Category Archives: Energy

which recovers first, crude oil or base metals?

April 14, 2016 By in oil and natural gas, shale oil, Uncategorized Tags: , , , , Leave a comment

I’m in the oil first camp.  (My private opinion is that it could take a decade or more for base metal prices to perk up.  Whether that turns out to be true or not is less important to a long-only investor like me than the idea that recovery is not soon.)

How so?

history

Leading with (the opposite of what you’re supposed to do) my weakest reason, look at the last cycle of gigantic investment in expanding natural resources production capacity.  Oil and metals prices both peaked in 1980-81  …and then plunged.  Oil stabilized and began to move up again in 1986; for metals recovery was over a decade later.

closing the supply/demand gap

There’s only a gap of a couple of percentage points between the amount of oil the world is demanding and the amount producers are willing to supply.  Growth in the car industry in China, the replacement of scooters and motorcycles with cars in other high-population countries like India and the strong increase in gasoline consumption in the US now that prices are lower all argue that the shortfall between demand and supply is, little by little, being erased.

On the other hand, the extent of base metals overcapacity is less easy to put your finger on, but is, nevertheless, massive.  Demand is also more cyclical–therefore less dependably growing, as well, but that’s less important than that mining capacity is added in gigantic chunks.

the nature of the enterprise

The up-front cost of a base metals mining project is very high.  There’s the mine itself, the huge machines that rip the ore out of the earth and the sometimes elaborate plants that crush or grind or otherwise separate it from the ordinary dirt.  Then there’s the transport link with the outside world.  All of this infrastructure can lie fallow for long periods without impairing the mine’s ability to be restarted–even expanded from its prior size–very quickly.

For oil, in contrast, finding new fields is a much more important issue.  Drilling new wells in an existing field is, too, in many cases.  As time has passed, the focus of the big oil majors has increasingly been on mega-projects that make them look much more like base metals miners than they did when I was covering the oil industry as a securities analyst in the late 1970s – early 1980s.

Hydraulic fracturing, however, has changed the industry for good.  This technology has made huge numbers of projects economically viable that have limited output that goes on for relatively short periods.  This converts 21st century oil exploration, in the US at least, into a sharp-pencil engineering business that even small firms can excel at.  Granted, the fact that production can turn on very rapidly when prices are high enough puts a cap on how far they can rise.  But the fact that several millions of barrels of daily output can be turned off equally quickly argues that the response time of the oil industry to a supply/demand imbalance will be much quicker than has been the case in the past.

 

the Obama $10 per barrel oil tax

February 8, 2016 By in oil and natural gas, shale oil, Uncategorized Tags: , , , , 1 Comment

Last week, the Obama administration said its upcoming budget will contain a proposal for a $1o a barrel tax on oil.  Its purpose would be to fund infrastructure, as well as to use price as a tool to redirect Americans toward other forms of energy.

Anything more than these bare bones is still a puzzle.

Clues:

–the adminstration says the tax would not be collected from oil producers at the wellhead, i.e., it isn’t a tax on crude oil

–nevertheless, the tax would be collected by oil companies

–the levy would not apply to oil products refined in the US and then exported

–it would apply to oil products refined abroad and imported, though.

Effect:

A barrel (42 gallons) of crude oil refined in the US ends up on average as 19 gallons of gasoline, 12 of diesel/heating oil and 10 of other stuff.

If passed on to end users completely and evenly by the as yet unspecified collectors, a $20 a barrel ta would mean a $.24 per gallon increase in the retail price of each product.

This would be a baby step along the road to lessening dependence on OPEC already traveled by every other country in the developed world in the 1970s.  Better late than never, in my view.

My take:

We’ll hear more later this week, I guess.  But it strikes me from what has been said so far that the proposal has been defined more by what Mr. Obama doesn’t want to do than by anything positive he intends to accomplish.

–I think collecting the $10 at the wellhead from producers would likely tip some shaky shale oil producers into bankruptcy and discourage others from doing any development.  After all, in a world awash in extra crude oil being stored in bunkers and even on ships tethered off the shores of producing countries, how is any independent US producer going to be able to pass on any part of the $10 to its refinery customers?

