oil at $10 a barrel

In my early stock market days, one of my bosses sent me on a tour of commodity-trading centers to get me up to speed on palm oil.  This was so I would understand the plantation stocks in Malaysia.  I mentioned to one head of trading I spoke with that my trip was part of a months-long project.  He looked at me like I was an idiot and slowly (so that even I could understand) explained that commodities were all about gut instinct and decisive action.  He hired good high school athletes, not scholars.   A classic jock vs. nerd confrontation.

This is to say that I’m not a commodities expert.  So maybe you should take my comments about crude oil with a grain of salt.  Anyway,

–crude for May delivery plunged over the weekend to right around $10.  On Friday April 3rd a barrel was going for $28+

–the main reason is that oil production is still miles ahead of oil use and there’s no easy way to store excess crude oil output

–this is an epic low in inflation-adjusted terms.  Saudi crude sold for less than $3 a barrel in dollars of the day in the early 1970s and rose to close to $30 in 1979-80, before plunging to $8 (about $27 in today’s dollars) in the recession that followed

–there would be an arbitrage opportunity if there were storage, since crude for August delivery is trading just under $30

–this is where my not knowing oil trading hurts:  I would have expected that future months would have collapsed in line with the current month.  I read this as traders thinking the May situation is a temporary blip, but I really don’t know

–for many years natural gas has sold at a substantial discount to crude, on a heating value basis.  Today they’re roughly equal.

my stock market take

The oil market is saying this is a temporary blip.  I’m not so sure.  But I don’t know.  And the energy sector is so small that I don’t need to do any more than observe.  So I’m going to sit on my hands.

If it persists, this situation is very bad for third-world countries like Venezuela or Russia that are radically dependent on oil.  It’s also not good for the oil countries of the Middle East, which have similarly one-dimensional economies.  They can likely continue to produce at a profit even at today’s price, but I’d expect that their governments would be forced to begin to liquidate their foreign investments as budget deficits soar.  This could have a negative effect on global stock and bond markets.

The largest effect on the US is a redistribution of wealth away from the big hydrocarbon-producing states to the consuming ones.  In theory, this should be an overall wash.  But since there’s very little discretionary driving going on, I think it’s a mild negative.

The price fall is good for the EU and most of Asia.

The US stock market is flattish, despite the oil price.  Both NASDAQ and the Russell 2000 are up slightly, suggesting that neither industries of the future and small business will be hurt by lower oil.  Even the Dow, which is showing its deep roots in industries of the past, is only down by about a percent.

An addendum (stuff I just found out):  the May crude contract expires tomorrow.  The holder is required to take physical delivery of 1,000 barrels/contract.  The price shows virtually no one wants to do so.  Apparently, it’s not clear whether storage will be available on settlement date.

contract closing:  the May crude oil contract closed today at minus $37+, meaning that the seller had to pay the buyer $37,000 to shoulder the burden of taking delivery of the 1,000 barrels each contract represents.  The buyer gets the oil plus the money.

 

 

oil below $20 a barrel

The Energy sector of the S&P 500 makes up 2.8% of the index, according to the S&P website.  This is another way of saying that none of us as investors need to have an opinion about oil and gas production, which makes up the lion’s share of the sector.

Last weekend Saudi Arabia and Russia, with a fig leaf provided by the US for Mexico’s non-participation, led an oil producers’ agreement to cut production by around 10 million barrels daily.

Prior to the meeting, crude had rallied from just over $20 to around $23.  Right after, however, the Saudis announced price discounts reported to be around $4 barrel for buyers in Asia.  Prices were reduced by a smaller amount in Europe but went up for US customers–apparently at the Trump administration’s request.  That sent crude prices into the high teens.

Why is this the best strategy for Saudi Arabia?

The commonsense answer is that Riyadh thinks it’s more important to secure sales volumes than it is to be picky on price.  This is at least partly because the world output cuts reduce, but by no means eliminate, the oversupply.  So there are still going to be plenty of barrels looking for a buyer.  Another reason is that since demand has dried up the Russian ruble has dropped by 20%.  That’s like a 25% local currency price increase for Russian crude, meaning lots of room for Moscow to undercut rivals.

investment implications

The most leveraged play to changes in oil prices is oilfield services.  Companies that specialize in exploration–seismic services, drilling rig firms–are the highest beta, firms that service existing wells less so.  During the oil price crash of the early 1980s, however,  drilling rigs were stacked for a decade or so.  On the other hand, oilfield services firms are the ultimate stock market call on rising oil prices.

