latest news on oil

Three developments in the last week or so:

Saudi Arabia has clarified for reporters the significance of its recent agreement with Russia, Venezuela and Qatar to refrain from increasing oil production.  The Saudis have no intention of decreasing production, as the media had speculated, but will not pump out more than it is doing at present.

This makes it resoundingly clear, as if it weren’t already, that Saudi Arabia is taking a page out of J D Rockefeller’s nineteenth-century playbook.  It intends to maintain oversupply until weaker, higher-cost competitors are driven out of business.

the International Energy Agency has revised up its estimate of how long it will take for steadily increasing world demand for petroleum to catch up to the current level of supply.  The breakeven date is being pushed back into 2017.

This breaking even consists of two separate elements:  the point when daily usage rises to/above the level of current oil production, and the subsequent–possible quite extended–period during which accumulated excess inventories will be run off.

My first guess is that the prices of oil equities will begin to readjust when the first of the two comes into sight.

J P Morgan announced with its latest earnings report that it is tripling the reserves it is providing on its balance sheet for potential oil company loan losses.

This is “old” news, in the sense that this is accounting recognition of economic damage that has already occurred.  Two reasons for the lag:

—bank loans are typically secured by the oil and gas reserves that the borrower owns.  Their value can change either because the selling price of output rises/falls, or because the quantity of output that can be brought to the surface at a profit changes with price.   It’s conceivable that a small firm that had a million barrels of reserves a year ago only has 500,000 today–because 100,000 have been produced and 400,000 are not economically viable at today’s selling price. Because of this, in an extreme case a halving of the oil price could conceivably wipe out 90% of the value of reserves.  Figuring this out depends on getting a report from petroleum engineers who “audit” reserves annually.  Many such reports have presumably been just rolling in since yearend.

—accounting theory and tax law both argue against a bank making a good-faith guess at what the potential liability will be.  The more prudent course is to wait for reserve reports (required in the loan covenants) from borrowers.

My bottom line:  the only surprise here is the IEA surmise that supply and demand won’t be back into balance before next year.  Otherwise, the oil market adjustment process appears to me to be playing out as one might have expected six or more months ago.  On the good news front, we’re passing the seasonal low point for oil demand.  On the bad news side of the ledger, there’s no evidence that the successful, if economically crazy, stock market trading linkage between equities and oil is being broken.  If I were a trader, though, I’d keep working the trade despite the lack of economic underpinnings until I stopped making money with it.