The waning of US shale would also have the disastrous consequence of handing control of the crude oil market back to OPEC and Russia.

–adding $.25 to the federal tax on gasoline and diesel fuel, which I think would be the simplest and most economically sound alternative, would upset the US auto companies, who are now raking in money from selling gas-guzzling SUVs.  Autos are a traditional Democratic constituency and a perennial problem-child industry that the government rescued from bankruptcy less than a decade ago.  So a gas tax is likely off the table.

In addition, a Republican congressman already raised the gasoline tax issue last year.  He got a lot of grief and no support from anyone on either side of the aisle.

–This leaves refiners and/or distributors is most likely to be the parties taxed.  To me, this implies that the $10 cost would be shared among producers, refiners and end users according to who has the most market clout.  2015 results from refiners and distributors tell us that they have already been keeping a substantial portion of the benefits of lower crude oil prices for themselves, rather than passing them on to customers.  My guess is that shrinking margins for refiners and middlemen would be the primary effect of the proposed new levy.

Also, if the past is any guide, the issue of tracking and differentiating between refined products for export and those for domestic use would be a regulatory/compliance–and a fertile field for fraud.

 

As we get more details, we’ll be able to decide whether the oil tax is something concrete or just wishful thinking.

 

 

 

oil: confusing correlation and causation

December 15, 2015 By in oil and natural gas, shale oil, shale oil and gas, Uncategorized Tags: , Leave a comment

This is about the current state of the oil market.

The fact that two things occur together (correlation) does not always mean that one causes the other.

For example, every morning the rooster crows and the sun comes up.  But killing the rooster won’t plunge the world into eternal darkness.

Birds fly south and winter begins: birds fly north and winter ends.  Same story.

 

Some commentators are arguing that the sharp decline in the price of oil is a harbinger of recession, using the argument that low prices and recession are very often linked.  I don’t think this is correct.

The causal connection between lower demand and price works something like this:

When aggregate global demand begins to contract, sellers of end products see their businesses begin to slow down.  They may cut their prices to sell stuff they have on hand and they certainly begin to shrink their inventories to a level that matches the lower demand they are experiencing.  They do so by cutting back new orders sharply.  Middlemen do the same.  This process typically hits producers with a very sharp decrease in new orders.  Producers respond in the only way they can, by cutting prices.

In the case of oil today, none of this is true.  Yes, prices are only a third of what they were eighteen months ago.  But aggregate demand is steadily rising.  So too world inventories.  The majority of oil producers are increasing their output, as well.

What’s happening with oil is that years of very high prices established a pricing umbrella that encouraged new entrants (shale oil), previously uneconomical, to invest tons of money and enter the business.

Established producers, meaning OPEC, have started a massive price war to force the new guys into bankruptcy.  The producers are learning the basic, but bitter, lesson that it’s much easier to keep new entrants out (by keeping prices low) than it is to deal with them once they have invested in plant and equipment and have begun production.

Shaping a Portfolio for 2016: petrodollars

December 10, 2015 By in oil and natural gas, shale oil, Shaping a Portfolio for 2016, Uncategorized Tags: , , , , , 1 Comment

Petrodollars is the term coined in the 1970s to describe the money flow from oil consuming nations to oil producers–meaning by and large OPEC–during a decade when the crude oil price skyrocketed from around $3 a barrel in 1970 to $25+ in 1979.

Some economists of the day feared that this massive increase in money paid for fuel would be, in effect, withdrawn from circulation in the global money supply, and that the resulting money supply contraction could cause a worldwide recession.  (I have no idea where this notion came from, but it was seriously discussed.  Another strange idea being floated then was of the “backward-bending demand curve,” i.e., that there was something magical about oil so that the higher the price went, the more demand increased.)

What happened instead was that these funds were quickly recycled into the world money supply through increased spending by OPEC and through gigantic purchases of financial and other assets, from Treasury bonds to real estate to large stakes in publicly listed companies in Europe and the US.

