Kremlin is the nagging thought that all they have to do to cause a global geopolitical crisis and force the price of energy to whipsaw back up to $100/bbl in the course of a week is to kick the hornets nest: Roll the tanks into Donetsk and Lukhansk. Overnight crisis and EU buckles because it is now winter and Germany will freeze without the Ukrainian transit gas (Nordstream can only supply about one third of what Europe needs to stay warm).
6. I can’t even begin to fathom what the dynamics going on in Syria / Iraq are right now, but it can’t be good. I’m sure Baghdad had to guarantee Kurdistan a minimum cut in the negotiation to let them export. Well, either Baghdad or Kurdistan is not going to get that minimum cut agreed in that negotiation. How do you think things are panning out in their relations now?
This situation has the makings of a new Arab Spring / Cold War settling in… and it cannot remain in equilibrium for a whole 12 months.
The change in commodity prices, oil included, was triggered by a change in financing attitudes of some buyers. Changing Fed policy added uncertainty to a sure bet. Same thing happened on a smaller scale when Bernancke hinted that bond buying might stop someday.
Oil Bears and Analysts are driving the oil price down with their unrealistic attitude towards:
a) Negative growth;
b) India’s energy appetite; and
c) The fallacy of Nirvana in the Middle East.
Not to mention that Pick-Ups and large SUVs are back in vogue in North America…
I also believe that Putin will rattle his sabre and agitate conflict somewhere, to raise uncertainty and thus prices – if the drought in Oil prices remains lower much longer. After all, the fall in the price of crude in the mid 80’s (and Reagan) brought the USSR to its knees. He will not repeat that. Guaranteed.
Waiting for a firm bottom – then backing up the truck for more PTA.
No one will know the absolute bottom, at the “Hard Right Edge” of the charts. Bottoms are only know once some time are passed, and by then, you won’t be able to buy at the bottom price. That’s the reality of prices. The key is Money Management – always make sure to have enough cash to buy at lower prices when bargains avails themselves. For highly cyclical stocks, a rough yardstick is 75% fall in prices from the peak for decent names. E.g. SDRL is one that I think could be interesting – peak price was $48 in 2013, and is now trading near $12, or 75% fall. I would allocate around 4% of my portfolio to this, to be split into 4 bullets, and have actually deployed first bullet at $13.50. I’ll be looking for a final buy price of around $7 (approximately 50% fall from my first entry), and these types of buys are just put into the drawer and forget. When the drawer is opened in 1-3 year’s time, you will most likely earn anywhere from 50% to 100% gains or more.
Meanwhile, have the stomach to see the value of what you bought dropped by 50% from what you purchased. Don’t ever think about selling then, because the Reward to Risk of holding is much, much better.
And diversify into 3 issues at the very least, so that total exposure to crude oil is no more than say 12% trading capital. I am just very cautious, but of course, at the very bottom, for the 4th buy, you could double or triple the buy size and raise the 12% up to say 15%-20% capital … but these type of substantial increase must show capitulation, i.e. big price drops with big volumes …. (SDRL has shown the first capitulation last week and this week, and usually, there’s more than 1 capitulation). And if you are a nimble trader, you would also consider adding on the way up, e.g. when Weekly RSI(14) crossed above 20 and Daily RSI(14) dropped back down to around 30-40 or so ie. dipping on the way up, if you are worried that you only have 3% capital in this during the bottom.
PS. SDRL falls into my screen, because at $13.50, it is trading at NAV, and well below Replacement Cost. So, if it falls to $7, that would be trading at 50% NAV approximately, and is good enough for me.
Thank you for your compliments. Also, good luck with PTA (Petroamerica Oil) which is debt free with a pristine balance sheet, as shown in my previous articles.
excellent article. While I’m hesitant to predict WHEN oil prices will go back up, it’s obvious that they will. Outside the middle east, most resources cannot be economically accessed at a price below $70, so while the market price may go below, the pendulum invariably will swing back because
– more and more suppliers will go out of business or reduce supply
– consumption and hence demand will rise if oil is that cheap.
There are a lot of factors at play as you well demonstrated – geopolitical, GDP growth, but also competing energy sources (and I’m not talking nuclear fission, but renewables). But the overriding factors appear to be speculation and herd behaviour. And we all know they can only go for so long into one direction.
The article makes some very sound points. I must disagree with the view that the shale plays are going to “play out” in the near future. If anything, we have continually underestimated what innovation and knowledge are achieving in exploring and producing from tight formations. Lower prices will slow the growth in shale exploration and production, but the quantity of resource present in shale plays is enormous and not fully understood.
Old Mule, you are correct. We have, indeed, continually underestimated what innovation and knowledge are achieving.
Also, not all shale formations are so thin as to horizontally support only single laterals. Some, like the Wolfcamp, are very thick, and the first wells drilled are really only the first of many stacked laterals.
Back to innovation and knowledge, that is not limited to shale plays, either. Not all of the new oil production is shale production. At least some if not much of it is from new horizontal development of non-shale assets. For example, look at the Spraberry in W TX.
Also, the shale wells that are drilled and produced typically hold under the leases of unsophisticated lessors other zones that have not yet been tapped.
There is more to be squeezed out of these formations than most people realize, and with advances in cost savings along the way, there still remains quite a bit of money to be made.
If it is “not fully understood” then you cannot say anything about future shale production. Currently, the author is correct. Until production is realized, such as current retrievable shale oil, for investment purposes, it doesn’t exist.
To the contrary, even though it is not fully understood, we know for sure that we are not getting all out of it, and there has to be a way to get more out of it as technology and knowledge improve and as economic opportunities arise.
What it is going to take to send men to Mars is not fully understood, either. But that does not mean that we cannot say anything about sending men to Mars at some point in the future.
In terms of the shale oil and the technology, I believe that the technology cannot make wonders overnight. And more importantly, the current technology cannot get a lot better overnight, given that it took us (George Mitchell) many years to improve this shale process and bring it to the point where we are now.
If the oil price remains at the current levels for long, the peak oil event will occur in 2015, in my view.
Good article. I like the attitude to keep one’s head cool and act on facts, not emotions.
I buy the long case for Oil, long term. But the question is that of how long it will take to come back.
The political unrest in the middle east ist not necessarily a cause for less supplies: the ISIS for instance uses Oil to finance their war. The anarchy actually can dislocate the production discipline and lead to lower prices. But agreed with you, anarchy is not sustainable and Oil prices will eventually move up again.
Author’s reply » Emmanuel, Thank you for the kind words. The political unrest in the Middle East often leads to production disruptions, statistically speaking. And things in the Middle East are not better now than in H1 2014. In contrast, things now are much worse.
Wow!! Talk about talking up your book! There are so many things wrong with this article it makes it hard to even take it seriously. I’m wondering if this is Dan Dicker writing under a different name with his whole “Barrels at risk” theory that artificially buoyed prices for the 5 years between 2009 and now.
The author seeks to discount the additional 3.5 million barrels the US produces that were not available 5 years ago by saying the wells dry up fast and the production cost are too high. That is the true “lame thinking” here. I heard estimates that some production cost in the Bakken are as low as $29 dollars and that $70 is actually on the high end. His cost estimates are from years ago. Good ole American ingenuity drives down the cost of recovering this oil daily.
The author doesn’t deal with the death spiral that OPEC currently finds itself in. The more profligate members need a high oil price in order to maintain their spending. If I can’t make my revenue with a high oil price what is my alternative? That’s right pump more. Their state goal at this last meeting was to keep the production quotas in place. What was unsaid and the real reason oil took another dive is cheating on production quotas will reach an all time high over the coming months as these governments seek to shore up their finances.
Finally, the author displays several charts but proceeds to ignore what the charts say. We have firmly broken all uptrends and any recovery will be very difficult. I would further break his argument down but that would just give more credence to yesterday’s theory about the state of energy supplies in the world.
The OPEC death-spiral, with poorer members exceeding quotas, has been going on for at least a couple of decades, nothing new there. As far as a Bakken play that can produce for $29 and keep it there – if you find one, please share.
I picked up the $29 number from a Market Watch article written by Tim Mullaney entitled “Opec is wrong to think it can outlast U.S. on oil prices”. If that number is incorrect it’s not because I made it up. I agree that cheating has been going on since OPEC’s inception but never before have the weaker members of OPEC been in such tenuous positions with their populace which I believe will spur further more pronounced cheating.
TC: I don’t necessarily disagree with your scepticism, but apart from Saudi Arabia there is very little spare capacity in OPEC (Libya’s may be higher than the rest, but even that’s not so high and Libya is likely to have real problems for a while). So the capacity to cheat is limited, even if the will to do so may not be. I’m beginning to wonder if SA gives a toss about OPEC at all. They can’t get the other members to cut (because they will cheat), and they need not be concerned about them increasing output.
quant: you could be very well right about their lack of capacity. I have read though in the last couple days about another 300k barrels coming online from a Kurdish/Iraqi government agreement as well. My point was simply that US shale drilling cost are only dropping so that isn’t supportive of higher prices and OPEC isn’t cutting or even holding to the quotas they agree on.
While you are not wrong, I have a hard time understanding why this wasn’t presented or “paraded” 6 and 12 months ago.. Surely this has not been an overnight occurrence.
Secondly, just like in October when everybody “woke up!!” and sent the market down 10%, because NOW the world is going into recession, good call btw. I highly doubt you bears are any more correct on your reactionary projections after crude fell from $90, you must be rich predicting this stuff.
As an aside Gartman has been one of the best contrarian indicators of the past 2 years.
And just to put my money where it counts, not that seeking alpha isn’t awesome.I recently sold multiple strike puts on EOG, NOV, PXD, XOM, CLR. Implied volatility is ridiculously high, and if history is any indicator its a very high probability trade.
Good, detailed piece, even if I am running the risk of confirmation bias (I am long oil stocks). But one thing. Nuclear fusion reactor on the back of a car – that is Back to the Future, rather than Star Trek!
Edmund
A few months ago with oil above $100, I was a lonely bear calling for sub $50 oil. Now that oil has fallen $35, I have lots of company in the bear camp. Still there are lots of analysts and investors trying to call a bottom in oil prices here so i would say that sentiment is somewhat equally divided between bulls and bears here. I think we have a ways to go before oil bottoms. First, we just had a major trend break and those don’t turn around quickly. Second, most of the recent decline was in reaction to OPEc deciding not to cut output. In other words, the focus has been on supply while I think what drives oil below $40 in 2015 will be much weaker demand than is currently being assumed, fueled by a global contraction.
Both oil and oil stocks have a lot further to fall in upcoming months. There will be a far better entry point for both later in 2015. Investors would be wise to exercise some patience here and let things play out for a while. Buying the first sharp break is rarely a good idea, particularly not when there are so many signals indicating that the global economy is losing momentum.
Ironic that an analyst writes an article encouraging investors to ignore the analysts.
Oil prices will ultimately come back, until then focus on the myriad of economic sectors that benefit from cheaper energy. It should also present a great buying opportunity for a whole host of energy stocks.
This piece has too much emotion embedded in it for my liking.
Good article Digger. Whether people agree with your points or not, I don’t see how any investor could disagree with the first two paragraphs of the article. You nailed it spot on. One question though, would you care to share any specific names of shale producers that You feel will be extinct within a few years?
