oil


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Oil hasn’t been at the forefront of market discussion for a little while now. It may be soon. Oil is falling once again.

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With it, now, are the energy stocks who’s fortunes are tied to the oil price. Oil supply is plentiful and no-one on the producer side seems willing to cut or halt production. Therefore, you would expect further pressure on the price of oil.

Will the overall market follow oil and oil stocks lower?

Who really knows. But the overall market as measured by SPY, DIA, QQQ, hasn’t really moved anywhere in the last month or so. Earnings reports that beat, go nowhere.

Cheaper oil for me is great if it brings down petrol prices, and good for manufacturers/producers that use oil somewhere in their product.

But the overall market just doesn’t seem to like lower oil prices. If oil continues lower to retest the previous lows, the overall market may just follow again.

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Earnings recession history and market reaction.

Energy, which is in [large] part to blame for this current series of earnings’ misses has always been a significant component in the over-all market’s capitalisation.

Weakness in energy, is then almost a weakness in the market…in respect to earnings.

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I remember lining up for petrol as a child with my parents. I think we could only buy petrol on certain days of the week depending on car registration or something, might have been alphabetical based on your licence.

When we first went to the States, petrol was something like $0.30/gallon. Incredibly cheap. Prices sky-rocketed.

Currently, after the ‘peak-oil’ scare, oil is again [seemingly] in plentiful supply. Electric cars have established enough of a toe-hold to eventually replace petrol based cars, although it will take a while yet. Thus one of the safest trades, the oil trade, is now questionable.

Its not going to totally fall apart, but buying oil producers as an investment will become much harder than it has been. Previously you could buy the big national producers and ride out any slumps. Can you still do this?

I’m going to have a look at the various ETF’s in the space just to see what’s on offer and whether there are any compelling valuations that might overcome the decidedly questionable longevity of the trade now.

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Oil’s charge on the day is being led by data from the US Energy Information Administration (EIA) released on Wednesday that showed oil production in the country has fallen to its lowest level since September 2014. US production decreased by 113,000 barrels per day last week, marking the biggest weekly decline in output since last July. US domestic output has now fallen for 11 consecutive weeks.

That further fall in production suggests that the markets are going someway to addressing the supply/demand imbalance that has plagued markets and caused prices to fall from more than $100 per barrel in 2014 to as low as $27 in January.

Oil was also given an extra boost after, as Accendo Markets’ Mike van Dulken says: “Wildfires in Canada were seen to affect production there, while an escalation of violence in Libya did the same on this side of the pond.”

Despite the good news from the EIA, oil inventories actually continued to grow last week. The EIA’s Weekly Petroleum Status Report showed that U.S. commercial crude inventories increased by 2.8 million barrels for the week ending April 29.

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The blowup of Halliburton-Baker Hughes will reverberate beyond the energy patch. The promised merger of two of the world’s top oil-services companies is the latest mega-deal foiled by regulatory pressure this year, after Pfizer’s $160 billion bid for Allergan. Baker Hughes pockets a $3.5 billion payment for its efforts, at Halliburton owners’ expense. Punishing Halliburton’s boss and board would yield a more enduring lesson in M&A hubris.

Investors were already pricing in failure for the deal, valued at $35 billion when it was agreed in November 2014. Baker Hughes shares finished last week trading 26 percent below Halliburton’s cash-and-shares offer. Even the thwarted acquirer’s shares held up despite the colossal break fee, reflecting the market’s anticipation of failure all along.

That doesn’t mean there shouldn’t be a reckoning. Baker Hughes boss Martin Craighead ought to emerge unscathed. The saga wasted management time, but playing hard-to-get when Halliburton came courting has proven wise. Baker Hughes plans to buy back stock and pay down debt, thanks to negotiating the largest cash break fee ever. That will go some way towards numbing the pain of the $980 million net loss the company suffered in the first quarter as the slump in oil-drilling activity worsened.

Halliburton Chairman and CEO David Lesar, on the other hand, emerges a loser for his poor reading of the antitrust zeitgeist. The promise of $2 billion of annual cost savings might have made the huge break fee seem worth the risk at the time. Yet having agreed to pay away most of the present value of those savings to Baker Hughes shareholders to clinch the deal, he is now handing over cash worth more than the next three years of Halliburton’s expected net profit to a leading competitor.

