Category Archives: shale oil

Saudi Arabia’s about-face

December 7, 2016 By in oil, oil and natural gas, Saudi Arabia, shale oil, Uncategorized Tags: , , , 1 Comment

About a week ago, Saudi Arabia brokered an agreement among oil producing countries to cap their aggregate output of crude at 32.5 million barrels daily.  This will require daily liftings to be reduced by 1.2 million barrels.  Of that 1.2 million barrels in cuts, the Saudis themselves will account for 486,000, or just over 40%.

This Saudi decision flies in the face of the kingdom’s previous policy and its experience in the 1980s, when it repeatedly reduced production in a vain attempt to stabilize prices.  What happened back then?   …other OPEC countries, with more pressing needs for cash and with relatively short-lived reserve bases (so playing a long game made little sense, just as today), failed to make the output reductions they agreed to.  More than that, they boosted their liftings instead in amounts that more than offset the Saudi cutbacks.  So prices continued to fall, and for years afterward Saudi Arabia lost access to long-time customers.

Over the past two years, because of the bitter experience of the 1980s, Saudi Arabia has refused to reduce its output despite pleas from other OPEC members.  It  has even increased production a bit.

…until now.

What should we make of this about-face?

The superficial arithmetic for Riyadh is clear–reduce output by 5%; the price per barrel rises by 10% as a result; total revenue rises by 5%.  That’s assuming no cheating by other parties.  But in the case of every economically-driven commodities cartel, cheating always happens.  And the Saudis know that OPEC proved itself no different from other cartels 35 years ago.

 

What’s interesting about this case is that for us as investors situations like these, where we have imperfect information, arise more often than we would like to believe.  Rather than obsessing about what we don’t know in these cases, it’s important to see what conclusions we can draw from what we do know.

In particular:

–Saudi Arabia simply can’t have forgotten about its experience in the first half of the 1980s.  It must believe that eventually some parties will fail adhere to their production quotas.  But it must have some reason to believe that this won’t happen immediately

–it’s possible the kingdom thinks that with supply and demand are almost evenly matched, output reductions will cause the crude oil price to rise substantially.  The price rise will ward off cheating

–the Saudis must also think that what they’re doing now is a better strategy for them than that of pumping full-out and keeping prices low.  Why should this be?  My first thought is that Riyadh’s finances are not in strong enough shape to continue to endure $40 a barrel oil

–the Saudis must realize as well that $50+ a barrel will reinvigorate the shale oil industry in the US, capping any possible price rise.  On the other hand, keeping prices at, say, $40 a barrel won’t make shale oil go away.  The industry will simply lie dormant for a while, ready to spring to life again when prices are higher.  On the other hand, they may no longer believe that they can destroy the shale oil business forever by keeping prices low.  they may even fear that technological advances and cost-cutting will make shale viable at $40 if they are allowed to take place.  So, counterintuitively, the best strategy for combating the threat of shale may be to discourage the development of such new techniques by keeping prices higher

my take

Buy shale oil and monitor OPEC closely.

 

 

 

 

 

firming oil prices: seasonal strength or something more?

October 20, 2016 By in Industry Analysis, oil, oil and natural gas, shale oil, shale oil and gas, Uncategorized Tags: , , , , Leave a comment

September through mid-January is the period of greatest seasonal strength in oil prices.  Early in this period, refineries shift from making gasoline to supply drivers to manufacturing heating oil in advance of winter in the northern hemisphere.  There’s normally some friction in the supply chain as this takes place.  But the key reason for current oil price strength, I think, is the typical behavior of wholesalers, retailers and end users accumulating supplies of heating oil for winter use as autumn commences.

This period of strength usually ends in late January–after which there’s be no time to get newly-refined heating fuel to users before the weather warms.

What follows from February through April is the period of greatest seasonal weakness for oil.

 

What to make of current firmness in crude.  Is there any evidence that the proposed OPEC production limiting agreement is exerting upward pressure on the price?

My private hunch is that, yes, there is.  At the same time, I also think there will be little lasting (meaning over six months or a year) collective discipline to keep to promised quotas once they’re seen to be having an effect.  Budget deficits are too large and the third world us-against-them cohesiveness that enabled OPEC’s remarkable past cartel success is no longer present.

 

Still, I think that prices will be strong seasonally for a while in any event, so there’s no need to have a view on whether a production agreement will stick.  That time will come early in the new year.

At that point, for 2017 investment success, having a (correct) opinion about oil will be crucial, I think.  I’m hoping–and anticipating–that I’ll be able to make that decision on other grounds, i.e., the innate cheapness (or not) of shale-related exploration stocks, even without price increases.  In the meantime, I’m content to be on the sidelines.

 

crude oil: from shortage to surplus

September 16, 2016 By in oil and natural gas, shale oil, shale oil and gas, Uncategorized Tags: , , , , , 1 Comment

Until very recently, petroleum industry thinking about crude oil supplies has been dominated by what has been called “peak oil theory.”  Developed by geologist and Shell Oil researcher M. King Hubbert in the 1950s, the simplest statement of the theory is that world production of crude oil would peak shortly after the year 2000, and then begin an inevitable decline.  The reason?   …all the world’s oilfields would have been discovered and fully exploited by that time.

We now know that Dr. Hubbert’s hypothesis is incorrect.  In fact, it’s wildly–even directionally–wrong, done in by the incentive of high prices and the development of hydraulic fracturing.

 

Peak oil is of more than academic interest, since strong belief that the world is facing an inevitable decline in oil production has informed the capital spending budgets of all the major oil companies for the past generation.  For them, the present situation of abundant supply at around $50 – $60 a barrel was unthinkable.  As a result, the majors have poured billions and billions of dollars into locating very high-cost hazardous-environment oil prospects that may now be not economically viable.