Please see my previous articles and comments to find my bearish calls on several energy stocks over the last months i.e. Halcon Resources (HK), Goodrich Petroleum (GDP), Cobalt International (CIE), GMX Resources (GMXRQ), ATP Oil and Gas (ATPGQ), CAMAC Energy (CAK), Pinecrest Energy (PRY.V), Midstates Petroleum (MPO) etc.
The title really sums up how stupid investors are being now. The current daily correlation between a 50 cent or $1 move in oil taking down oil stocks by a few percent is ridiculous. Dennis Gartman has no credibility, I don’t understand why CNBC has him on regularly.
Cramer needs to take my friends 100 level college logic class. The first thing my friend tells his students, on the first day is, “Getting louder doesn’t make your argument better.”
Contrarian, That is true about Cramer but the difference is that CNBC could eject Gartman with ease, while getting rid of Cramer would mean getting new anchors and having to replace his show.
Right now, small cap oil stocks should be bought for a year end rally, stocks like MDR, WG, etc could see huge gains from current levels.
Oil prices are bound to rise again… Just wait. Everoyne is getting excited over low gas prices but we all know it’s a cycle. If we’re at the bottom, you know the peak is on the way
Everyone seems to have an opinion on oil pricing and what will happen to stocks. Up – down talk gets to be nauseating. Some articles are short winded while others (this one) are long winded. One equals the other. Forgetting all of that, I thoroughly know is that I filled up my car yesterday smiling at my lower fuel bill. I also realize, OPEC be damned, oil prices present a buying opportunity both at the pump and with the cheaper share prices of the big producers. Observing more cars on our roads and those in China and elsewhere just adds frosting to the cake. What are you doing? Are you immersing yourselves in the noise presented by this article and others of its ilk, or are you adding some oil shares to your portfolio?
Couldn’t agree more, everyone in the world is now an oil analyst. Specifically, since oil has dropped considerably, they project more declines..what are the odds?!!
I think investors need to pull the trigger on stocks they wanted lower instead of watching tv for a buying signal.
Buy quality that has paid uninterrupted dividends for decades, despite what happened with oil prices. That way you’ve got whatever situation we’re in now covered. You get paid for waiting..
I agree that the ‘glut’ in supply is a bit of a nonsense and I’ve read a few articles recently lending weight to this argument.
However, the claim that $80-$100 is the breakeven for shale seems unfounded – I think it was the IEA that said that only 4% of production uneconomic under $70?
I also read a very interesting article today, I think on CNBC (apologies for the lack of sources), that discussed how transportation costs have plummeted in the past years.
It mentioned that in 2011, companies were paying up to $28 a barrel in transport costs. It is now $1-$3 because of pipeline construction.
If that is indeed the case, it is clear that a lot of shale is economic way below $70.
Gartman and his nuclear fusion. What a tool. I made the exact same point elsewhere that unless engines are replaced with fusion reactors and someone discovers how to make plastic from ‘fusion’ we will be using oil for some time to come…
I think the plummeting oil prices are the result of speculation more than any other factor but, as always, the market can remain irrational for longer than most of us can remain solvent.
I hope he’s right…that we’re not going to see a “new normal” in oil prices, but it’s too early to tell. Don’t underestimate the impact of overhead supply in oil stocks. A whole lot of damage has been done here and if we don’t see a rapid reversal, it’s going to be a long and painful thing to watch as holders bail out on any rally attempt.
It’s simple. Saudi Arabia is the only low cost producer in the world, but the rest of OPEC has costs similar to the US.
Saudi only produces 10M bbl out of 30M bbl. I predict NOCs can only withstand the pain for 6 months. after that, they can elect to exit OPEC, and form a non-Saudi cartel to sell at $80-$90 band. Saudi can sell their 10M bbl cheap if they elect to, but that’s not enough to meet global demand, so buyers will have to pay non-Saudi price.
Value Digger I do not think that Seeking Alpha is including your articles in their daily email of “Today’s articles on Energy Investing.” Or at least I have not been seeing them there.
Also: Andrew John Hall has been dead wrong for the past few years.
He is betting that the price of oil will increase. He is correct in this assertion. Everyone knows the price of oil is going to go up, eventually.
““When you believe something, facts become inconvenient obstacles,” Hall wrote in April, taking issue with an analyst who predicted a shale renaissance could result in $75-a-barrel oil over the next five years.”
“The team acknowledges that the project is in its earliest stages, and many key challenges remain before a viable prototype can be built. However, McGuire expects swift progress. The Skunk Works mind-set and “the pace that people work at here is ridiculously fast,” he says. “We would like to get to a prototype in five generations. If we can meet our plan of doing a design-build-test generation every year, that will put us at about five years, and we’ve already shown we can do that in the lab” . . . . An initial production version could follow five years after that.”
And then ramping up commercialization of fusion power, another decade? we’re looking at 15-20 years best case scenario before fusion has any affect on fossil fuel prices. This just goes to support the author’s conclusion that oil prices are low due to “lame thinking.”
Growing up, my neighbor Roy had the coolest mom. She let him put up a poster in his room of an eagle swooping down on a little mouse that had a single finger extended in the air. That visual flashed in my mind as I read this.
No chart of the relationship between the strength of the dollar and the price of oil. Is it relevant?
Oil will stay low for at least a few years the world economy is contracting not expanding and the U.S will enter a recession in about 2.5 years or so tops as part of the business cycle. Look at how oil stayed low in the 80s and 90s after being high in the 70s it was not a short term phenomena.
I agree with you; oil should rise in 2015 if not this month. I don’t see much if any downside: we all knew that opec would probably not cut production; yet when they ratified that fact, oil prices went down another 10%. The whole thing is overdone, and what went down (in this case) must go up again.
It would have been helpful to foresee this decline in oil was coming but no one did. .. To now claim we know what happens next seems not credible (again)
To all those investors who believe operators in the unconventional reservoirs can keep producing while oil prices are dropping, check out their H1 budget forecasts for negative changes in CAPEX. That will remove much of the guess work and hand waving on how profitable they expect their operations to be. They know better than the analysts and economists on when to turn the taps off.
good article.. totally agree.
gartman is the worst of the worst in my opinion. he really is clueless. I dont know why they keep having him on every other day on fast money and the like.
Its funny how media affect sentiment changes on a dime that makes everyone forget the bigger picture as you referenced above.
remember ebola and the airline stocks in october? ignore the noise.
Author’s reply » juscallmej, Thank you for the compliments. Truth is that some people had better not speak publicly so often because they shoot themselves in the foot.
Regards,
VD
That was NOT a LAME article ! Great Job! You covered a lot of material.
I think at some point sooner than the media and herd thinks that oil will bounce hard upward. OPEC made a good move to instigate a needed correction and put the industry in check. Now I think (in the short term) we will see a scary drop lower fueled by more moves by OPEC such as todays move to cut prices from SA to Asia/India and USA. SA sees India as growing and needs to subdue the fact that demand is growing. I would not be surprised if massive amounts of capital is also used to force the commodity down further to keep the herd moving ion that direction. OPEC knows that they can turn it around very quickly (just tell the world they are cutting production and the herd reverses quickly) when they need to so they are in the drivers seat for sure.
A LOT of people and greedy oil speculators will be burned by shorting at the current levels. They have to pay for their mistakes and their greed, as always.
Lot of chutzpah here. You denigrate those with opposite viewpoints, then present everything you say as “facts.” When the fact of the matter is, nobody has a perfect crystal ball. Yes, oil will go back up. Question right now is “when.” The other question, how far does it fall from here? When you can definitively answer those questions, you can invest with confidence. Let us know when that occurs. Lot of good research here if you tone down the ego.
There is nothing about ego here. You misunderstood it. I have a clear opinion that I support it with facts and links. If you have a different opinion, you are welcome to present it coupled with facts in another article. If you present speculation only, it will not help, I think.
Gartman is surely way to optimistic with his fusion forecast but a better and more immediate alternative is already here, Hydrogen powered cars. With new technical breakthroughs coming rapidly such as graphene membranes, Hydrogen will replace electric cars this decade and will start to make a serious dent in gasoline as well.
Another paradigm changing event already mentioned is China. The enormous real estate debt bubble and steel production bubble also fueled by debt has to come to a head soon. Yes, the collapse of China has been forecasted “forever” but so was the 2007 US recession which also was belittled for years right up to the edge. So was the collapse of the Soviet Union. The Chinese Govmnt has been able to keep the ball in the air because they control most of the economy but the Piper stands at the door. A Chinese economic collapse which WILL come will also collapse the oil price. Maybe it will recover some first but no energy investor can afford to ignore this.
Caveat Emptor!
I don’t know, I’m not sure of any of this, and I’m standing by my
position, firmly. [until I change it]
What I am sure of, is that this situation will change, and that change
is inevitable.
NO, I am not an analyst.
I don’t know what the price of oil will be, just look at the charts and they are still going down. China is buying up a lot of excess oil and sticking it in tankers etc.
What I want to know is a chart from the EIA on Zero Hedge showing retail gasoline sales in the USA have declined almost 75%!!!! since 2004. Then Bloomberg showed a photo of the first gas station in America selling gas for below $ 2.00. Weird that below the gas price it showed Diesel selling for $3.39 plus! The EIA does not explain that stuff well why diesel is much more expensive than gasoline.(a six cents higher tax from the Feds. low suphur costs and “demand” globally????) Then the EIA shows gasoline production in the USA has risen!!! OK that tells me big oil is exporting refined petroleum products to other countries to make tons of money off us. Killing diesel over environmental EPA type stuff for political reasons because gasoline costs more to make than Diesel even with the other factors and six cent tax, and Exxon is back in Green River developing their shale oil in situ electro-fracking method for the largest oil play on earth-TRILLIONS of BARRELS in AMERICA. All comes down to costs, the big boys games, and ignorance of the average US citizen willing to be played and fleeced.
Yes overall your article was good but there’s a lot more going on the secret weird world of big oil than any of us will understand like how in the 70’s the US “government” supposedly allowed Saudi Arabia to shut down our nation in the WINTER and I froze waiting in gas lines? The USA??? Biggest army on earth plus Standard Oil of California developed the Saudi oil???? Or that their lawyer, John J. McCloy told at least seven US “presidents” what to do and say through Reagan and HW Bush? Heck he even ran the Warren Commission with Dulles and World War 11. Harold Hamm says he can drill existing wells in the “Scoop” at 99 cents a barrel and tried to sue OPEC. He is not going to shut down next year and plans on ramping up oil production big no matter what the price is. He wants to ream OPEC and make them blink unlike the 1986 oil bust when we went broke.
All highly interesting and I am watching and going to buy back when I think oil has hit the low-could be next year though?
why are you looking at GDP growth rates when talking about oil demand when oil demand figures for those same countries are available?
I dislike articles that spend their time making fun of other oracles and then turn around and make their own guesses of what the future holds. It’s an emotional argument.
Re: “too much time spent making fun of the analysts.”
Actually, I like that part – in my nearly 2 decade experience, I’ve seen far too many investors put too much faith on analysts and it’s important to show actual real life examples where analysts are fallible also.
For example, take a look at SDRL. When SDRL was above $40, there were not many analysts telling investors to sell, the prevailing tone was “crude oil is going up, up, up, and buy, buy, buy”.. But when SDRL cuts dividends to zero at $15-$20, they are now downgrading SDRL. Buy at $40, sell at $20? I think you can go to the poorhouse very fast following these “anal-ysts”.