Lesar already forwent his 2015 bonus because of Halliburton’s poor financial performance. Another zero this year might start to restore some lost credibility – and might make other empire-building CEOs think twice before getting caught up in merger mania. Stricter sanctions, including a rethink of Lesar’s job, would more effectively reinforce the point.

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The biggest result from the collapse in oil prices could be a future price spike.

Oil prices at $30 per barrel have put most producers under water. That has led to austere budgets and severe cuts to spending. Wood Mackenzie recently estimated that $380 billion in major oil projects have been delayed or canceled since. That means that about 27 billion barrels that had been slated for production from those projects will now not be produced.

But more cuts are expected moving forward. “There has been a $1.8 trillion reduction in spending planned for 2015 to 2020 compared to what was expected in 2014,” historian and oil expert Daniel Yergin said at the World Economic Forum in Davos, according to the Telegraph.

The oil industry has long been spending beyond its means. The shale boom was made possible by the massive monetary expansion from the U.S. Federal Reserve since 2009, with near zero interest rates allowing nearly every mom-and-pop driller to access credit. The result was a surge in oil production. Many companies struggled to be profitable before the collapse in crude oil prices. Now most are losing money on every barrel sold.

But the problem is that the market will overcorrect. The $1.8 trillion cutback in spending that Daniel Yergin cites will lead to a shortfall in supply in the coming years. The world needs to replace about 5 percent of total production each year just from natural depletion. That is somewhere around 5 million barrels per day (mb/d) each year in new output.

Moreover, demand is expected to rise. The IEA says that oil demand grew by at a five-year high of 1.8 mb/d in 2015, and while that is expected to slow in 2016, the world will still consume an extra 1.2 mb/d of oil this year. That will continue to rise. Assuming a little more than 1 mb/d each year in new demand growth, the industry will need to supply an additional 7 mb/d by 2020.

But oil supply growth will be flat this year. OPEC has little room to expand beyond what Iran will be able to return to the market, which is somewhere between 500,000 to 1 mb/d. Other members could see production fall. Non-OPEC production, especially from the U.S., is expected to fall much more significantly in 2016. Other major non-OPEC producers, such as Russia andBrazil, will also see lower output moving forward compared to what everyone thought in 2014.

From today’s vantage point, that does not seem like a big problem given the fact that oil is down to $30 per barrel. But the five-year outlook is more worrying. The IEA estimates that global upstream investment fell by 20 percent in 2015 and could fall by another 16 percent this year. “This is unprecedented: we have never seen two years in a row of falling investment. Don’t be misled, anybody who thinks low oil prices are the ‘new normal’ is going to be surprised,” the IEA’s executive director Fatih Birol said in Davos, according to the Telegraph.

OPEC’s president Emmanuel Ibe Kachikwu agreed. “The bottom line is that production no longer makes any sense for many, and at this point we’re going to see a lot of barrels leave the market. Ultimately, prices will shoot back up in a topsy-turvey movement,” he concluded.

Shale proponents argue that oil prices will stay low for a long time because shale producers can bring production back online once oil prices rise to $50 or $60 per barrel. While that is true, it is highly questionable that shale can fulfill the large demand needs expected in the future, especially with so many large-scale deepwater projects now scrapped.

The market could overcorrect, leaving the world woefully short of supply in a few years. Of course, there is one scenario in which this price spike does not play out: the global economy enters a recession. A major recession could kill any prospect of a price spike by suppressing demand. Even ifn the economy does not crash, the slowdown in China could upend the business-as-usual oil demand scenarios.

ExxonMobil just cut its forecast for Chinese oil demand to 2.2 percent each year through 2025, which is about 10 percent lower than its previous estimate. China’s energy consumption only expanded by 0.9 percent in 2015 while GDP grew at 6.9 percent (although there are some questions surrounding the reliability of those figures). Just about all energy forecasters dramatically overestimated China’s energy demand in 2015, including ExxonMobil, BP, and the IEA.

So where does all of this leave us? To sum up, the simplified answer is that the severe spending cuts taking place in the energy industry right now will create the conditions for a price spike in the not-so-distant future. That is, unless the world economy, led by China, begins to falter.

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Lots of cheap cash sloshing around the financial system was soaked up by producers looking to take advantage of $100 oil.

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