Category Archives: oil and natural gas

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.

 

 

 

the Lucky Country, the Dutch/Detroit disease and the Middle East

April 27, 2016 By in "Dutch disease", oil and natural gas, Uncategorized Tags: , , , , , , , , Leave a comment

lucky countries

where is Wikipedia when you need it?

The original “Lucky Country” was Argentina.  As I googled the term before writing this post, however, I found no trace of a link between the name and the South American agricultural giant.

Still, I began my international investing career in the mid-1980s with an Australian portfolio.  In that Cro-Magnon time the Argentina/Australia comparison was common.

The idea for both nations was that they were endowed with abundant natural resources, but that this was a curse, not a blessing.  That good luck spawned its opposite–excessive reliance on food/mineral production, insularity, dysfunctional government and resultant economic misery.  In contrast, resource-poor places like Japan or Korea were blossoming as economic powerhouses.

the Dutch/Detroit disease

I stuck in the Detroit part.  For me the Michigan analogy is much more current and powerful.

The Dutch “disease” was the discovery of gigantic offshore oil deposits.  They required a lot of labor to develop–mostly strong backs and a willingness to spend long periods of time on floating oil development platforms. 

The jobs required a lot of people, however, and paid maybe 3x normal wages.  Combine that with a small national population and the result was soaring wages and, therefore, a mass migration of non-oil industries to other countries.  When oil prices peaked in December 1980 and began a swoon that would reduce them by about 3/4, the oil business collapsed.  Government finances fell apart and unemployment skyrocketed as laid-off oil workers couldn’t find new domestic jobs.

The “disease,” then, is small area and reliance on a single industry.

Detroit is the American equivalent, with automobiles instead of oil.  The domestic auto industry grew fat and lazy in the 1970s-80s behind protective barriers erected against imports.  It paid high wages that drove most other businesses out of the area.  Heavy reliance on the “Big Three” car makers, corrupt government and the arrival of foreign auto manufacturers in lower-cost areas in the US eventually combined to drive the city into bankruptcy.

the Middle East

Economically, the typical oil producing country is Detroit in the desert.

Two twists on the all-eggs-in-one-basket theme:

— very young populations, meaning an imminent threat of significant youth unemployment; and

–a reluctance to allow women into the workforce.

Both probably turn them into Detroit on steroids.

I have no idea how this all works out.  Dubai, which has no oil, is looking a lot smarter than it did six or seven years ago.  The recent Saudi announcements of a radical restructuring of its economy are just the curtain being raised on what may be a lengthy, twisty-plot drama, I think.

 

the proposed Aramco IPO: why?

April 26, 2016 By in oil and natural gas, Saudi Arabia, Uncategorized Tags: , , , , , , 1 Comment

Aramco and an IPO

Over the past few days, as a new, younger generation prepares to take over leadership of Saudi Arabia, the kingdom has been announcing plans to overhaul the structure of its radically oil-dependent economy.

The most concrete of these is a proposed IPO for the Saudi national oil company, Aramco (the Arabian American Oil Company before it was nationalized in the 1970s).  The idea would be to sell roughly a 5% interest in Aramco to the investing public, with a dual listing in Saudi Arabia and somewhere else.  The leading “somewhere else” contender is the US.

It’s not clear yet exactly what the future shareholders would have an ownership interest in.  Aramco contains all sorts of oil-related operations, from exploration and production to refining to petrochemical production.  The Saudis intend to restructure Aramco into a holding company with subsidiaries–structured presumably by type of business–before offering equity.  To me, it sounds as if the offering will be of stock in a subsidiary, not the holding company.

Why?

money

The obvious answer is that the kingdom wants to raise money to fund its budget deficit.  It figures the proposed IPO will raise $100 billion – $150 billion, a figure that already has investment bankers around the world salivating.  This, by the way, implies a total value for Aramco of $2 trillion – $3 trillion.

deeper motivation

But there’s almost invariably a deeper motivation when a country takes action like this.  It wants to focus and streamline operations of the to-be-IPOed company, either because current service is terrible and/or to generate more funds from operations to fill government coffers.  The IPO offers potential wealth and prestige to the management of the government-owned company if they run it well.  That substitutes for pre-IPO motivation, which may simply be to do the least work possible, and make the fewest waves, without getting fired.

better than they look

In my experience, such IPOs, however dreary the prospectus may sound, often do quite well for at least the first couple of years.  Two reasons:

–their scope for change becomes much wider when public scrutiny protects the manager from interference by politically-connected sluggards who like the status quo, and

–managers tend to, in a sense, stop working once they find out an IPO is in the offing.  Why make improvements today that will only make post-IPO earnings comparisons harder?  Better to save them for the time when the stock is publicly traded and holders of stock, stock options and management incentive plans will cash in on them.

in sum

The IPO itself is evidence that the Saudis are serious about a reorientation of their economic priorities.  Human nature argues that 2016 will be like wading through molasses for Aramco but that it will break very quickly from the gate after the IPO.

last weekend’s “failed” Doha oil meeting

April 21, 2016 By in oil and natural gas, Uncategorized Tags: , , , Leave a comment

Representatives from a large group of national oil companies, both Opec and non-Opec, met in Doha last weekend, ostensibly to see if they could mutually agree not to raise their oil production from current levels.

From a practical economic view, the conclave made little sense.  Because all the countries involved are strapped for cash, they’re already producing flat out.  The only exception is Iran, which declined to participate.  It is ramping up its output for the first time in a long while now that sanctions are being lifted, and has no intention of stopping.

 

It was clear from the outset that the best outcome would be an agreement where the parties said they wouldn’t do what they couldn’t do anyway.  So Doha was all about optics, about satisfying internal political demands that the local oil ministries were leaving no stone unturned.  Weird, maybe, but understandable if you’re an oil functionary who wants to keep his job.

Nevertheless, there was an immediate spike down in the oil price when failure to reach agreement was announced.  To my mind this was more traders playing games in the market than an expression of dismay.

More interestingly:

–crude oil prices are higher today than they were before Doha, and

–Brent crude, a proxy for non-US demand for oil (because it can be used in older refineries), is beginning to establish its traditional premium  over West Texas Intermediate.

my thoughts

We passed the seasonal low point for oil demand in mid-February and are entering the strongest seasonal period now.  So it makes some sense that the price should be strengthening.

The Brent premium suggests US drivers aren’t the only ones consuming more oil products.  The lower price may also be stimulating usage in the rest of the OECD, where petroleum taxes are much higher.

The (crazy) period of securities trading where low oil was thought to be a harbinger of recession appears to be behind us.

My guess is that traders will continue to search for a price ceiling, which I think is around $50 a barrel.

I wonder if the major non-government owned oil companies have been holding back production on the idea that prices are too low, thereby, consciously or not, aiding the recovery process.  This wouldn’t be much different from how these firms acted during the period of oil price controls in the US in the 1970s -1980s.