SDRL is not an isolated example. Today, after massive price falls, I see Zacks now telling investors to sell their energy mutual funds after these funds have massive falls …
As for the future, no one knows what is going to happen, you have to follow your own investing/trading thesis. For me, I think SDRL has fallen 75% from peak, cut dividends to zero, so, I am slowly starting to accumulate SDRL, looking to spend up to 4% capital when it finally gets down to say $7. Yes, no guarantee it will fall down that far when today is only $12, but I like the fact that it has fallen from a peak of $48 down to $12 … that’s my unsubstantiated opinion also, and probably emotional as well 🙂 And yes, I’m starting to think of accumulating when analysts consensus is to sell … it worked very well for me over the past decade ….
justforfun777: I dislike articles that spend their time making fun of other oracles and then turn around and make their own guesses of what the future holds.
———————-…
Exactly so! I am elevating my standard by lowering theirs. Sad, very sad indeed.
XOM is my largest holding; also have PBA, SE, and LNCO (oops). However, this Bloomberg article has some “paradigm shift” ideas that should be entered into the conversation. Oil is no longer the only game in town, and that has to be considered. Also, just because our politicians refuse to take climate change seriously, doesn’t mean the rest of the world isn’t taking notice and preparing to do something about it:
Here is the link to Lockheed-Martin’s compact fusion announcement. These researchers/engineers are the best of the best, I would think, so if they’re making an announcement, they must have something legitimate up their sleeve, I would think:
Interesting article on Fusion, nice read.
However, the recent crude oil price fall down to $66 is most likely unrelated to Lockheed-Martin’s fusion piece, as that piece seems more about promoting Lockheed-Martin in research and what they think they could achieve in 5 years time, and still not yet confirmed …. but good to cast a quick glance from time to time on these sort of things ….
If Lockheed-Martin managed to bring this to commercial production at small enough sizes at reasonable prices (that’s a BIG IF), then, I think we first see Lockheed-Martin’s stock price zooms up first a lot more than what we’ve seen so far, before we see global crude oil prices comes down significantly … that’s just my gut feel …
PS. Regarding “paradigm shifts”, I would treat that with a huge grain of salt. In 2008, crude oil fell from $147 down to $33, and a lot of articles came out with “paradigm shifts”. If you had invested in crude oil counters then, you would be laughing with +100%-+400% gains when crude makes its way back up to $110 in just 2-3 years …
There is no guarantee we’ve seen bottom in crude yet, but I feel we are now entering a period where Value Investors should start to feel excited on some of the high quality issues that are beaten up hugely, to trade below NAV and trade well below Replacement Costs …
TF: Thanks for your response. I agree, the LMT fusion concept probably has nothing to do with the drop we’ve seen, and any shift would be sometime down the road. Yet, these things sometimes land on your lap before you realized they would.
I haven’t sold any of my oil stocks, but I haven’t added yet, either. Would love to buy some LNCO to bring down my cost basis, but I’m concerned they’ll have to cut, or pull a Seadrill and eliminate, their dividend.
After I read your article http://bit.ly/1thepsy, I was quite impressed with your reasoning and knowledge.
I have been waiting for a follow-up and this seems to be the one.
Again I am impressed by your knowledge and your reasoning but I’m a bit disappointed too. Especially by not addressing points 3 and 4 of these 8 major reasons.
CheeseLover: Again I am impressed by your knowledge and your reasoning but I’m a bit disappointed too. Especially by not addressing points 3 and 4 of these 8 major reasons.
———————-
Just to refresh, points 3 and 4 of these 8 major reasons:
3) The weakening of the U.S. dollar.
4) OPEC’s decision to cut supply in November 2014.
Agree this is very much a TITANIC cruise ship that will take a few miles to turn … apparently, the weekly US Oil production figure need to show 2 to 3 consecutive week of decline at the very least first. Until then, odds are crude oil will keep falling (short term momentum). I now feel we may be close to bottom, but we are not confirmed there yet, and I won’t be surprised if crude makes $30 very briefly, before a strong and fast recovery once a few of these marginal producers are out of the picture …
Just as Saudis and US are stubborn right now to curtail production, in a year’s time when a few of the US producers goes bust, the Saudis will have achieved their objective and cut production, and just as quick, I see crude oil could rise back to $100 very fast … the US production numbers are always a surprise to markets, I expect the Saudi’s response to also be a surprise to the market when they cut back production in 6-12 months time – those looking for signs will not find it, I believe it will be a surprise to the market when it happen anytime within the next 12 months …
“Also, the world’s biggest oil consumers are growing at rates that either are in line with 2013 rates or exceed expectations. There is nothing to indicate that global supply and demand imbalance has fundamentally changed in the past six months.”
Whilst I agree with your base thesis and believe that the price of oil is going back up to what are more “normal” levels, some of the biggest consumers of oil on the planet are likely going to use less-and-less of it as time goes on. For example, there are pretty strict rules in place for future vehicle mileage requirements in the US, the EU has been clamping down hard on emissions for a pretty long time and lots of companies are now involved in the business of making energy efficient equipment and machinery. The list is long – GE, Siemens, Caterpillar, Deere, Hitachi, Volvo, Komatsu…..and so on.
The historical environment for oil consumption is becoming more-and-more dated when compared to what the oil consumption environment will look like going forward. It’s hard if not impossible to use the past as an accurate guide to the future.
The future oil consumption environment in two words – different and lower.
raj,
If you are short on crude oil, I don’t see a reason why you need to close your shorts now as crude keeps falling. You should only close it when you see a confirmed uptrend, at least, that’s my view.
Value Investors though are a different breed – they ease their way in specific value stocks, and now, many oil related stocks are trading at below NAV and well below Replacement Costs with strong cashflows during the last oil crisis … these stocks could still fall by another 25%-50% or close to bottom, no one really knows and so, they start to accumulate a little bit at a time … history has shown that crude oil will eventually recover, and they could be looking at +100% returns in 1-3 years time … the Value approach does not require market timing, and crude oil being highly cyclical in nature means we will definitely see $80-$100 crude oil again eventually over the next 1-3 years, we just don’t know exactly when. If it goes back to $100, you can be sure many of these crude related counters will go back up to their former levels, potentially 100%-300% gains …
Mr Market has presented a compelling opportunity, the key is Money Management, accumulate a few high quality counters, and once bought, lock them up in a drawer and don’t worry about the daily price volatilities. In 1-3 years time, the gains of +100%-300% can be had … know the strategies in advance, never allocate more than 15%-20% portfolio to oil related counters at the bottom, and certainly, never go on margins. I have been staying cash majority of my portfolio, I just recently allocate 2% capital on oil counters, and plan to slowly work my way to 15%-20% assuming these stocks could fall up to 50% from current levels … This is a no-brainer approach, I just don’t care about the daily price volatilities.
I’m eyeing SDRL – originally, I plan to go in with 4 bullets, at $13.50 (already done), $11, $9 and $7 very roughly speaking, but now, I will most likely try to take advantage of the short term down momentum (I am a trader) to cut loss some and take wait to pick it up at lower prices, and wait for a better technical signal. Allocating just 4% capital for SDRL.
The other 2 counters are HP (this is a Dividend Aristocrat that keeps paying higher dividends every year for over 25 years) and NE (this is a nice Value play), but I haven’t triggered any buys in either yet as Crude keeps falling and the counters keep falling … Again, 4 bullets each, total 12% capital when I’m done all the 3 buys at the bottom.
Originally, I plan to make a “simple” buy approach of just buying at set levels, but the more I study the crude markets fundamentally, the more I realize that I can fine-tune my entry better, so, let’s see if this is successful or not …
Glad you didn’t go for futures / options with time expiries – I just don’t know how long these crude oil price can fall – it can keep falling and falling, and the bottom and recovery I believe will be a huge surprise to me.
Personally, I prefer safer, large caps, very liquid stocks that institutional buys with average daily volume greater than 500k to 1000k shares, and try to buy using a combination of writing puts and directly, and sell covered calls also.
Whilst my current list is SDRL, HP and NE, if I find something else better, I’ll most likely drop one for that …
Oil company stock valuation is based on EV/B/D; EV/EBITDA and EV/Reserve; It does not matter whether large cap or debt; In case of low rev they can always curtail drilling and be very liquid to pay down debt. Worse come worse they will sell their reserves for better price than current valuation. We just bid on various leases offered by Chevron and we did not get it as there are numerous buyers willing to pay higher price.
This is an awful lot of cut and paste combined with high handed comments intimating the writer is a genius who knows more than everyone else. It is not original analysis. The fact that so many comments suggest this ois “excellent analysis” goes a long way toward explaining the somewhat sad state of oil and gas investment. I’m not hating, but re-read this article. It is just not analysis. Period.
That’s impossible to call.
One could make educated guesses based on the geopolitical actions/goals of the major oil producing countries, changes in demand, etc.
I’d rather see oil stay around these levels for a while as I accumulate.
What’s interested me is the issue of sovereign debt and reliance on oil revenues for certain countries.
Looking at Venezuela and Iran for example – the oil price before the crash, at it’s peak…was nowhere near the quoted figures given for these countries to approach break even; so who goes broke first…small shale producers in the USA or the countries that need $150 oil to just break even, or do they just continue to go broke forever?
I don’t think the OPEC decision is targeted solely at US shale plays…there’s others that are in far more pain over this, the rest of the global economy benefits while oil producers suffer a small but probably needed shakeout: I’ve got investments in oil but it’s ok to lose paper money on one part of the portfolio if another part benefits… I think sovereign default would be a lot worse for everyone involved. Oil will go back up in price eventually, and the median price will rise over time as the asset depletes. When is actually not that important unless you need your money tomorrow.
” On top of that, there are some additional geopolitical clouds on the horizon that can make oil jump by H1 2015. For instance, the current low oil price has brought many OPEC members to their knees, while the holders of those countries’ sovereign debt are toast as long as oil stays at the current levels. Iran, Iraq, Libya, Algeria and Venezuela are not prepared to withstand low oil prices for long and they are now in serious danger of political upheaval at current prices.
According to yesterday’s news from CNBC, the first signs of an escalating social unrest in Venezuela are already there, and things will definitely get worse over the next weeks.
Furthermore, Russia and Saudi Arabia will be anxiously watching the rapid depletion of their sovereign wealth funds, which will make the political situation in these two countries dicey over the next months. “
What will be quite interesting to see is if all of the pundits are correct regarding shale production being a “Ponzi scheme” etc.
The sharp increase in production in the US over the past 5 years is simply amazing, however, it would be interesting to see what the overall average decline rate is for the US over the same time period.
I’m inclined to believe that the decline rate is substantially higher in part due to the tremendous number of unconventional wells that have been drilled in the past few years and the fact that they are in the steep part of the decline curve. So, while production has been climbing, it seems that the Saudi’s are hoping to curb drilling and therefore let the decline curve catch up with the industry. With a sustained drop in prices, eventually borrowing base redeterminations will result in at least a moderate decrease in drilling, perhaps even drilling within cash flow!
Also, while my opinions mean very little, I think it is important to point out somewhat misleading comments about certain plays being profitable at $40 or whatever they want to insert. Yes, if lease operating expenses and field level costs, transportation, ad valorem etc are $25-$40 per barrel, then those wells will be cash flow positive as long as pricing remains above that price.
However $25-$40 oil will not provide a decent IRR for new wells. Remember most of these shale wells exhibit very high initial production and have sharp hyperbolic type declines. Producers need to get full payout in the first 12-24 months. Wells might decline 60-70% within the first 24 months. Look at the NPV of many of the Bakken wells at $60/bbl. Not nearly as attractive as when they were $100.