What happens now?

 

My mind keeps going back to the late 1990s and the mad rush to lay fiber optic cable around the world to support the internet.  Corning and a few Asian suppliers made the highest-quality glass cable.  Global Crossing and others spent immense amounts of money as they raced to complete undersea cables to connect the US to the rest of the world.  Internet traffic was expanding at such a fantastic rate that, in these firms’ minds, the fact that a whole bunch of firms were all doing so made no difference.

In hindsight, a key assumption these companies all made was that each optic fiber in a cable would be able to handle only one transmission at a time.

Then came dense wavelength division multiplexing.   DWDM amounted to putting a prism at each end of a fiber, breaking the light into a number of different wavelengths and sending a separate communication over each wavelength.   First it was two wavelengths, then four, then 256…

Suddenly the looming fiber optic shortage was an actual fiber optic glut.

What happened beak then?    The fiber optic cable business fell apart.  So too equipment suppliers like JDS Uniphase.  The most aggressive fiber optic cable layers went into bankruptcy.

 

I’ve been thinking that it’s time to poke around in the wreckage of smaller US oil exploration firms, although I suspect we may not see oil price lows until the end of the winter heating season (assuming there is one) next February.  But I also continue to think that the DWDM analogy is a reasonable one.  It suggests that there’s still lots of trouble ahead for the biggest and best-known names in the oil industry.

 

 

thinking about Big Oil

August 16, 2016 By in oil and natural gas, shale oil, Uncategorized Tags: , , , , , , 2 Comments

I’m starting to feel I should be interested in oil stocks again.  That’s mostly because I think that we’ve already seen the lows for the oil price earlier in this year, when quotes were flirting with $25 a barrel.  I continue to think that crude will trade in a range between $40 and $60.

Under normal circumstances, I’d figure that the big multinational integrated oils would be the safest bet and that one could add some oilfield services shares to provide speculative upside potential.

For today, however, I don’t think the traditional formula is right.  Instead, I think the main thing to come to grips with is the technological change that hydraulic fracturing has brought to the industry.  I think this is similar to what happened in the steel industry when mini-mills began to compete with blast furnaces  …or to semiconductor manufacturing when third-party fabrication plants opened in Taiwan, enabling the separation of thought-intensive design from capital-intensive plant ownership  …or to the computer industry when the minicomputer and the PC replaced the mainframe.

If I’m right about this, then anything that has to do with the older order is out.  This means multi-year mega projects in remote or hostile environments (physically or politically) are substantially more risky than they have been.  It also means that the builders of giant offshore drilling equipment to find, lift or transport this kind of output aren’t coming back any time soon.  Nor are the service companies that own this sort of equipment and specialize in this kind of drilling.

The Big Oil majors, who have been the leading proponents of exotic mega projects, must also come into question, as well.   How quickly can/will they mentally adjust to a new era of abundant oil rather than perpetual shortage?  What will they do about projects that are now under way?

What other industries undergoing radical transformation have shown in the past is that the incumbents take a surprisingly long time to adjust to the new circumstances.  If that proves true again, then the best way to make money will be to undertake the tedious task of examining smaller fracking-related drillers and service companies to see how they will benefit.

 

oil at $50 a barrel

June 8, 2016 By in oil and natural gas, shale oil, Uncategorized Tags: , , , , , , , , Leave a comment

It has been a wild ride.

Crude began to run up in early 2007.  It went from $50 a barrel to a peak of around $150 in mid-2008.  Recession caused the price to plunge to $30 a barrel late that year.  From there it began a second, slower climb that saw it break back above $100 in early 2011. Crude meandered between $100 and $125 until mid-2014, when increasing shale oil production from the US caused supply to outstrip demand by about 1% – 2% a year.  That was enough to cause a second slide, again to $30, that appears to have ended this February.

Since then, the price has rebounded to $50 a barrel, where it sits now.

To recap:  $50, then $150, then $30, then $125, then $30, now $50.

Where to from here?

We know that supply remains relatively steady, with additions to output from the Middle East offsetting falls in US shale oil liftings caused by lower prices.  We also know that lower prices have stimulated consumption.

The past eight years have also shown us that crude can have exaggerated reactions to small shifts in supply and/or demand.  So, in one sense, no knows what the crude oil market will do next.

On the other hand, we can set some parameters.

–the first is psychological.  The oil price has fallen to $30 a barrel twice in the last eight years.  The first was in the depths of the worst recession since the Great Depression.  The second was during a period of general market craziness earlier this year (caused, I think, by algorithms run amok).  I think it’s a reasonable assumption that prices will have a difficult time getting that low again–and if they do that they won’t stay there for long.

–the second is physical, and is about shale oil.  Overall shale oil output in the US is now shrinking.  Firms still pumping out shale oil are of two types:  companies being forced by their banks to sell oil to repay loans; and companies whose costs are low enough that they’re making a reasonable profit at today’s prices.  Cash flow from the first group is by and large going to creditors, so this output will diminish as existing wells are tapped out.  That’s probably happening right now, since shale oil wells typically have very short lives. This means, I think, the question about when new supply comes to market–putting a cap on prices, and perhaps causing them to weaken–comes down to when healthy shale oil firms will uncap existing, non-producing wells, and/or begin to drill new ones in large enough amounts to reverse the current output shrinkage.

I’m guessing–and that’s all it is, a guess–the magic number is $60 a barrel.

My personal conclusion, therefore, is that the crude price may still have a gentle upward bias, but that most of the bounce up from $30 is behind us.