Category Archives: Energy

reading the paper yesterday morning…

January 21, 2015 By in Energy, hedge funds, Portfolio management, Trading Tags: , , , , Leave a comment

I’m postponing writing about my early days as an oil analyst until tomorrow.

An article in the Wall Street Journal,  “Investor Bind:  How Low Can Oil Go?,” struck my eye as I was waiting a doctor’s office yesterday morning.  Two aspects:

The article quotes a Swiss oil trader as saying the current market for petroleum is “irrational.”  He explained that the craziness consisted in the market concentrating solely on bad news and ignoring any possible ray of sunshine.

Yes, this is irrational.  But, more to the point, this is the essence of a bear market, that good news gets ignored and only bad news gets factored into prices.  (A bull market is just the opposite.  In a bull market, all the bad news goes in one ear and out the other; only the good news has an influence on prices.)  I wonder why he didn’t just say that.  Maybe he did, but the reporter didn’t understand.  On the other hand, maybe he didn’t realize.

Second, the article leads off with hedge fund Tusker Capital, LLC of Manhattan Beach, California.  The fund had been betting heavily on a decline in crude oil prices since at least the middle of last year and has just cashed in its chips after cleaning up oin a major way on the subsequent 60% fall in the oil price.

According to the article, Tusker gained 17% overall in 2014 and is up by 10% for 2015 through mid-January.  Implied, but not explicitly stated, is that the largest part of the +10% this year comes from the bet against the price of crude., with is down by 8.6%.  Why else would it be the lead in a sotry about a crashing oil quote.

The occupational disease of analysts is that they analyze.  As I sat in the waiting room–and waited–it became increasingly clear that I couldn’t make the Tusker numbers make sense.

Tusker has “roughly” $100 million under management now (I take that statement to mean the assets under management are just shy of $100 million, but let’s say $100 million is the right figure).  This means it had $91 million under management on December 31st and $78 million at the end of 2013–assuming no inflows or outflows.

Let’s say all of the $11 million gain in assets under management in early 2015 comes from the negative bet on oil.  If the same bet were maintained through the second half of 2014, it should have produced a gain of about $55 million.  But Tusker’s assets were only up by $13 million in 2014.  Either a lot of customer money left, or something really horrible happened in the rest of the portfolio, or “all” is too high a number.  My hunch is that at least the last is correct.

Let’s say half the 2015 gain comes from the negative bet on oil (regular readers will know that 1/2 is my default guess on most things).  If so, then the bet should have produced a profit of around $27 million in 2014.  Same story, although with somewhat less draconian figures–something else happened that caused $14 million in assets to disappear–disaster or withdrawals, or both–or maybe Tusker initially had a much smaller bet gainst oil that it expanded as crude began to sink.

I later Googled Tusker and found an article, from the New York Post, of all places, that said Tusker had assets of $105 million at the end of June 2013 and that the firm strongly believed that the end of quantitative easing in the US would cause a collapse in commodities prices.

To sum up: Tusker made a hugely successful bet against oil that likely made it $40 million – $70 million.  Yet it now has less money under management than it did 18 months ago (a period during which the S&P 500 went up by about 30%).  There’s certainly a story here.  It may not be about oil, though.

 

 

 

natural resources and economic growth

January 20, 2015 By in Energy, Gold, Industry Analysis, Long-term themes, Mining, Shaping a portfolio for 2015, Strategy Tags: , , , , , , 1 Comment

I ended up with my first stock market job, more or less by accident–and without any finance experience or training–in the late summer of 1978.  A few months later, the firm’s oil analyst was headhunted away and I took his place.  Within a couple of years (an MBA from NYU at night along the way) I had picked up a bunch of metals mining companies, too, and was in charge of the firm’s natural resources research.

The oil industry was (and still is) really non-intuitive–more about my early adventures tomorrow.  Today I want to write about the mining industry, which is a little more straightforward.

natural resources in the 1970s

I started out by reading the annual reports and 10-Ks of the major base metals mining companies for the prior five or six years.  What stood out clearly was that all the firms held very strongly a series of common beliefs, namely:

1.  that global economic growth would continue to be strong for as far into the future as one could imagine,

2.  that the availability of all sorts of base metals–lead for batteries, copper for wiring and tubing, iron ore for steel, and so on–was a necessary condition for this growth

3.  that, therefore, demand for base metals would grow at least in lockstep with GDP increases.

Implicitly, the companies also assumed that:

4. that oversupply was highly unlikely,

5.  that substitution among raw materials–like aluminum or PVC for copper–wouldn’t be an issue, and

6. that, because of 4. and 5., the selling price of output from future orebody discovery/development would never be a concern.

CEOs’ conviction was buttressed by reams of computer paper containing economists’ regression analyses “proving” that all this stuff was true.

a massive investment cycle…

Naturally, the companies, not risk-shy by nature, went all in across the board on new base metals mine development.

As I was reading these documents in 1979-80, the first (of many) massive new low-cost orebodies were coming into production.  This wave turned out to have been enough to keep most base metals in oversupply–and a lot of mines unprofitable–for the following twenty-five years!!!  Miners were also in the midst of a massive switch to exploring for gold, where high value deposits could be developed quickly and at low-cost–causing, in turn, a twenty year glut of the yellow metal.

…that didn’t work out

The mining CEOs turned out to be wrong in a number of ways:

–like any capital-intensive commodity business where the minimum plant size is huge, industry profits for base metals are determined by long cycles of under-capacity followed by massive investment in new mines that causes long periods of over-capacity

–although it wasn’t apparent in the 1970s, substitution of cheaper materials has been a chronic problem for base metals.  Take copper.  There’s aluminum for heat dissipation and wiring, PVC for plumbing, and glass/airwaves for audiovisual transmission.