I don’t know what oil pricing will do in the next few months, nor do I know what OPEC and the Saudi’s will do in 6 months. I do however believe that US oil producers will eventually have to reign in drilling budgets as cash flow wanes. I don’t know if that will mean production growth will taper, if production will hold steady with new production offsetting natural decline or if total US production will slowly decrease. I do know that it will be interesting to see it unfold.
And while my opinion isn’t worth much, I believe that we will eventually find some happy medium where US producers can achieve decent IRRs and production can grow modestly. My guess is $75-$80 bbl.
I thoroughly enjoy VD’s articles, despite the fact that now all 4 of my positions initiated based on his recommendations are down from 30-60%. I still value them because their fundamental analysis, as outlined by VD, shows that they are still good investments; I will hold onto them for the long term.
While VD is great at pointing out value, guessing what will happen to the price of oil will always be speculation. I like the argument given here, but the truth is that no one really knows.
Investors in oil-producing companies should do so because they believe that their fundamentals will allow them to be successful and profitable in any environment of oil pricing.
Thanks for your reply. One of the things I appreciate about your articles is always standing by your track record. Given that, here are some of your picks from this year:
CAZFF Recommended 5/15/14 – market price $0.30, currently at $0.14.
PTAXF Recommended 8/26/14 – Market price $0.38, currently at $0.14
LNREF Recommended 6/7/14 – Market price $0.35, currently at $0.19
They have all experienced significant losses (on average 52%). However, I agree that I am not a day trader so if I liked these companies enough to buy them, I would still hold on as long as the fundamentals have not changed. As Buffet said, if you aren’t willing to lose half of your investment in the market, you shouldn’t be there.
I remain long, but the simple fact is that there have been some significant losses in the short term.
Rrb1981, agree $40/bbl would probably cover variable cost and thus existing producing tight oil wells would not be shut in. But you are right that much higher price needed for new wells to be economic. From what I Recall best locations in Baaken formation could probably be economic for new wells at $65, maybe a little lower. Eagle Ford would be something like $55, believe Niobrara in between. But, many wells have been drilled in less productive parts of these formations and those need much higher oil price to be economic. Again, these are rough, directional estimates. In reality production techniques keep improving, and some companies are will better, or have better locations, than others.
My view is some new tight oil wells would still be drilled if oil stayed below $70, but likely not enough to overcome the rapid depletion from existing wells. I believe we will start to see US production drop sometime in H2 2015, but until then US production keeps going up. Think it will take maybe 6 months for wells already committed to be drilled and completed. After that market should at some point get back to $80-$85, maybe 12 months. But likely to be a volatile ride along the way. I personally think we have not seen bottom yet. Too much downward momentum, global oil production likely to keep increasing for the near term.
Best to prepare for the volatility and try to recognize the opportunities as they play out, IMO. So many things could intervene ( geopolitics, global economic activity, China credit, etc)!
Excellent article Value Digger, I share your outlook on oil as well. I would strongly advice reading this article as well in regards to the significant risks of $150B in cancelled oil capex in 2015 and a subsequent supply crunch later in the decade. At current prices up to 12.2m barrels in new supply are at risk between today and 2025:
The one and singular reason that world oil prices have collapsed is that U.S. shale production has gone from zero to 5 million BOEPD in 5 years.
If this 5 million BOEPD were not on the world market today, where would we be?
We would be short on oil.
Instead, we are long on barrels because every dumba** American oilman that drills a good well immediately turns around and puts all of the cash flow from his good well into ANOTHER well. Plus he borrows a few million bucks to drill a few more wells.
How else can you explain the unprecedented exponential oil production growth in this country?
I wish these geniuses would spend their profits on wine, women, song, jet airplanes, country houses or something, besides plowing every single dollar of profit back into the ground.
This is all about the Ukraine. Saudi is the US’s bitch and driving down the price of oil is simply to put the hurt on Russia. Price of oil will bounce back once Russia gets the hell out of the Ukraine. As far as the laws of supply and demand all you need to do is take a look at copper. The LME is sitting at a 5+ year low and the price is below $3. Don’t make the mistake of thinking the markets make any sense. Listen to technicals.
Good article. This market is not for traders, but for real investors. When you are a true investor you must be cool, sober, analytical but especially well informed. This is exactly what Value Digger is doing. I think his analysis is excellent and his <<cool blood>> will win in the end. Do you really believe that the oil sector will be destroyed? I don’t. But careful don’t spent your OWN money at once, keep them for worst times. There is no other way to make money in these markets. Value Digger you have my respect.
Value Digger, thank you for another informative article of Petroleum production, pricing and demand. The amount of comments is indicative of your timely in depth analysis.
You make a statement in your piece that sums up your whole thesis: “new oil is not cheap.”
Any way we look at the supply situation, most new production will continue to come from expensive unconventional means such as shale or tar sands. Surely there are new conventional pockets of crude to be found, but they won’t be Elephants and will probably be expensive “deep water” reservoirs.
Petroleum remains a key product for Global Energy & Industrial production and current low prices will NOT allow future demand to be satisfied.
In a recent interview with Jim Cramer, Boone Pickens stated that the Saudis will eventually have to cut production. (my comments: OPEC will not survive if the Saudis let Venezuela, Iran, Algeria, Nigeria, Libya, as well as Russia descend into chaos. Not to mention destabilizing an already fragile world economic situation. When the Saudis cut, oil will soar.) B.P. also stated that the producers will be forced to cut CapEx. As they do US production will come down. Based on this, B.P. thought oil would rebound to $100 by mid-2015. Most people will dismiss Boone Picken’s comments. But when a wise old billionaire oilman speaks, I pay attention.
I think most oil services companies will have a rough 2015 (buying opportunity for HAL, SLB). Also, highly leveraged small producers may be forced into bankruptcy, but stronger producers will benefit by picking up their producing acreage and reserves for pennies on the dollar.
Brett, I watched the same interview and although his projects over the past several years have not really been home runs, this slump in pricing is certainly not his first rodeo! As you aptly stated “when a wise old billionaire oilman speaks, I pay attention.”
Thanks for the food for thought.
Regarding Syria, it seems clear the US has opted to fight a war of attrition in northern Iraq rather than cut the head off the snake in Syria. This approach takes care of a number of problems (high casualties on both sides) and is training a whole new generation of US pilots and drone operators.
I take your comments regarding portable fusion to be light hearted because the neutron flux off such reactors would kill everyone in the car.
The greatest proof against Fleischmann–Pons knuckleheaded claims of nuclear fusion at room temperature was that they were alive at the announcement. The thought that Fleischmann & Pons conducted such an experiment in an occupied building should have been grounds for dismissal or incarceration.
LMT is relying on plasma (not room temperature). This compounds the problems with having some random drunk driving around with a nuclear fusion device. Perhaps LMT can make electricity that is too cheap to meter, which would be big, but it is just speculation and not 5 years away.
In the end, the House of Saud is still in control of the price of oil. Thank God the Iranians are not in that seat.
By the way, in 1938, the US producers predicted the US has a 10 year supply of oil. I think producers can only see ten years ahead.
It confirms what I have been thinking, although without the sources that you cite!
Geo-politically, the world is a much more uncertain place at present! As for the pace of economic activity in the U. S. and elsewhere, the numbers are always after the fact! Can’t measure what hasn’t happened yet! Prognostication is fine for what it is, but it is just that- a guess, however educated!
Oil prices may have further to decline, I don’t know, but the value of some of the oil stocks, I find compelling at these levels.
‘Funding problems are increasing dramatically. We think Russia is now flirting with systemic problems,’ said Danske Bank
The currency has been in free fall since Saudi Arabia and the Gulf states vetoed calls by weaker OPEC members for a cut in crude oil output. ByAmbrose Evans-Pritchard,The Telegraph
The Russian Rouble has suffered its steepest one-day drop since the default crisis in 1998 as capital flight accelerates, raising the risk of emergency exchange controls and tightening the noose on Russian companies and bodies with more than $680bn (£432bn) of external debt.
The currency has been in free fall since Saudi Arabia and the Gulf states vetoed calls by weaker OPEC members for a cut in crude oil output, a move viewed by the Kremlin as a strategic attack on Russia.
A fresh plunge in Brent prices to a five-year low of $67.50 a barrel on Monday caused the dam to break, triggering a 9pc slide in the Rouble in a matter of hours.
Analysts said it took huge intervention by the Russian central bank to stop the rout and stabilize the Rouble at 52.07 to the dollar. “They must have spent billions,” said Tim Ash, at Standard Bank.
It is extremely rare for a major country to collapse in this fashion, and the trauma is likely to have political consequences. “This has become disorderly. There are no real buyers of the Rouble. We know that voices close to president Vladimir Putin want capital controls, and we cannot rule this out,” said Lars Christensen, at Danske Bank.
“Funding problems are increasing dramatically. We think Russia is now flirting with systemic problems,” he added.
Some Russian banks have already started limiting withdrawals of dollars and euros to $10,000, an implicit lock down for big depositors.
Rouble against the dollar since December 2012.
Russian premier Dmitry Medvedev said 10 days ago that capital controls are out of the question. “The government, myself, my colleagues and the central bank have repeatedly stated that we are not going to impose any special restrictions on capital flows,” he said.
Ksenia Yudaeva, the central bank’s deputy governor, said the authorities are battening down the hatches for a “$60 oil scenario” lasting deep into next year. “A long decline is highly probable,” she said.
Russia has lost its ranking as the world’s eighth biggest economy, shrinking in just nine months from a $2.1 trillion petro-giant to a mid-size player comparable with Korea or Spain.
In a further setback, Mr Putin gave the clearest signal yet that the South Stream gas pipeline – intended to supply Europe without going through Ukraine – may never be built. “If Europe does not want to carry it out, then it will not be carried out,” he said.
Oil and gas provide two-thirds of Russia’s exports and cover half of its fiscal revenues, a classic case of the “Dutch Disease” that leaves the country highly exposed to the ups and down of the commodity cycle.
Protracted slumps in crude prices crippled the Soviet Union in late 1980s, and caused Russia to go bankrupt in the late-1990s. “The Rouble will not stabilize until oil does,” said Kingsmill Bond, at Sberbank.
The bank said Russia faces a mounting deficit on its capital account. The country is no longer generating a big enough trade surplus to cover capital outflows. Sberbank warned that reserves are “likely” to fall to levels that ultimately require capital controls, unless Western sanctions are lifted.
While Russia has $420bn of foreign reserves, this war chest is not as a large as it seems for a country with chronic capital outflows that relies heavily on foreign funding. Lubomir Mitov, from the Institute of International Finance, said investors may start to fret about reserve cover if the figure falls to $330bn.
The Rouble’s slide has led to fury in the Duma, where populist politician Evgeny Fedorov has called for a criminal investigation of the central bank. Critics say the institution had been taken over by “feminist liberals” and is a tool of the International Monetary Fund. The office of the Russia general prosecutor said on Monday it was opening a probe.
The central bank has refused to intervene to defend the Rouble over recent weeks, letting the exchange rate take the strain rather than burning through reserves to delay the inevitable, as Nigeria and Kazakhstan are doing. It squandered $200bn of reserves in a six-week period in late 2008 and triggered an acute banking crisis, learning the hard way that currency intervention entails monetary tightening.
By letting the Rouble fall, it shields the Russian budget from the slump in global oil prices, though not entirely. Deutsche Bank said the fiscal balance turns negative at crude prices below $70.
