Category Archives: Mining

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.

 

 

nearing crunch time for the oil price

November 16, 2015 By in Energy, Mining, Refining, shale oil, shale oil and gas Tags: , , , , , , Leave a comment

recap

By allowing/encouraging the oil price to stay over $100 a barrel, OPEC unwittingly created a pricing umbrella that spawned a significant new, relatively high cost, shale oil industry in the US that, at its peak last year, was pumping an extra 5 million barrels of crude a day onto the world market.  At that point, world supply rose above demand, with the natural consequence that prices began to fall.

The OPEC response ot lower prices has been to increase its production, with the intention of spurring new demand and of forcing shale oil producers out of business.  Since for most OPEC countries, oil is the principal source of GDP and of hard currency, more barrels out the door also eased revenue shortfalls somewhat.  Nevertheless, OPEC is generally experiencing a significant cash squeeze.

The plan has worked, to some degree.  American consumers have lost their taste for compact cars and are buying gas-guzzling trucks in huge numbers.  Shale oil production is gradually fading.  Overall world demand continues to rise at 1.5+ million barrels per day.

where we stand now

The excess of supply over demand is still about two million barrels per day, according to the International Energy Agency, (whose latest monthly report can be found in financial newspapaers).

The end to economic sanctions on Iran is likely to free 500,000 barrels of Persian oil for sale sometime next year, however–and that figure might be as high as a million.  And China has been using the fall in prices to increase its strategic petroleum reserve.  Some reports say that this process is close to an end.

storage is a key 

The most important near-term factor to watch, in my view, is overall world inventories–which are at extremely high levels.

Petroleum storage is of two types:

–storage of crude, normally in tank farms, but also in rented oil tankers

–refined products storage, both in tank farms owned by refiners and (the thing we know least about) in customers’ hands–from industry to the gas tanks in individuals’ automobiles.

We do know that crude tank farms in Asia and Europe are full, and that refiners’ output storage tanks are bursting at the seams.  In addition, the cost of renting a crude oil tanker to store barrels for future delivery is now higher than the profit an arbitrageur would make by buying oil now and entering a futures contract for later delivery.

On top of all that, warm weather has meant that the usual seasonal buying surge for heating oil has not yet happened.

to summarize

At the current rate of adjustment, oil supply and demand may not come into balance until late 2016–and maybe early 2017.

The world is running out of places to stash the extra crude.  The globe already appears to have run out of places to do so at a profit.

Therefore, it’s possible that, at the very least, the oil price will decline again–even in a period of seasonal strength like the present–to a level where the arbitrage of buying now and storing for future delivery makes money.  But when stuff like this happens, the world is rarely rational.  The Goldman scenario in which the crude price falls to $20 no longer seems like a footnote.  It’s something that has–I don’t know–say, a one in three chance of occurring.

If that happens, I think it would be a great chance to sift through the rubble for medium-sized US shale oil firms that will survive until better days arrive in maybe 18 months.

 

 

thinking about 2016: oil

October 21, 2015 By in Energy, Gold, Industry Analysis, Mining, oil and natural gas, shale oil and gas Tags: , , , , , 1 Comment

Regular reader Chris commented about yesterday’s post that we may be in the early stages of a decade+ downcycle in the oil price.  I thought I’d elaborate on that thought today.

base metals–gold, too

I think the situation with base metals is very clear.  Capacity is typically added in very large increments, and by all parties in the industry at once, creating the top of the market.  The mines can be shut down, but the orebodies don’t disappear.  Neither does the machinery.  So operations can be restarted fairly easily.  As a result, the market only comes back into balance as economic growth slowly expands, eating into the oversupply overhang.  Last time around, in the early 1980s, this process took well over a decade.

oil

Th case of oil is slightly different.  The petroleum industry is far bigger and more important than metals.  In most cases, there are no good substitutes.  Use for heating and transportation can’t be postponed.

Discovery of new reserves is a much more important factor in production.  The ability of oilfields to extract output without significant new drilling can deteriorate sharply if wells are shut down, interrupting the underground flow of oil to them.  Because of this second factor, very small differences between supply and demand can have dramatic.