Given that US hydrocarbon output and usage are roughly equal, the country as a whole should be indifferent to price changes (yes, it’s more complicated, but at this point we want only the general lay of the land) rather than the net winner it was 15 years ago.  However, within the country oil consumers normally come out ahead, while oil producers are losers.

Typically, the resulting low gasoline prices would be a boon to truckers and to commuting drivers.  The first is probably still the case, the second not so much.

The bigger issue, I think, is the fate of the Big Three Detroit auto producers, who are being kept afloat by federal government policies that encourage oil consumption and protect high-profit US-made light trucks from foreign competition.  While nothing can explain the wild gyrations of Tesla (TSLA) shares, one reasonable interpretation of the stock’s resilience is the idea that the current downturn will weaken makers of combustion engines and accelerate the turn toward electric vehicles.

Personally, I’m in no rush to buy TSLA shares–which I do own indirectly through an ARK ETF.  But it’s possible both that Americans won’t buy new cars for a while (if gasoline prices stay low, greater fuel economy won’t be a big motivator).  And the rest of the world is going electric, reducing the attractiveness of Detroit cars abroad, and probably making foreign-made electrics superior products.

If there’s any practical investment question in this, it’s:  if the driving culture in the US remains but the internal combustion engine disappears, who are the winners and losers?

 

 

 

 

 

 

 

 

OPEC and $80 oil: last week’s meeting

$80 per barrel oil

Over the past year the price of a barrel of crude oil has risen from $50 to $80.  The latter figure is substantially below the $100+ that “black gold” averaged during 2011-2014, but hugely higher than the low of $25-minus thee years ago.

conventional wisdom upended

Two pieces of conventional wisdom about oil have changed during the past half-decade:

–effective shale oil production technology has shelved the previous, nearly religious, belief in the near-term peaking of world oil productive capacity.  More than that,

–the development of viable electric cars has won the world over to the idea that a substantial amount of future transportation demand is going to be met by non-petroleum vehicles.

new meaning for “peak oil”

The “peak oil” worry used to be about the day when demand would outstrip supply (as emerging economies switch from bicycles/motorcycles to several cars per household–just as conventional oil deposits would begin to give up the ghost).  The term now means the day (in 2040?) when demand hits a permanent peak, and then begins to fall as renewable energy supplants fossil fuels.

new OPEC solidarity

When Saudi Arabia, the most influential member of OPEC, said during the recent supply glut that its target for the oil price was $80 a barrel, I thought the figure was much too high.  Why?  I expected that the cartel wouldn’t stick to mutually-agreed output restrictions (totaling 1.8 million daily barrels) for the years needed for oversupply to dry up and the price of output to rise.  That was wrong.

I think the main reason for OPEC’s uncharacteristic sticktoitiveness (first time I ever typed that word) is the realization that petroleum is going to yield to renewables as firewood was supplanted by coal in the mid-nineteenth century and coal was replaced by oil in the mid-twentieth.

There are other factors, though.  The collapse of the Venezuelan government means that country now produces about a million barrels a day less than two years ago.  Also, Mr. Trump’s aversion to all things Obama has prompted him to pull the US out of the Iranian nuclear agreement and reinstate an embargo.  This likely means some fall in Iranian output from its current 4.5 million or so daily barrels, as sanctions go back into effect.  Anticipation of this last has upped today’s oil price by something like $10 a barrel.

adding 600,000 barrels to OPEC daily output

Just prior to the Trump decision on Iran, Russia and Saudi Arabia were suggesting publicly that the coalition of oil producers eventually restore as much as 1.5 million barrels of daily production, as a way of keeping prices from rising further.  Mr. Trump has reportedly asked the two to make any current increase large enough to offset the $10 rise his Iran action has sparked.

Unsurprisingly, his plea appears to have fallen on deaf ears.  Last Friday the cartel announced plans to put 600,000 barrels of daily output back on the market–subject, I think, to the condition that the amount will be adjusted, up or down, so that the price remains in the $75 – $80 range.

optimizing revenue

The old OPEC dynamic was Saudi Arabia, which had perhaps a century’s worth of oil reserves and therefore wanted to keep prices steady and low vs. everyone else, whose reserve life was much shorter and who wanted the highest possible current price, even if that hastened consumers’ move to alternatives.