Yet the devaluation is causing prices to spiral upwards in the shops and may at some point cause a self-feeding crisis if it evokes bitter memories of past currencies crashes. The finance ministry said it expects inflation to reach 10pc in the first quarter of 2015.
There is already a dash to buy washing machines, cars and computers before they shoot up in price, a shift in behavior that signals stress.
The Rouble slide is ratcheting up the pressure on Russian companies facing $35bn of redemptions of foreign debt in December alone, mostly in dollars. Yields on Lukoil’s 10-year bonds have jumped by 250 basis points since June to 7.5pc.
Most Russian companies have been shut out of global capital markets since the escalation of Western sanctions, following the downing of Malaysia Airlines Flight 17 in July. They are forced to pay back debt as it comes due, seek support from the Russian state or default. The oil giant Rosneft has requested $49bn in state aid.
Sberbank said companies must repay $75bn next year in dollar debt and cannot hope to roll over more than a tiny sliver of this. Nor can they expect more than $10bn of fresh capital from China.
The bank said there are companies that are profiting nicely from the devaluation, since they sell abroad yet their costs are local. These include the base metals groups Norilsk and Rusal, as well as steel producers, and fertilizer groups such as Uralkali and PhosAgro. “Some of these are making a lot of money right now, and their stocks are flying,” said one trader.
The Russian equity index is trading at 0.5pc of book value. Rarely has a market ever been so cheap.
by Olivia Pulsinelli
Oilfield worker on a rig
Source:
by
Easy Money Martin 
The reason oil stayed as high as it did was the fact that India and China subsidized it. The fact that China passed the US in imports misses the point. China uses 36mm boe in coal every year. They manufacture 700 million tons of steel versus 40 in the US. This is due largely to $5 trillion in QE. In the process of this absurd borrowing, they have wiped out most of their neighbors.
Earnest and Young estimates that there is 300 million tons of excess steel capacity in the world and China is STILL building new capacity. That 300 million tons is assuming China continues to use 640 million tons internally. Once countries start to protect their steel producers, China is going to collapse. Steel requires 11 BOE of energy per ton. 300 million tons is the equivalent of 10 million BOE of energy per day. If there’s a recession, you could see total energy use drop by 15-20 million BOE per day.
Demand isn’t what people want, demand is what they can pay for. Once the wold starts defaulting on this junk corporate debt, petroleum demand is going to collapse. The last time we went through a shock like this was 1982 and 6 million BPD of demand came of the market. This one is going to be far far worse. You could easily see oil go to $50 and stay there for a decade. According to Evans-Ambrose Prichard, Jim Chanos and Kyle Bass, China is going to collapse.
” The recovery of the oil price will be much quicker than the recovery of the real estate sector, given that this slump of the oil price has been driven by lame thinking, arbitrary speculation and sentiment, while having nothing to do with evaporating geopolitical risks around the world or a material deterioration of the global supply-demand fundamentals”.
and this one:
” In fact, the rapid decline has already started. First, the Energy Information Administration said yesterday U.S. crude-oil supplies declined 3.7 million barrels on the week ended Nov. 28. Analysts surveyed by Platts had expected crude inventories to increase by 380,000 barrels on the week.
According also to today’s news from Seeking Alpha, new permits, which outline what drilling rigs will be doing 60-90 days in the future, showed heavy declines for the first time this year across the top three U.S. onshore fields: the Permian Basin, Eagle Ford and Bakken shale. Specifically, there is an almost 40% decline in new well permits issued across the U.S. in November 2014, with only 4,520 new well permits approved last month, down from 7,227 in October 2014. “
I did not actually expect such big declines so soon. Both declines really surprised me. How long can an investor remain in denial?
“China is going to collapse.”
People have been saying that for around, well, forever.
How many people world-wide have been sitting on the proverbial sidelines at $100+ oil? Waiting to start or expand a biz. Waiting to buy a car?
All of a sudden, poof, 40% off on the COGS!
Possibly a big demand shock coming.
Answer: None.
Most people (Americans) can’t even tell you who Ben Franklin was, much less tell you the price of oil.
They can’t even remember how much their last tattoo cost them, or their boyfriend.
Nonetheless, I don’t buy some of the talk I’m reading on the internet that “the US shale drillers will keep right on going with oil at $65”. That idea is just totally ridiculous. The operating cash flow generated by US shale producers will decline dramatically if oil stays below $80 and they won’t be able to raise nearly as much capital because of lower stock prices and substantially higher yields required to sell bonds. So US shale drillers will be forced to cut back on drilling activity because of a simple lack of capital and cash flow to pay for horizontal drilling, which is expensive. This big drop in drilling activity, which will happen for sure if oil stays below $80, should cause US oil production growth to drop sharply in the first half of next year and that drop will probably cause the oil market to correct back up into the 80s by the second half of next year.
I’ve been surprised that the Saudis have been willing to let oil prices fall all the way below $70. I’m starting to wonder if anyone really knows what oil price they need to balance their national budget. Same thing with the Russians–it’s difficult to get good credible information from the Middle East, South America, and Russia about national budgets and other subjects like what kind of oil production technology they’re using today and what their marginal cost of production is today. Do Wall Street analysts and those sleepy international agencies in Europe really know what’s going on in the Middle East and Russia? I’m starting to wonder.
Thank you for your compliments. The huge divergence between the reality and the market perception is more than apparent in the oil markets now.
The geopolitical risks have worsened compared to 2013 and H1 2014, the GDP growth rates in 2014 are at or above expectations in the world’s largest oil consumers compared to 2013, while the crude inventories and the new permits have already started to drop rapidly. We talk for a 40% decline here.
To me, this is the definition of: THEATER OF THE ABSURD.
Let’s see how long this THEATER OF THE ABSURD will go on.
Regards,
VD
Thank you for your compliments. As mentioned above, what is going on now in the oil markets is the definition of the: THEATER OF THE ABSURD.
Let’s see how long the oil bears will keep behaving in this irrational manner trying to make money at the bottom although the facts are not there.
Regards,
VD
Re: “I don’t buy some of the talk I’m reading on the internet that “the US shale drillers will keep right on going with oil at $65″. That idea is just totally ridiculous. The operating cash flow generated by US shale producers will decline dramatically if oil stays below $80 and they won’t be able to raise nearly as much capital because of lower stock prices and substantially higher yields required to sell bonds”
If oil price keeps going down, and I’m a shale driller with sunk cost already, wouldn’t I want to try to keep pumping MUCH, MUCH more first to try to keep my fixed costs even lower, to try my best to survive, before the inevitable happens? In other words, I think we might just be seeing the beginning of the price fall … sure, 6-12 months down the road, we’ll see some real bust happening (not all producers have enough liquidity to last 6-12 months), but the time from today to the next 3-6 months could be really painful for longs … before they cut production, I think, they’ll try to produce a heck of a lot more to try to survive, before the financial constraints starts to work – remember, financials have many avenues, some will still pump more, borrow from banks to suvive, etc. i.e. we could be looking at 6-12 months pain before recovery, before the banks finally say enough is enough, before capital markets starts to rate the bonds as junk, etc. These process could last a long time, and until then, we might be seeing continued increased weekly production which will keep depressing crude oil prices …
Originally, I plan to go long on crude oil stocks, but I’m now thinking of holding back my longs until I see a real bottom in prices. I like to see US production slows down for 2 to 3 weeks in a row, and right now, we are just not seeing this happening at all – US producers keep producing more oil every week, and with Saudis not cutting down, the supply of oil on a weekly basis keeps going up, and prices inevitably must come down … I have a feeling, $65 will not be the immediate bottom yet … but let’s see …
I do think there is a temporary glut of supply that triggered the decline, coupled with the obligatory unwinding of long positions…crude prices may capitulate further, but they won’t stay down for long. The tricky part is staying patient and waiting for a tradeable bottom, and separating the long term winners from the ones with excess leverage and poor fundamentals. We know the hedge funds are herd animals so expect more piling on of short positions to drive crude lower.
I am getting sick when I see how quickly all these highly paid “gurus” change their mind depending on which way the wind blows, while ignoring the facts. And they behave like parrots repeating the words and imitating the actions of another.
This is why, I felt the need to write this factual article that clearly demonstrates what these “gurus” were telling us in 2013 and H1 2014, and what could drive prices at $150/bbl.
Also, separating the wheat from the chaff is something that ALL the investors must do now. They must NOT make the mistake to load the heavily indebted energy companies because it will be a “dead cat bounce”, if these companies ever bounce back.
Regards,
VD
I greatly value your research, time and effort put into you articles.
However, timing is everything. This piece feels desperate. I have read a lot of details on the subject of late and there were many signs of this slump in prices coming that were not accounted for by those who only see oil prices as going up.
Prices go up and they go down. I don’t see the compelling evidence that it will suddenly go up soon.
Just pull up the price charts of crude oil over the past 20 years.
You’ll see this current price drop is the 2nd longest drop over that period.
The only time when crude had a bigger drop was back in 2008, from a peak of $147, down to a low of $33, near the 200 month MA. Today, we are near the 200 month MA as well which is currently around $60-$65 … we can’t time it precisely, but over the next few months, I feel we are close to the current bottom, and it makes sense to pick good quality issues relating to crude oil, and slowly work your way inside. Never go on margin, this is really Value Investing at its finest, and if you are not scared, you are not doing Value Investing properly – I won’t bat an eyelid if the purchases made this week drops by 50% more at the bottom, because history has shown that they will rise much, much more. I’m looking at +100% gains over the next 1-3 years at the least …
Demand for oil in the six segments that simply cannot stop are impervious to economic slowdown (plastics, oceangoing freight, train freight, fertilizer, aviation, modern armies). Regardless of consumer slowdowns, these six segments represent 80% of oil and net gas consumed around the world. When economies slow down, the food, freight, aviation and military segments do not, they continue on. A recession in Europe or China would only slow the rise in demand, not reverse it. Look at the demand trend of the past year and understand that even if demand only rises at one half the slope is has followed from 2004 until now, it will still outstrip current expected global production for Q1 2015. Oil price strip is highly elastic to tiny percentage changes in the supply-demand balance. Current situation is creating the coiled spring and that coiled spring WILL unwind before the end of 2015.
We just hope it is a measured controlled unwind throughout the year, otherwise we will have the $140 spike we saw in 2008 for a month or two before settling down to something in the $90 – $100 brent range.
Set your DCF and NAV models for $90 brent / $85 WTI. This is going to get ugly before the weather gets cold again in 2015. I’m willing to go out on a limb and say you can quote me on this one.
Here is the reality when Brent is $70/bbl for more than one or two months…
1. Venezuela is cash flow negative and cannot make coupon payments on its foreign debt. Venezuela WILL default on its debt before end of 2015 in this price regime.
2. Iran cannot feed its army at this price. The mullahs depend on the support of their army to maintain power. Kicking this leg out from under the government stool makes their continued existence precarious. Martial law kind of precarious.
3. The government in Tripoli cannot feed their guard at these prices. If the government in Tripoli cannot do this, they cannot protect the pipes that carry crude to their northern port. When that happens the other government in the west breaks through and shuts the pipe down to prevent revenue from reaching the Tripoli government and thereby trying to strangle it. 800,000 bbl/day go off stream.