 

At the last oil peak in 1980-81, two factors conspired to stretch out in time the fall in prices needed to restore supply-demand balance.

–The US, the world’s largest petroleum consumer, enacted a byzantine series of price control laws to prevent higher oil prices from being passed on to consumers.  This delayed conservation into the 1980s, when the regulations were dismantled.

–Saudi Arabia, then the largest oil producer in the world, decided to cut its production in an unsuccessful attempt to prop up prices.  It went from 10+ million barrels per day in 1980 to just over 3 million in 1985.  Although other OPEC members also agreed to curtail production, widespread cheating (typical cartel behavior) undermined the supply reduction effort.  The oil market finally bottomed at around $8 a barrel (the high was $34 in December 1980) when the Saudis got fed up and began to restore production in 1986.

 

This time, neither factor is present.  The only residual of 1970s efforts to promote oil use in the US is the country’s relatively low level of tax, by world standards, on gasoline.  Saudi Arabia, having learned a bitter lesson from the 1980s, has actually increased production slightly.

 

I think this means that the bottom for oil will come much more quickly than in the 1980s.  It may be happening now.

I don’t think there will be a quick rebound, however, even though the excess supply now present in the world may only amount to 2% – 3% of total demand.  That’s because:

–demand is growing more slowly than experts have been predicting

–hydraulic fracturing is proving less vulnerable to lower prices, as frackers streamline their procedures to lower costs (no one worried about efficiency when oil was $100 a barrel)

–removal of economic sanctions on Iran will give a one-time boost to supply of about 500,000 barrels a day (on world production of roughly 90 million bbl/’day).

my thoughts

If I had to guess, I’d say that fracking has permanently changed the supply/demand situation in oil.  New capacity can be added quickly, in lots of small increments, at around $60 a barrel.  I think this puts a (permanent?) ceiling on the oil price, or at least one that lasts for longer than we as investors need to worry about.

The bottom is harder to figure out.  If we were back in 1980, when world demand was about 60 million barrels a day and almost half came from ultra-low-cost sources in OPEC, revisiting the 1986 lows might be an ugly but realistic option.  However, with production now around 90 million and the Middle East closer to an afterthought than a real price-setting power, enough output is being curtailed at current prices that I think we’re probably in the bottoming process now.

At some point, aggressive investors will sift through left-for-dead small exploration companies to find survivors.  I’m sure industry experts are already doing so.  I’m not an expert any more.  I’m not doing so yet.  My inclination is to look for consumer or tech companies that stand to benefit from the boost to economic activity created by lower oil.

 

$20 a barrel oil?

September 16, 2015 By in Energy, Industry Analysis, Mining, shale oil, shale oil and gas Tags: , , , Leave a comment

Last week, Goldman Sachs released a research report to clients in which it observed that if the world oil market develops in a less favorable way (to oil producers) than it currently anticipates, the crude oil price might plunge to as low as $20 a barrel before enough production is removed from the market for prices to stabilize.

This “doomsday” scenario has, naturally enough, captured all the press headlines.  I haven’t seen the GS report, but I do know the factors involved.  They are:

forces for price stability around $40 a barrel

  1.  Under normal conditions in a commodity market, when oversupply develops prices fall to a level below the out-of-pocket production expenses of the highest-cost producers.  This eventually causes them to stop generating output.  The reduction in supply stabilizes prices.  If producers mothball their operations and fire their workers, that itself may be enough to start prices rising again.
  2. Even for producers who are still profitable at lower prices, decreased cash flow leaves them less money to invest in project expansion.  Price uncertainty may cause them to hesitate, as well.  For those who have borrowed heavily, contracts with their lenders may force them to divert cash away from operations toward debt repayment.