Today’s dynamic is different, chiefly because the Saudis now realize that the age of renewable energy is imminent.  Today all parties want the highest possible current price, provided it is not so high that it accelerates the trend to renewables.  The consensus belief is that the tipping point is around $100 a barrel.  $80 seems to give enough safety margin that it has become the Saudi target.

 

 

 

 

 

 

the Saudi Aramco ipo

A while ago Saudi Arabia decided to list its government-owned oil and gas company, Aramco, both on its own national stock exchange as well on at least one foreign bourse.  The potential listing date is thought to be some time next year.  The Saudis are rumored to be thinking of selling 5% of the company for $100 billion–implying a $2 trillion valuation for the company as a whole.

Why the long delay?

It’s to whip a government bureaucracy into palatable enough shape for foreign investors, as well as local citizens, to want to buy shares.  It’s also to find a foreign stock exchange big enough, and willing enough, to act as host.  “Willing,” in this case, means among other considerations, being able to accept the corporate opacity that the Saudi government would surely like to surround the operations of its national treasure.

While world interest centers on trying to figure out what stock exchange is the most eager to compromise its governing principles in order to achieve a huge payday for its domestic brokerage firms (my answer:  all of them), I don’t think this is the most interesting question.

My query is why the offering.  I see two possibilities:

–the Saudi government hopes to achieve greater efficiency of operations by opening Aramco management to the scrutiny of the investing public

–the Saudi government wants/needs the $100 billion proceeds to fund its government spending.

I’m sure the reality is that both are key objectives.  The question, however, is which of the two is uppermost in Riyadh’s mind.

 

If it’s the former, then the stock is likely, I think, to be a perennial laggard.   And it will give a black eye to whatever foreign listing venue it chooses (London and New York are understood to be the frontrunners, although Hong Kong is also big enough to handle an offering of Aramco’s intended mammoth size).

If the latter, the stock may be worth taking a chance on.  After all, it does have a massive amount of extremely low-cost oil and gas reserves.  However, whatever the case, Aramco appears destined to miss the current market, in which companies like Snap and Blue Apron floated successfully,  and which would have been the ideal time for any issuer to come public.

BP Energy Outlook 2016

BP just released its annual Energy Outlook.  

The company is projecting faster development of shale oil, coming mostly over the next few years from the US, than it previously thought.  Renewable energy supply will rise more quickly; (heavily polluting) coal usage will fall faster.  Most of the action will be in developing nations like China and India.  The US will attain energy self-sufficiency in a handful of years, oil self-sufficiency shortly after that.

 

To me, the most interesting topic the release brings up is not actually contained in the report.  It comes from comments by Spencer Dale, BP’s chief economist, during a press conference promoting the new Outlook.

According to the Financial Times, Mr. Dale said that there’s twice as much technically recoverable oil available as the world is expected to need between now and 2050.”

First, “technically recoverable” means only that all of this oil can be extracted from the ground using current oilfield methods.  It does not mean it can be done profitably.  In fact, the choice of the word “technically” suggests BP believes that a significant portion is uneconomical at today’s prices.

Second, according to BP, much of this oil is unlikely to see the light of day…ever.    That’s because global demand for energy is likely to grow by less than 2% yearly.  Most of that will be supplied by renewables and natural gas; oil demand increases by less than 1% annually.

At some point, as the price of renewable energy continues to fall, and absent a decline in the oil price, demand for oil begins to shrink.   Since one might imagine that this drop might not take place thirty years, it may be of little practical concern to you and me.  However, for OPEC countries like Saudi Arabia, which holds perhaps 100 years worth of economically viable oil, and whose economy is radically dependent on petroleum, this is a significant worry.

Investment implications (assuming BP is correct):

–the oil price is unlikely to go up

–OPEC + shale oil will squeeze out higher cost oil production from the rest of the world

–future shale oil company profits will come as much from lowering production costs as from new finds

–big oil firms probably still have plenty of stranded assets (meaning oilfield investments that have become uneconomical and where recovery of the money already spent is unlikely) on their balance sheets.