4. Saudi Arabia is burning $2b/month from their sovereign wealth fund. At that burn rate, the ENTIRE sovereign wealth fund runs dry in 60 months. They need to turn the boat around long before that happens because if they burn through more than about 25% of it, angry men with beards and automatic rifles start to hang around the palace gates. Not a stable internal situation. Riyadh has made major financial promises to its citizens in return for peace and their support. And in Saudi Arabia, the citizens do not have peaceful protest marches when they are aggrieved.
5. Russia is burning $2.5b/month form their sovereign wealth fund. At that burn rate, the ENTIRE sovereign wealth fund runs dry in 48 months. They will tighten their belts, suffer, freeze, grit their teeth and tough it out. BUT! (and this is a big one) understand that at the back of the mind of every strategist in the Kremlin is the nagging thought that all they have to do to cause a global geopolitical crisis and force the price of energy to whipsaw back up to $100/bbl in the course of a week is to kick the hornets nest: Roll the tanks into Donetsk and Lukhansk. Overnight crisis and EU buckles because it is now winter and Germany will freeze without the Ukrainian transit gas (Nordstream can only supply about one third of what Europe needs to stay warm).
6. I can’t even begin to fathom what the dynamics going on in Syria / Iraq are right now, but it can’t be good. I’m sure Baghdad had to guarantee Kurdistan a minimum cut in the negotiation to let them export. Well, either Baghdad or Kurdistan is not going to get that minimum cut agreed in that negotiation. How do you think things are panning out in their relations now?
This situation has the makings of a new Arab Spring / Cold War settling in… and it cannot remain in equilibrium for a whole 12 months.
Thank you for your comment. But, my article is full of facts as always. If you disagree with the facts, it is your choice.
Regards,
VD
Thank you for your compliments. Good luck with your investments.
Regards,
VD
Oil Bears and Analysts are driving the oil price down with their unrealistic attitude towards:
a) Negative growth;
b) India’s energy appetite; and
c) The fallacy of Nirvana in the Middle East.
Not to mention that Pick-Ups and large SUVs are back in vogue in North America…
I also believe that Putin will rattle his sabre and agitate conflict somewhere, to raise uncertainty and thus prices – if the drought in Oil prices remains lower much longer. After all, the fall in the price of crude in the mid 80’s (and Reagan) brought the USSR to its knees. He will not repeat that. Guaranteed.
Waiting for a firm bottom – then backing up the truck for more PTA.
No one will know the absolute bottom, at the “Hard Right Edge” of the charts. Bottoms are only know once some time are passed, and by then, you won’t be able to buy at the bottom price. That’s the reality of prices. The key is Money Management – always make sure to have enough cash to buy at lower prices when bargains avails themselves. For highly cyclical stocks, a rough yardstick is 75% fall in prices from the peak for decent names. E.g. SDRL is one that I think could be interesting – peak price was $48 in 2013, and is now trading near $12, or 75% fall. I would allocate around 4% of my portfolio to this, to be split into 4 bullets, and have actually deployed first bullet at $13.50. I’ll be looking for a final buy price of around $7 (approximately 50% fall from my first entry), and these types of buys are just put into the drawer and forget. When the drawer is opened in 1-3 year’s time, you will most likely earn anywhere from 50% to 100% gains or more.
Meanwhile, have the stomach to see the value of what you bought dropped by 50% from what you purchased. Don’t ever think about selling then, because the Reward to Risk of holding is much, much better.
And diversify into 3 issues at the very least, so that total exposure to crude oil is no more than say 12% trading capital. I am just very cautious, but of course, at the very bottom, for the 4th buy, you could double or triple the buy size and raise the 12% up to say 15%-20% capital … but these type of substantial increase must show capitulation, i.e. big price drops with big volumes …. (SDRL has shown the first capitulation last week and this week, and usually, there’s more than 1 capitulation). And if you are a nimble trader, you would also consider adding on the way up, e.g. when Weekly RSI(14) crossed above 20 and Daily RSI(14) dropped back down to around 30-40 or so ie. dipping on the way up, if you are worried that you only have 3% capital in this during the bottom.
PS. SDRL falls into my screen, because at $13.50, it is trading at NAV, and well below Replacement Cost. So, if it falls to $7, that would be trading at 50% NAV approximately, and is good enough for me.
Thank you for your compliments. Also, good luck with PTA (Petroamerica Oil) which is debt free with a pristine balance sheet, as shown in my previous articles.
Regards,
VD
Warren Buffett has said more than once that he has NEVER managed to buy at the bottom and sell at the top. Nevertheless, he is a billionaire.
Regards,
VD
– more and more suppliers will go out of business or reduce supply
– consumption and hence demand will rise if oil is that cheap.
There are a lot of factors at play as you well demonstrated – geopolitical, GDP growth, but also competing energy sources (and I’m not talking nuclear fission, but renewables). But the overriding factors appear to be speculation and herd behaviour. And we all know they can only go for so long into one direction.
Thank you for your compliments.
Regards,
VD
Also, not all shale formations are so thin as to horizontally support only single laterals. Some, like the Wolfcamp, are very thick, and the first wells drilled are really only the first of many stacked laterals.
Back to innovation and knowledge, that is not limited to shale plays, either. Not all of the new oil production is shale production. At least some if not much of it is from new horizontal development of non-shale assets. For example, look at the Spraberry in W TX.
Also, the shale wells that are drilled and produced typically hold under the leases of unsophisticated lessors other zones that have not yet been tapped.
There is more to be squeezed out of these formations than most people realize, and with advances in cost savings along the way, there still remains quite a bit of money to be made.
If it is “not fully understood” then you cannot say anything about future shale production. Currently, the author is correct. Until production is realized, such as current retrievable shale oil, for investment purposes, it doesn’t exist.
What it is going to take to send men to Mars is not fully understood, either. But that does not mean that we cannot say anything about sending men to Mars at some point in the future.
Thank you for your kind words.
In terms of the shale oil and the technology, I believe that the technology cannot make wonders overnight. And more importantly, the current technology cannot get a lot better overnight, given that it took us (George Mitchell) many years to improve this shale process and bring it to the point where we are now.
If the oil price remains at the current levels for long, the peak oil event will occur in 2015, in my view.
Regards,
VD
———————-…
Please let me know when the majority of oil newsletter writers turn bearish, that is when I’ll be a buyer.
best,
-samberpax
You are NOT a subscriber of my newsletter that was out just 3 months ago, in September 2014, when the oil price was already falling.
If you were a subscriber, you could check my picks and the recommended entry prices.
And please let me know and I will gladly send you the returns from my picks in H1 2015, based on the recommended entry prices.
Regards,
VD
I buy the long case for Oil, long term. But the question is that of how long it will take to come back.
The political unrest in the middle east ist not necessarily a cause for less supplies: the ISIS for instance uses Oil to finance their war. The anarchy actually can dislocate the production discipline and lead to lower prices. But agreed with you, anarchy is not sustainable and Oil prices will eventually move up again.
Rgeards,
VD
The author seeks to discount the additional 3.5 million barrels the US produces that were not available 5 years ago by saying the wells dry up fast and the production cost are too high. That is the true “lame thinking” here. I heard estimates that some production cost in the Bakken are as low as $29 dollars and that $70 is actually on the high end. His cost estimates are from years ago. Good ole American ingenuity drives down the cost of recovering this oil daily.
The author doesn’t deal with the death spiral that OPEC currently finds itself in. The more profligate members need a high oil price in order to maintain their spending. If I can’t make my revenue with a high oil price what is my alternative? That’s right pump more. Their state goal at this last meeting was to keep the production quotas in place. What was unsaid and the real reason oil took another dive is cheating on production quotas will reach an all time high over the coming months as these governments seek to shore up their finances.
Finally, the author displays several charts but proceeds to ignore what the charts say. We have firmly broken all uptrends and any recovery will be very difficult. I would further break his argument down but that would just give more credence to yesterday’s theory about the state of energy supplies in the world.
So whats the max production capacity for the rest of OPEC for them to keep ‘pumping more’ to make budgets meet?
Secondly, just like in October when everybody “woke up!!” and sent the market down 10%, because NOW the world is going into recession, good call btw. I highly doubt you bears are any more correct on your reactionary projections after crude fell from $90, you must be rich predicting this stuff.
As an aside Gartman has been one of the best contrarian indicators of the past 2 years.
And just to put my money where it counts, not that seeking alpha isn’t awesome.I recently sold multiple strike puts on EOG, NOV, PXD, XOM, CLR. Implied volatility is ridiculously high, and if history is any indicator its a very high probability trade.
Edmund
Yes, that would be Dennis “Marty McFly” Gartman. To be honest, I would rather have the sports almanac than my oil stocks right now.
Thank you for the compliments. And when it comes to the nuclear fusion reactor, I do not disagree with you. We can definitely see it both ways.
Regards,
VD
Both oil and oil stocks have a lot further to fall in upcoming months. There will be a far better entry point for both later in 2015. Investors would be wise to exercise some patience here and let things play out for a while. Buying the first sharp break is rarely a good idea, particularly not when there are so many signals indicating that the global economy is losing momentum.
Oil prices will ultimately come back, until then focus on the myriad of economic sectors that benefit from cheaper energy. It should also present a great buying opportunity for a whole host of energy stocks.
This piece has too much emotion embedded in it for my liking.
I am not a professional analyst who is living from this analysis.
I am an investor instead.
Regards,
VD
Thank you for your compliments.
Please see my previous articles and comments to find my bearish calls on several energy stocks over the last months i.e. Halcon Resources (HK), Goodrich Petroleum (GDP), Cobalt International (CIE), GMX Resources (GMXRQ), ATP Oil and Gas (ATPGQ), CAMAC Energy (CAK), Pinecrest Energy (PRY.V), Midstates Petroleum (MPO) etc.
Regards,
VD
The title really sums up how stupid investors are being now. The current daily correlation between a 50 cent or $1 move in oil taking down oil stocks by a few percent is ridiculous. Dennis Gartman has no credibility, I don’t understand why CNBC has him on regularly.
Thanks again for the article!
They have Jim Cramer on, so why not Dennis Gartman? They both change their minds on a daily basis and do it with conviction.
Right now, small cap oil stocks should be bought for a year end rally, stocks like MDR, WG, etc could see huge gains from current levels.
Thank you for your compliments.
Regards,
VD
I think investors need to pull the trigger on stocks they wanted lower instead of watching tv for a buying signal.
What you describe is the definition of “HERD MENTALITY” that has brought the oil price at the current ridiculously low levels.
But Einstein has said: “Two things are infinite: the Universe and human stupidity. And I am not sure about the Universe.”
Regards,
VD
However, the claim that $80-$100 is the breakeven for shale seems unfounded – I think it was the IEA that said that only 4% of production uneconomic under $70?
I also read a very interesting article today, I think on CNBC (apologies for the lack of sources), that discussed how transportation costs have plummeted in the past years.
It mentioned that in 2011, companies were paying up to $28 a barrel in transport costs. It is now $1-$3 because of pipeline construction.
If that is indeed the case, it is clear that a lot of shale is economic way below $70.
Gartman and his nuclear fusion. What a tool. I made the exact same point elsewhere that unless engines are replaced with fusion reactors and someone discovers how to make plastic from ‘fusion’ we will be using oil for some time to come…
I think the plummeting oil prices are the result of speculation more than any other factor but, as always, the market can remain irrational for longer than most of us can remain solvent.
GL
Saudi only produces 10M bbl out of 30M bbl. I predict NOCs can only withstand the pain for 6 months. after that, they can elect to exit OPEC, and form a non-Saudi cartel to sell at $80-$90 band. Saudi can sell their 10M bbl cheap if they elect to, but that’s not enough to meet global demand, so buyers will have to pay non-Saudi price.