–Peter Drucker was writing about knowledge workers as early as 1959.  Nevertheless, the mining companies and their economists weren’t able to imagine a world where GDP growth might not require immense amounts of extra physical materials.

I’ve been looking for a sound byte-y way to put this all into perspective.  The best I can do is a gross oversimplification:

–real GDP in the US has expanded by 245% since 1980.  Oil usage is up by about 10% over that period; steel usage is down slightly.  The supposed dependence of GDP growth on increased use of natural resouces simply isn’t true.

Why am I writing about this today?

…it’s because I continue to read and hear financial “experts” say that weak oil and metals prices imply declining world economic activity.  To me this argument makes no sense.

 

 

 

crude oil (ii): what’s happening now

January 8, 2015 By in Energy, Mining, shale oil, shale oil and gas Tags: , , , , , , , 1 Comment

lower oil price+=less new drilling

Sharply lower oil prices have two main effects on the planning of new drilling by oil exploration companies:

–the more obvious is that they are only getting about half as much for the oil they are selling today than from output they sold half a year ago.  If production is constant, their cash flow has been cut in half

–the second is that projects on the drawing board and highly profitable at $100 a barrel may not be moneymakers at $50.

For both these reasons, less cash flow and fewer winning projects, exploration firms are cutting their capital spending budgets for 2015.

also…

–when prices are rising, oil explorer/developers tend to build up large inventories of supplies for “just in case.”  Instead of having, say, a three-month supply of the steel drill pipe that lines the walls of the wells, companies may want six months’ worth.  Now that drilling may only be half the level originally anticipated, a wildcatter could be saddled with what is now a year’s worth of pipe, or 4x what he could carry in normal times.  And he’s looking to save cash.

One of the company’s first calls is to suppliers.  It will want to cancel any outstanding orders–and to see if the supplier will take back some of what the firm already has in inventory.

It’s no surprise, then, that US Steel just announced layoffs at a big steel pipe-making plant.

–In good times, banks are happy to lend.  Wildcatters–natural optimists and not very risk averse–are eager to borrow.

I remember talking in early 1982 with the CFO of a mid-sized oil explorer that a short time later went bankrupt.  He said that over the preceding few years he routinely went to the local bank for drilling loans, which were always promptly approved.  He assumed the bank had done all the analysis needed to determine that the project was sound;  the chief loan officer assumed that because the CFO had an MBA he had done the work.  In reality, no one had.  Whoops.

During the same period, a small Oklahoma bank called Penn Square (located in one tiny office in a strip mall) originated tons of drilling loans, supposedly vetted by expert loan officers and collateralized by oil and gas assets, and sold them on to other Midwestern banks eager to participate in the late-1970s drilling boom.  Turns out no screening was done   …and documents securing the collateral were never signed.

In today’s world, a lot of drilling finance has come through junk bond issuance rather than bank loans.  That may be a plus for the exploration companies, if lenders have done their usual poor job of protecting their own interests through debt covenants.

At any rate, I think the bad debt story for drilling companies has just begun to unfold.

a price turnaround?

At some point–which I don’t think is anywhere close to today–at least a few savvy producers will begin to withhold production from the market.  This will come as/when they think oil is too cheap and likely to rebound in price within a relatively short period of time.

We’ve also already seen American car buyers adjust to lower gasoline prices by starting to favor gas guzzling cars and trucks again.

However, like any other commodity, the bottom for oil will come when the cash flow of the highest-cost firms turns negative and they cease production.   My not-very-well-informed guess is that this is between $40 and $50 a barrel.

 

 

crude oil

January 7, 2015 By in Energy, Industry Analysis, shale oil Tags: , , , , , , , 3 Comments

starting with the basics…

A barrel of crude oil is a container filled with flammable liquid that weighs about 300 lb and occupies a volume of about 5.6 cubic feet.  A cube measuring a yard on each side would hold about 7 barrels and weigh a ton.  In other words, storing and transporting oil is a major issue.

According to OPEC, world oil demand is now about 91 million barrels daily.  That figure is likely to grow by about a million barrels daily during 2015.

World supply is just under 93 million barrels daily.  The difference between supply and demand, 2 million barrels daily, is enough each week to fill three of the largest oil tankers around.

Oil producers prefer to keep output steady,  because that optimizes the amount of oil that can be recovered through a given well.  Oil usage, on the other hand, is seasonal, with peaks in the US–the world’s largest consumer of petroleum products–during the summer driving season and the winter heating oil season.  Temporary storage, either in tanks or on the seas in oil tankers, holds the “extra” oil in the slack seasons.

…and on from there

What happens to the 2 million barrels of daily output that consumers more or less don’t want?

The standard answer is that speculators with access to storage bid a price on the spot market that they figure will allow them to cover their costs and make a profit when they eventually sell.

There have also been press reports that China has been buying large amounts of oil recently to build its strategic oil reserve.

The issue of imbalance between supply and demand has been developing for several years.  High prices prompt conservation, for one thing.  They also make high-cost shale and tar sands extraction economically feasible.  And until  relatively recently continuing instability in the Middle East has kept output from this important producing region below normal–offsetting the growth of shale oil from the US.

near-term potholes

In a few weeks, we’ll be entering the lowest-demand time of the year for oil.  It will be too late to manufacture and deliver heating oil to customers for winter use; driving doesn’t pick up until April-May.

Paradoxically, lower prices can trigger a spate of new output entering the market.  This could come from oil-producing countries trying to offset the price-related shortfall in their inflows of hard currency, or from financially leveraged private companies needing cash to service bank loans, or from companies whose oil inventories now look much too big.

 

More tomorrow.