Economic growth in the OECD did slow markedly during the 1970s and inflation rose sharply in places like the US, as industry heavily reliant on ultra-cheap oil struggled to adjust.  One might also argue that the fact that money was going from the pockets of avid consumers to those of wealthy savers also retarded economic expansion.

What I’ve just written is only interesting, other than to me, because the reverse of that 1970s flow is now happening.  More money is remaining in the hands of consumers.  According to the Financial Times, during the September quarter alone, Middle Eastern sovereign wealth funds cashed in at least $19 billion of their investments to underpin current government spending. Since not all asset manager report withdrawals, the true figure could easily be twice that.

It’s clear that a large shift of wealth away from OPEC and to oil consumers is under way.  But, in addition, as OPEC liquidates financial investments to fund current spending–Saudi Arabia is actually talking about issuing international bonds to fund its budget deficit–it will provide another monetary (and consumption) tailwind for economic growth in 2016.

Shaping a Portfolio for 2016: a data dump on oil

December 3, 2015 By in oil and natural gas, Refining, shale oil, shale oil and gas, Uncategorized Tags: , , , , , Leave a comment

This time last year I was embarrassingly silent about oil, which I considered to have poor prospects–and still do.  So naturally I’m going to go overboard in the other direction now.

If there’s a method to my madness, it’s that  an interesting buying opportunity may emerge at some point during next year.  Especially so, if the current imbalance between supply and demand causes the price to fall significantly again.  That could happen as early as 1Q16.

seasonality

Because many large oilfields are multi-decade projects that depend on a steady flow of output to the surface to maximize recovery of the underground oil, and because producers need the money to fund national spending or (in the case of small wildcatters) to service debt, the supply of oil into the market is relatively steady.

Not so demand.  We’re now in the high season for buyers, as the winter heating season in the northern hemisphere unfolds.  Late January through March are the lowest points of the year for demand.  Heating fuel has already been delivered to customers and driving is in its winter lull.  From April on, demand beings to build into the summer.  It plateaus from there until autumn heating demand causes the price to reach its yearly high point.

In a normal year, the oil price should be rising today.  But it’s falling instead–suggesting that the market could get ugly once the peak heating oil season is over.

arbitrage

What happens to the excess oil that’s now being produced?  It’s bought by arbitrageurs who store the stuff for future sale, while simultaneously entering into futures contracts to lock in a price.  The trouble is that, although no one has good numbers, global onshore storage appears to be getting close to being completely full.

There’s lots of offshore storage available–in oil tankers–but current rental rates imply crude would have to fall by $5 – $10 a barrel to make arbitrage trades economic.

the slow convergence of supply and demand

Ignoring seasonality, there’s probably on average 2 million barrels of excess crude oil now being produced each day.  That may rise by another 500,000 – 1,000,000 once Iranian sanctions are lifted next year.  Then there’s the temptation for government-owned producers to put a little extra on the market to help close the national budget deficit.  And there’s the creditor pressure on independent producers to continue to service their debt.

Demand is probably rising by about 1.2 million daily barrels annually.  The gradual removal of supply by high-cost producers is shrinking supply by maybe 500,000 – 1,000,000 daily barrels a year.  This would imply that we’d come back into supply-demand balance at the end of next year or in 2017.  Given all the moving parts–especially seasonality and Iran–it’s possible that there’ll be another price spike downward before we come back into equilibrium.  That’s where the buying opportunity thing comes in.

sensitivity to oil price changes

from low to high…

big international integrateds

smaller independent explorers

service companies–development and maintenance

service companies–new drilling

service companies–new drilling, offshore or hostile environments

Refiners don’t fit on this table.  They’re currently enjoying a field day because they’re not passing on all of the benefit of lower input prices to customers.  There are also non-energy companies, like steel producers, who may have important subsidiaries that make oilfield tools and supplies.

Two other important notes:

–integrateds aren’t quite in the favorable defensive positions that my table would imply.  That’s because for years they’ve been devoting large chunks of their massive cash flows to developing gigantic high-cost oil projects that may no longer have any economic justification

–some independents have enormous debt burdens.  While the most speculative may arguably have the highest return potential during a future selloff, that’s no good if they go into Chapter 11 before that potential can be realized.