Regards, VD
He is betting that the price of oil will increase. He is correct in this assertion. Everyone knows the price of oil is going to go up, eventually.
““When you believe something, facts become inconvenient obstacles,” Hall wrote in April, taking issue with an analyst who predicted a shale renaissance could result in $75-a-barrel oil over the next five years.”
He should listen to his own advice, it seems.
Here is one article where the “5 year” buzz line comes from:
http://bit.ly/1viOe43
“The team acknowledges that the project is in its earliest stages, and many key challenges remain before a viable prototype can be built. However, McGuire expects swift progress. The Skunk Works mind-set and “the pace that people work at here is ridiculously fast,” he says. “We would like to get to a prototype in five generations. If we can meet our plan of doing a design-build-test generation every year, that will put us at about five years, and we’ve already shown we can do that in the lab” . . . . An initial production version could follow five years after that.”
And then ramping up commercialization of fusion power, another decade? we’re looking at 15-20 years best case scenario before fusion has any affect on fossil fuel prices. This just goes to support the author’s conclusion that oil prices are low due to “lame thinking.”
No chart of the relationship between the strength of the dollar and the price of oil. Is it relevant?
Good luck with your picks.
To all those investors who believe operators in the unconventional reservoirs can keep producing while oil prices are dropping, check out their H1 budget forecasts for negative changes in CAPEX. That will remove much of the guess work and hand waving on how profitable they expect their operations to be. They know better than the analysts and economists on when to turn the taps off.
gartman is the worst of the worst in my opinion. he really is clueless. I dont know why they keep having him on every other day on fast money and the like.
Its funny how media affect sentiment changes on a dime that makes everyone forget the bigger picture as you referenced above.
remember ebola and the airline stocks in october? ignore the noise.
Regards,
VD
I think at some point sooner than the media and herd thinks that oil will bounce hard upward. OPEC made a good move to instigate a needed correction and put the industry in check. Now I think (in the short term) we will see a scary drop lower fueled by more moves by OPEC such as todays move to cut prices from SA to Asia/India and USA. SA sees India as growing and needs to subdue the fact that demand is growing. I would not be surprised if massive amounts of capital is also used to force the commodity down further to keep the herd moving ion that direction. OPEC knows that they can turn it around very quickly (just tell the world they are cutting production and the herd reverses quickly) when they need to so they are in the drivers seat for sure.
Thank you for the compliments.
A LOT of people and greedy oil speculators will be burned by shorting at the current levels. They have to pay for their mistakes and their greed, as always.
Regards,
VD
There is nothing about ego here. You misunderstood it. I have a clear opinion that I support it with facts and links. If you have a different opinion, you are welcome to present it coupled with facts in another article. If you present speculation only, it will not help, I think.
Regards,
VD
when you started quoting your” gods ” and casting scorn on any who disagree i lost interest.
ps mr market is always right no matter how much fundamentalist cry.
Another paradigm changing event already mentioned is China. The enormous real estate debt bubble and steel production bubble also fueled by debt has to come to a head soon. Yes, the collapse of China has been forecasted “forever” but so was the 2007 US recession which also was belittled for years right up to the edge. So was the collapse of the Soviet Union. The Chinese Govmnt has been able to keep the ball in the air because they control most of the economy but the Piper stands at the door. A Chinese economic collapse which WILL come will also collapse the oil price. Maybe it will recover some first but no energy investor can afford to ignore this.
Caveat Emptor!
position, firmly. [until I change it]
What I am sure of, is that this situation will change, and that change
is inevitable.
NO, I am not an analyst.
What I want to know is a chart from the EIA on Zero Hedge showing retail gasoline sales in the USA have declined almost 75%!!!! since 2004. Then Bloomberg showed a photo of the first gas station in America selling gas for below $ 2.00. Weird that below the gas price it showed Diesel selling for $3.39 plus! The EIA does not explain that stuff well why diesel is much more expensive than gasoline.(a six cents higher tax from the Feds. low suphur costs and “demand” globally????) Then the EIA shows gasoline production in the USA has risen!!! OK that tells me big oil is exporting refined petroleum products to other countries to make tons of money off us. Killing diesel over environmental EPA type stuff for political reasons because gasoline costs more to make than Diesel even with the other factors and six cent tax, and Exxon is back in Green River developing their shale oil in situ electro-fracking method for the largest oil play on earth-TRILLIONS of BARRELS in AMERICA. All comes down to costs, the big boys games, and ignorance of the average US citizen willing to be played and fleeced.
Yes overall your article was good but there’s a lot more going on the secret weird world of big oil than any of us will understand like how in the 70’s the US “government” supposedly allowed Saudi Arabia to shut down our nation in the WINTER and I froze waiting in gas lines? The USA??? Biggest army on earth plus Standard Oil of California developed the Saudi oil???? Or that their lawyer, John J. McCloy told at least seven US “presidents” what to do and say through Reagan and HW Bush? Heck he even ran the Warren Commission with Dulles and World War 11. Harold Hamm says he can drill existing wells in the “Scoop” at 99 cents a barrel and tried to sue OPEC. He is not going to shut down next year and plans on ramping up oil production big no matter what the price is. He wants to ream OPEC and make them blink unlike the 1986 oil bust when we went broke.
All highly interesting and I am watching and going to buy back when I think oil has hit the low-could be next year though?
why are you looking at GDP growth rates when talking about oil demand when oil demand figures for those same countries are available?
I dislike articles that spend their time making fun of other oracles and then turn around and make their own guesses of what the future holds. It’s an emotional argument.
Actually, I like that part – in my nearly 2 decade experience, I’ve seen far too many investors put too much faith on analysts and it’s important to show actual real life examples where analysts are fallible also.
For example, take a look at SDRL. When SDRL was above $40, there were not many analysts telling investors to sell, the prevailing tone was “crude oil is going up, up, up, and buy, buy, buy”.. But when SDRL cuts dividends to zero at $15-$20, they are now downgrading SDRL. Buy at $40, sell at $20? I think you can go to the poorhouse very fast following these “anal-ysts”.
SDRL is not an isolated example. Today, after massive price falls, I see Zacks now telling investors to sell their energy mutual funds after these funds have massive falls …
As for the future, no one knows what is going to happen, you have to follow your own investing/trading thesis. For me, I think SDRL has fallen 75% from peak, cut dividends to zero, so, I am slowly starting to accumulate SDRL, looking to spend up to 4% capital when it finally gets down to say $7. Yes, no guarantee it will fall down that far when today is only $12, but I like the fact that it has fallen from a peak of $48 down to $12 … that’s my unsubstantiated opinion also, and probably emotional as well 🙂 And yes, I’m starting to think of accumulating when analysts consensus is to sell … it worked very well for me over the past decade ….
———————-…
Exactly so! I am elevating my standard by lowering theirs. Sad, very sad indeed.
Best,
-samberpax
http://bloom.bg/12CBfjp
Here is the link to Lockheed-Martin’s compact fusion announcement. These researchers/engineers are the best of the best, I would think, so if they’re making an announcement, they must have something legitimate up their sleeve, I would think:
http://lmt.co/1yJEu5x
Interesting article on Fusion, nice read.
However, the recent crude oil price fall down to $66 is most likely unrelated to Lockheed-Martin’s fusion piece, as that piece seems more about promoting Lockheed-Martin in research and what they think they could achieve in 5 years time, and still not yet confirmed …. but good to cast a quick glance from time to time on these sort of things ….
If Lockheed-Martin managed to bring this to commercial production at small enough sizes at reasonable prices (that’s a BIG IF), then, I think we first see Lockheed-Martin’s stock price zooms up first a lot more than what we’ve seen so far, before we see global crude oil prices comes down significantly … that’s just my gut feel …
There is no guarantee we’ve seen bottom in crude yet, but I feel we are now entering a period where Value Investors should start to feel excited on some of the high quality issues that are beaten up hugely, to trade below NAV and trade well below Replacement Costs …
Cheers,
TF
I haven’t sold any of my oil stocks, but I haven’t added yet, either. Would love to buy some LNCO to bring down my cost basis, but I’m concerned they’ll have to cut, or pull a Seadrill and eliminate, their dividend.
I have been waiting for a follow-up and this seems to be the one.
Again I am impressed by your knowledge and your reasoning but I’m a bit disappointed too. Especially by not addressing points 3 and 4 of these 8 major reasons.
———————-
Just to refresh, points 3 and 4 of these 8 major reasons:
3) The weakening of the U.S. dollar.
4) OPEC’s decision to cut supply in November 2014.
Best,
-samberpax
Please bear in mind that the HERD MENTALITY is like the TITANIC cruise ship. The big ships need a couple of miles to turn….
Regards,
VD
Agree this is very much a TITANIC cruise ship that will take a few miles to turn … apparently, the weekly US Oil production figure need to show 2 to 3 consecutive week of decline at the very least first. Until then, odds are crude oil will keep falling (short term momentum). I now feel we may be close to bottom, but we are not confirmed there yet, and I won’t be surprised if crude makes $30 very briefly, before a strong and fast recovery once a few of these marginal producers are out of the picture …
Just as Saudis and US are stubborn right now to curtail production, in a year’s time when a few of the US producers goes bust, the Saudis will have achieved their objective and cut production, and just as quick, I see crude oil could rise back to $100 very fast … the US production numbers are always a surprise to markets, I expect the Saudi’s response to also be a surprise to the market when they cut back production in 6-12 months time – those looking for signs will not find it, I believe it will be a surprise to the market when it happen anytime within the next 12 months …
Whilst I agree with your base thesis and believe that the price of oil is going back up to what are more “normal” levels, some of the biggest consumers of oil on the planet are likely going to use less-and-less of it as time goes on. For example, there are pretty strict rules in place for future vehicle mileage requirements in the US, the EU has been clamping down hard on emissions for a pretty long time and lots of companies are now involved in the business of making energy efficient equipment and machinery. The list is long – GE, Siemens, Caterpillar, Deere, Hitachi, Volvo, Komatsu…..and so on.
The historical environment for oil consumption is becoming more-and-more dated when compared to what the oil consumption environment will look like going forward. It’s hard if not impossible to use the past as an accurate guide to the future.
The future oil consumption environment in two words – different and lower.
If you are short on crude oil, I don’t see a reason why you need to close your shorts now as crude keeps falling. You should only close it when you see a confirmed uptrend, at least, that’s my view.
Value Investors though are a different breed – they ease their way in specific value stocks, and now, many oil related stocks are trading at below NAV and well below Replacement Costs with strong cashflows during the last oil crisis … these stocks could still fall by another 25%-50% or close to bottom, no one really knows and so, they start to accumulate a little bit at a time … history has shown that crude oil will eventually recover, and they could be looking at +100% returns in 1-3 years time … the Value approach does not require market timing, and crude oil being highly cyclical in nature means we will definitely see $80-$100 crude oil again eventually over the next 1-3 years, we just don’t know exactly when. If it goes back to $100, you can be sure many of these crude related counters will go back up to their former levels, potentially 100%-300% gains …
Mr Market has presented a compelling opportunity, the key is Money Management, accumulate a few high quality counters, and once bought, lock them up in a drawer and don’t worry about the daily price volatilities. In 1-3 years time, the gains of +100%-300% can be had … know the strategies in advance, never allocate more than 15%-20% portfolio to oil related counters at the bottom, and certainly, never go on margins. I have been staying cash majority of my portfolio, I just recently allocate 2% capital on oil counters, and plan to slowly work my way to 15%-20% assuming these stocks could fall up to 50% from current levels … This is a no-brainer approach, I just don’t care about the daily price volatilities.