forces against stability

  1. Many members of OPEC, which accounts for about a third of world oil production, have relatively simple economies that are heavily dependent on oil to fund government spending and to provide money to ordinary citizens.  Where the textbook economic response to lower prices may be to produce less, in order to maintain government plans and services (keeping citizens happy) the only response from OPEC is to produce more to generate more income.  This is arguably self-defeating   …and makes the problem worse.  Still, OPEC has raised production by about 2 million barrels a day over the past months.  And Iran is saying that once sanctions are lifted, it will begin to sell 100,000 barrels of oil a day, with presumably more in the offing.
  2. At, say, $100 a barrel, producers of petroleum from oil sands or shale have had no pressing incentives to hone their techniques.  At $40 a barrel and facing potential shutdown, they’re becoming much more inventive.  So they are finding ways to lower their costs to keep delivering output to market.

oil storage

We know that the world is now being supplied with more oil than it needs because oil inventories are rising.  Middlemen continue to be content to buy from producers because they can immediately sell for future delivery at a profit through derivatives and store the stuff in the mean time.

My experience is that although the markets have a rough idea of how much storage capacity there is–in giant storage tanks, barges, tanker ships…,  the reality is that there’s always more capacity than the consensus suspects.

What happens when every storage container is full?    …no one buys oil that comes on the market because there’s no place to put it.

the doomsday scenario

Three parts:

–shale oil producers lower their costs so that their production doesn’t fall by the 500,000 barrels/day that the market expects

–storage gets all filled up

–OPEC keeps on increasing production because it needs the money.

Middlemen turn the stuff away.  Prices plummet.

probability?

I’m not worried, so I guess I think it’s low.  In reality, no one knows.

Goldman has credibility in this field not only because it has strong commodity trading operations, but also because years ago it predicted $100+ per barrel oil when no one else thought it was possible.

Tomorrow, consequences of doomsday, were it to happen.

 

thinking about China: economic growth and metals

August 26, 2015 By in Asian economic development, China, economics, Hong Kong, Japanese development, Mining Tags: , , , 1 Comment

In the late 1970s, Beijing decided that its central planning model of economic development wasn’t working because the domestic economy had become too complex.  It reluctantly shifted to the model Japan had used to recover from WWII–concentrating on export-oriented manufacturing, offering cheap labor in exchange for technology and industrial craft skill transfer.  China became an increasingly large user of natural resources (oil and metals) as it created industrial infrastructure, industrial plants and provided housing and other public services for its large population.

Maybe ten years ago China realized that it was soon going to run out of low-wage farm workers willing/able to switch to manufacturing in order to sustain the export-oriented model.  Associated pollution and other environmental problems were also becoming more acute.  So the natural resource intensive, export path to growth was nearing an end.

Five years or so ago, China, now out of cheap labor, began the shift to a consumer-oriented, domestic demand approach to GDP growth.  Government stimulus to offset the negative effects of the recent recession gave exporters one final surge of vitality.  Still, for years manual labor-intensive businesses have been leaving China for, say, Vietnam or Bangladesh.  Beijing has also been cracking down on relatively primitive steel and aluminum processing operations.

Politically and socially, as well as economically, this is a difficult transition to make, because rich and powerful forces of the status quo don’t want things to change.  Japan, Singapore and Hong Kong (multiple times) have made the shift; Malaysia, Thailand and much of South America have not.

One of the main characteristics of this period of change is a slowdown in demand for base metals and other industrial inputs.  For China, which had been the dominant customer for almost any base metal, the transition comes just as global mining companies have made (inexplicably, to my mind) huge additions to productive capacity.

The result of increasing supply at a time of flagging demand is easily predictable–lower prices.

Why write about this?

Many financial markets commentators have been pointing to low base metals prices as evidence of cyclical economic weakness in China.  That may ultimately turn out to be the case.  But it’s equally a sign of:  1) structural change in the Chinese economy, which would be a good thing, and 2) witless mining companies.  So it’s by no means a sure thing that bears on China are correct.

By the way, the last global collapse in base metals prices came in the early 1980s.  That followed a decade-long period of mine expansion that was based on the idea that the United States couldn’t grow economically without using copper, lead, zinc and iron in amounts that would increase in a straight line with GDP expansion.  In hindsight, what a mistake!  Although Peter Drucker had been writing about knowledge workers from the 1950s, no one put two and two together.  It took almost two decades for world growth to absorb the excess capacity that miners added back then.