oil at $50 a barrel

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.

 

 

 

is the current equity selloff about oil?

I’m postponing my 2015 Strategy summary/conclusion on Monday.

 

The price of oil has been steadily declining since June  It’s now below $60 a barrel, after having moved sideways at around $100 from January through early July.

I think the drop is being caused by the fact that supply and demand for petroleum are relatively inflexible in the short term, so small changes in either can cause surprisingly large changes in price.  In 2008, for example, the oil price quickly spiked up from $100 to almost $150 a barrel.   It moved above $125 for a short period in 2011 and again in 2012.

Unlike the prior three surges–caused by fears of supply disruption–the current decline is being created by the steady increase in shale oil output from the US.  In a sense, no one needs all the oil now being brought to the surface.  No one has a place to store the excess.  No producer is willing to cut back his lifting to make room for the extra.  The only mechanism available to clear the market is that the price drops until it reaches a level where buyers are willing to take the risk of increasing their inventories.   Doubtless, commodities speculators of all stripes have been accentuating the downward trend with their shorting activity.

Bad as the price drop has been for oil-producing countries–Russia, the Middle East and Africa–it’s a big plus for the rest of the world.    …yet stock markets are falling on the news.  Why?

–Some market strategists are saying that falling oil prices are being caused by a mysterious–and as yet unseen in other data–falloff in economic activity.  In other words, lower oil is supposedly a harbinger of recession.  Other than for the oil producers, this makes no conceptual sense.  And it flies in the face, at least in the case of the US, of all the economic data we’re seeing–which indicate that the economy is accelerating.

–Others argue that falling oil presages deflation, presumably of the type that has plagued Japan for decades.  Again, other than for oil producers and their banks, I don’t see the problem.  Ex oil companies, no one is going to have less money to spend or to use to repay debt.

–There is a stock market-specific issue, though.  Take the US as an example.  In rough terms, the country produces 13 million barrels of oil a day and uses 20 million.  So it imports 7 million.  The price fall means the country as a whole is keeping about $100 billion a year that was previously going to foreign pil producers.  The loss to domestic producers/gain to domestic consumers is about $200 billion a year.  That money isn’t leaving the country.  It’s just going into different pockets.

In an $18 trillion economy, the whole thing is peanuts, even with secondary effects.

But oil stocks represent 8%+ of the S&P 500 (for the MSCI Global index the proportion is about the same).  So the effect on stocks is much more dramatic.

Energy stocks went down by 10% last month   …and they’ve declined another 5% so far in December.  This has two influences on the market.  The drop in oil stocks themselves depresses the index.  In addition, short-term traders, thinking oil shares look cheap (rightly or wrongly), will short other sectors to buy the oils in the expectation of a bounce.  This arbitrage activity drags the rest of the index down as well.  This is just the way stocks work.

–The fact that we’re close to the end of the year, when many professionals have begun closing down for the year, doesn’t help.  They’ll prefer to sit on the sidelines for now and hunt for bargains in January.

my take

I think the “expert” opinions about possible deflation and recession are silly.  The outsized representation of oils in stock market indices is an issue, but a temporary and minor one, in my opinion.  If anything, I think the oil price fall is a trigger for investors to begin discounting potentially higher interest rates next year.  Some investors may simply be taking profits after a 2014 that has been much stronger than anyone expected.  But declines in December seem to me to imply a better chance of gains in 2015.

 

thoughts on the International Energy Agency release of strategic oil reserves

the IEA action

Yesterday, the International Energy Agency (IEA), an organization of oil consuming countries, announced its 28 member nations have agreed to release 60 million barrels of their collective emergency oil supplies, at the rate of 2 million barrels daily for thirty days starting early in July.  The idea is to offset upward pressure on the oil price that might arise during the summer high point in demand.

The extra oil, which represents a bit less than 4% of the total government reserves of the IEA, is ostensibly to replace crude lost to world markets by fighting in Libya.

The agency has done this twice before.  The first time was when Iraq invaded Kuwait in 1990; the second was after Hurricane Katrina.

Of the 60 million barrels, North America (read, the US) will supply half, Europe 30% and Asia the rest.  Each country will decide for itself how it will achieve its goal.  The US intends to release crude oil from the Strategic Petroleum Reserve.  Japan, in contrast, is simply going to reduce by three days the amount of refined petroleum products that refiner/marketers are legally mandated to maintain.  This presumably will ultimately lead to decreased purchases of crude by Japanese oil companies.

a stop-gap measure

The release of petroleum reserves is a stop-gap measure.  It appears to have been well-timed enough to be shaking some speculators out of their long positions in oil futures, and may therefore get the world through the summer months with lower gasoline prices.  But the move is also reminiscent of the ultimately futile attempts of the signatories to the Bretton Woods currency agreements to defend fixed exchange rates.

structural issues

In the case of oil, two structural issues stand out:

–the increasing affluence of the developing world means ever higher demand from these countries for fossil fuels for power generation and for transportation, and

–the US, the only developed country without a sensible energy conservation policy, consumes almost a quarter of the petroleum the world produces, even though it  represents just over 4% of the population of the globe.

effect on stocks

The initial reaction from financial markets is that the IEA action is bad for oil stocks and good for consumer names, especially in the US.  To some degree, I think this is the right response.  But production-sharing agreements signed between the big international oil companies and producing nations over the past twenty years call for progressively increasing percentages of oil sales revenue to go to the nation rather than the oil company as prices rise.  So the negative effect of the current price fall will likely be less than markets expect.  Also, the IEA move is more a temporary reprieve than a problem solution for hard-pressed consumers.

As a result, I think that, as it unfolds in the coming weeks, the IEA move will prove a better occasion for selling US retail stocks whose customers are ordinary Americans and buying oil names that it is to do the opposite.