Cheers,
TF.
i am heavily long on oil and hurting badly but i keep buying as price drops. i am in your camp
Oil futures, stocks or options? I hope it is not leveraged instruments? The trend is still down …
I’m eyeing SDRL – originally, I plan to go in with 4 bullets, at $13.50 (already done), $11, $9 and $7 very roughly speaking, but now, I will most likely try to take advantage of the short term down momentum (I am a trader) to cut loss some and take wait to pick it up at lower prices, and wait for a better technical signal. Allocating just 4% capital for SDRL.
The other 2 counters are HP (this is a Dividend Aristocrat that keeps paying higher dividends every year for over 25 years) and NE (this is a nice Value play), but I haven’t triggered any buys in either yet as Crude keeps falling and the counters keep falling … Again, 4 bullets each, total 12% capital when I’m done all the 3 buys at the bottom.
Originally, I plan to make a “simple” buy approach of just buying at set levels, but the more I study the crude markets fundamentally, the more I realize that I can fine-tune my entry better, so, let’s see if this is successful or not …
How about you? What counters are you looking at?
Glad you didn’t go for futures / options with time expiries – I just don’t know how long these crude oil price can fall – it can keep falling and falling, and the bottom and recovery I believe will be a huge surprise to me.
Personally, I prefer safer, large caps, very liquid stocks that institutional buys with average daily volume greater than 500k to 1000k shares, and try to buy using a combination of writing puts and directly, and sell covered calls also.
Whilst my current list is SDRL, HP and NE, if I find something else better, I’ll most likely drop one for that …
Good luck.
Cheers,
TF
Oil company stock valuation is based on EV/B/D; EV/EBITDA and EV/Reserve; It does not matter whether large cap or debt; In case of low rev they can always curtail drilling and be very liquid to pay down debt. Worse come worse they will sell their reserves for better price than current valuation. We just bid on various leases offered by Chevron and we did not get it as there are numerous buyers willing to pay higher price.
raj
One could make educated guesses based on the geopolitical actions/goals of the major oil producing countries, changes in demand, etc.
I’d rather see oil stay around these levels for a while as I accumulate.
Looking at Venezuela and Iran for example – the oil price before the crash, at it’s peak…was nowhere near the quoted figures given for these countries to approach break even; so who goes broke first…small shale producers in the USA or the countries that need $150 oil to just break even, or do they just continue to go broke forever?
I don’t think the OPEC decision is targeted solely at US shale plays…there’s others that are in far more pain over this, the rest of the global economy benefits while oil producers suffer a small but probably needed shakeout: I’ve got investments in oil but it’s ok to lose paper money on one part of the portfolio if another part benefits… I think sovereign default would be a lot worse for everyone involved. Oil will go back up in price eventually, and the median price will rise over time as the asset depletes. When is actually not that important unless you need your money tomorrow.
Please see the excerpt below:
” On top of that, there are some additional geopolitical clouds on the horizon that can make oil jump by H1 2015. For instance, the current low oil price has brought many OPEC members to their knees, while the holders of those countries’ sovereign debt are toast as long as oil stays at the current levels. Iran, Iraq, Libya, Algeria and Venezuela are not prepared to withstand low oil prices for long and they are now in serious danger of political upheaval at current prices.
According to yesterday’s news from CNBC, the first signs of an escalating social unrest in Venezuela are already there, and things will definitely get worse over the next weeks.
Furthermore, Russia and Saudi Arabia will be anxiously watching the rapid depletion of their sovereign wealth funds, which will make the political situation in these two countries dicey over the next months. “
Regards,
VD
The sharp increase in production in the US over the past 5 years is simply amazing, however, it would be interesting to see what the overall average decline rate is for the US over the same time period.
I’m inclined to believe that the decline rate is substantially higher in part due to the tremendous number of unconventional wells that have been drilled in the past few years and the fact that they are in the steep part of the decline curve. So, while production has been climbing, it seems that the Saudi’s are hoping to curb drilling and therefore let the decline curve catch up with the industry. With a sustained drop in prices, eventually borrowing base redeterminations will result in at least a moderate decrease in drilling, perhaps even drilling within cash flow!
Also, while my opinions mean very little, I think it is important to point out somewhat misleading comments about certain plays being profitable at $40 or whatever they want to insert. Yes, if lease operating expenses and field level costs, transportation, ad valorem etc are $25-$40 per barrel, then those wells will be cash flow positive as long as pricing remains above that price.
However $25-$40 oil will not provide a decent IRR for new wells. Remember most of these shale wells exhibit very high initial production and have sharp hyperbolic type declines. Producers need to get full payout in the first 12-24 months. Wells might decline 60-70% within the first 24 months. Look at the NPV of many of the Bakken wells at $60/bbl. Not nearly as attractive as when they were $100.
I don’t know what oil pricing will do in the next few months, nor do I know what OPEC and the Saudi’s will do in 6 months. I do however believe that US oil producers will eventually have to reign in drilling budgets as cash flow wanes. I don’t know if that will mean production growth will taper, if production will hold steady with new production offsetting natural decline or if total US production will slowly decrease. I do know that it will be interesting to see it unfold.
And while my opinion isn’t worth much, I believe that we will eventually find some happy medium where US producers can achieve decent IRRs and production can grow modestly. My guess is $75-$80 bbl.
While VD is great at pointing out value, guessing what will happen to the price of oil will always be speculation. I like the argument given here, but the truth is that no one really knows.
Investors in oil-producing companies should do so because they believe that their fundamentals will allow them to be successful and profitable in any environment of oil pricing.
– The recommended entry price for my picks, given that timing matters when it comes to investing. Buying a good company is not enough.
– The investment horizon, given that I am not a day trader.
Regards,
VD
Thanks for your reply. One of the things I appreciate about your articles is always standing by your track record. Given that, here are some of your picks from this year:
CAZFF Recommended 5/15/14 – market price $0.30, currently at $0.14.
PTAXF Recommended 8/26/14 – Market price $0.38, currently at $0.14
LNREF Recommended 6/7/14 – Market price $0.35, currently at $0.19
They have all experienced significant losses (on average 52%). However, I agree that I am not a day trader so if I liked these companies enough to buy them, I would still hold on as long as the fundamentals have not changed. As Buffet said, if you aren’t willing to lose half of your investment in the market, you shouldn’t be there.
I remain long, but the simple fact is that there have been some significant losses in the short term.
I was wondering why you did not mention:
AEI.T recommended at C$4.95, now at C$6.85, up 40% despite the slump of the energy stocks.
CKE.T recommended at C$0.82, now at C$1.25, up 50% despite the slump of the energy stocks.
CAZ.T was recommended at C$0.24 in May 2014.
LNR was recommended at $0.32 in June 2014.
PTA.V was recommended at C$0.39 AND C$0.25 in October 2014:
http://seekingalpha.co…
and for reference, Oasis (OAS) has dropped from $55 to $14,
Sandridge (SD) from $7 to $2.4
Magnum (MHR) from $8.6 to $3.9
Penn Virginia (PVA) from $17 to $4.8
Quicksilver (KWK) from $3 to $0.40
and many many other producers have returned back to their 2010 levels. I can continue if you want. This might help you see the big picture.
Regards,
VD
My view is some new tight oil wells would still be drilled if oil stayed below $70, but likely not enough to overcome the rapid depletion from existing wells. I believe we will start to see US production drop sometime in H2 2015, but until then US production keeps going up. Think it will take maybe 6 months for wells already committed to be drilled and completed. After that market should at some point get back to $80-$85, maybe 12 months. But likely to be a volatile ride along the way. I personally think we have not seen bottom yet. Too much downward momentum, global oil production likely to keep increasing for the near term.
Best to prepare for the volatility and try to recognize the opportunities as they play out, IMO. So many things could intervene ( geopolitics, global economic activity, China credit, etc)!
Take care
http://bit.ly/12EquNo
Regards,
Nawar
Thank you for your compliments and your insightful comment. Yes, the news you mention is another very strong bullish indicator.
Regards,
VD
If this 5 million BOEPD were not on the world market today, where would we be?
We would be short on oil.
Instead, we are long on barrels because every dumba** American oilman that drills a good well immediately turns around and puts all of the cash flow from his good well into ANOTHER well. Plus he borrows a few million bucks to drill a few more wells.
How else can you explain the unprecedented exponential oil production growth in this country?
I wish these geniuses would spend their profits on wine, women, song, jet airplanes, country houses or something, besides plowing every single dollar of profit back into the ground.
You make a statement in your piece that sums up your whole thesis: “new oil is not cheap.”
Any way we look at the supply situation, most new production will continue to come from expensive unconventional means such as shale or tar sands. Surely there are new conventional pockets of crude to be found, but they won’t be Elephants and will probably be expensive “deep water” reservoirs.
Petroleum remains a key product for Global Energy & Industrial production and current low prices will NOT allow future demand to be satisfied.
Us reserves….
http://bit.ly/1vYF4uf
china oil reserves
http://bit.ly/1vYF4ug
I agree with much of what you wrote.
In a recent interview with Jim Cramer, Boone Pickens stated that the Saudis will eventually have to cut production. (my comments: OPEC will not survive if the Saudis let Venezuela, Iran, Algeria, Nigeria, Libya, as well as Russia descend into chaos. Not to mention destabilizing an already fragile world economic situation. When the Saudis cut, oil will soar.) B.P. also stated that the producers will be forced to cut CapEx. As they do US production will come down. Based on this, B.P. thought oil would rebound to $100 by mid-2015. Most people will dismiss Boone Picken’s comments. But when a wise old billionaire oilman speaks, I pay attention.
I think most oil services companies will have a rough 2015 (buying opportunity for HAL, SLB). Also, highly leveraged small producers may be forced into bankruptcy, but stronger producers will benefit by picking up their producing acreage and reserves for pennies on the dollar.
Regarding Syria, it seems clear the US has opted to fight a war of attrition in northern Iraq rather than cut the head off the snake in Syria. This approach takes care of a number of problems (high casualties on both sides) and is training a whole new generation of US pilots and drone operators.
I take your comments regarding portable fusion to be light hearted because the neutron flux off such reactors would kill everyone in the car.
The greatest proof against Fleischmann–Pons knuckleheaded claims of nuclear fusion at room temperature was that they were alive at the announcement. The thought that Fleischmann & Pons conducted such an experiment in an occupied building should have been grounds for dismissal or incarceration.
LMT is relying on plasma (not room temperature). This compounds the problems with having some random drunk driving around with a nuclear fusion device. Perhaps LMT can make electricity that is too cheap to meter, which would be big, but it is just speculation and not 5 years away.
In the end, the House of Saud is still in control of the price of oil. Thank God the Iranians are not in that seat.
By the way, in 1938, the US producers predicted the US has a 10 year supply of oil. I think producers can only see ten years ahead.
Thanks for your article!
It confirms what I have been thinking, although without the sources that you cite!
Geo-politically, the world is a much more uncertain place at present! As for the pace of economic activity in the U. S. and elsewhere, the numbers are always after the fact! Can’t measure what hasn’t happened yet! Prognostication is fine for what it is, but it is just that- a guess, however educated!
Oil prices may have further to decline, I don’t know, but the value of some of the oil stocks, I find compelling at these levels.