Stock advice in actual English.
Joined Sep 2, 2009
1,224 Blog Posts


Oil just got beat again when it became public that OPEC is a dysfunctional organization. Who could have imagined that disparate oil producing nations with deep, cultural differences (read racism) might have trouble working through competition?

I never would have guessed it would crop up this quickly. But the demise of OPEC is hardly unforeseen. I myself penned an article this July discussing the possibility of the oil markets being upended.

But it is funny, reading through those thoughts going on just five months old, and seeing how violently they have diverged from what I expected.

I expected the development of US oil and gas reserves would create trouble for the old guards. I did not expect that oil would collapse 30% in two months. While you could say that those price swings were to be expected – just simple economics – I had expected the US might actually do more legislatively to erect a wall between us and the oil nations altogether. Obviously this happened much too quickly for any of that.

I had also guessed that when things started to get tough, OPEC would at least try to band together first. They’ve been successful at this in the past, so failing to construct even symbolic production cuts this round is certainly worse off along than I would have ventured.

The fallout in oil and energy names, following August, is not something I truthfully believed in. This may sound strange, but I was actually betting against myself when I made those sales of my oil and gas positions. And I never would have believed we’d fall so far. BAS is off 60% peak to trough, for crying out loud. Even when I knew we were experiencing a correction, I didn’t think it would be this extreme.

Now let’s put some context into all of this. Some of these energy names are trading at prices as bad as or worse than they were in 2010-2011 (when oil prices were pretty much where they are now); and lots of these energy companies were losing money back then, whereas they are making money today. I’m talking about BAS explicitly as an example.

So what happens now?

Well, I think that the prices of oil & gas plays are pretty compelling here. Yes oil is a bummer and there is big talk about $30 oil being right around the corner. And it’s no coincidence that I think this talk is stupid and that those responsible should be viciously ridiculed. I think the price drop is temporary, unremarkable and indistinct from any other major selloff that has gripped the price of oil in the past five years.

I think competition will continue to do real damage to the major oil nations in the world bringing about the greatest power shift of our lifetimes. But as apart from my peers, who seem to believe that a Venezuela or Russia has the ability to ramp up production into this price drop, leading to a deflationary spiral that ushers in 1990’s prices for all Western nations, I tend to feel this is silly.

You can’t call for the death of the Bakkens and simultaneously think that oil stays this low. Actually I have a hypothesis that the events that would have to converge to keep oil this low are few and far between. The big question here is timing as to when oil goes higher.

So my guess – and this is definitely just that – is that the US shale boom lives. And here’s what will enable that to happen.

These oil exporting countries have all made brazen moves with their budgets. Places like Russia, Saudi Arabia, or Iran are barely holding it together. Places like Venezuela can’t even muster that; oil prices for Venezuela are kind of like mattresses or trampolines to a guy already falling off a roof – a point of hope.

But if oil prices keep falling, you’re going to see one of these places – and Venezuela is definitely near the top of my list – buckle. Venezuela is probably the easiest case to get back to $100 oil, because one Venezuela is good enough to offset new US production. But it could just as easily be a combination of other smaller oil exporters. A half dozen of the smaller to mid size guys, or even a combination of Syria and Iraq plunging back into darkness. IS is obviously a possible trigger here; a bunch of pissed off twenty year olds, armed with rocket propelled grenades, trying to operate oil machinery? Sounds like a nice, safe combo.

What we’ve seen, repeatedly, is that when a place like, oh, Syria or Libya plunges into anarchy, it’s not just a small setback. Rather, the entire oil infrastructure gets taken offline for years at a time.

Another civil war or resurgent fighting could easily get us back to lower oil production in these places. Some US legislative work (now freed from the concerns about access to supply thanks to the US domestic advances) could help keep our own oil expertise from setting those places back up again after they tumble.

Why would we want to do this? Rome is sick of Carthage.

Just think about the sheer number of problems that these countries have dealt us over the past fifty years. We already know that the US can withstand $100 oil. We’ve been doing it for a few years now. And $100 oil benefits the US economy directly, whereas $80 oil is the worst of all worlds; too cheap or expensive to care about.

With the GOP in Congress and looking to juice the US a little, and with Obama increasingly looking for a major win, sticking a stake in the middle east is probably the lowest hanging fruit around. Kill IS by letting them destroy their own oil infrastructure, then restrict the companies that have usually bailed that region back out (Shell, Exxon, etcetera) from doing that. Lower Russia back into 1993 conditions, then tell Blankfein to keep out this time.

That’s how I see things playing out. Sure we could watch the US shale revolution just go to waste completely. But I think at this junction the US has a pretty vested interest in not letting that happen. It’s a new dawn, after all.

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  1. incometrader

    Shale oil is especially vulnerable because unlike the rest of the world, the dollar has not been cushioning the blow. For instance USDCAD has taken a 12% bite out of the 30%+ crude drop for those companies.

    At the very least any new projects not already too far along are going to be mothballed near term. Longer term the more expensive areas will be completely shutdown. Eventually costs will come down to make it sustainable again but short term pain is inevitable.

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  2. gorby

    Thanks for the work Cain.
    Only oil in the ointment that I can see
    is that low gas prices are acting as a
    huge tax cut right and with the big
    election just 24 months away who
    would want to wear- higher gas prices
    are good for us.

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  3. bonobo smores

    As Cato the Elder used to say after every Roman Senate meeting ‘Carthage must be destroyed’, until it was completely dismantled and the soil salted. Will history repeat itself?

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  4. tau


    Have you been watching BAS bonds? Their 7.75 due 2019 has a YTM now of 11% (it was 6% a few months ago).

    Seems like an compelling buying opportunity to me, unless I am missing something.

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  5. Dr. Fly

    nice piece

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  6. rahagar

    Interesting points. Does the US have a bigger interest in seeing cheaper oil and more consumer dollars available to flow into other areas…like the housing market and all consumer products. Or, a short term preservation of shale oil drilling? The oil will still be there for the future. The 80 dollar threshold may be a best of both worlds, we don’t lose oil jobs and we have more to spend.

    I am wondering who could benefit most in the long term by this possibly/probably short term drop in price. There could be some great opportunities for the Big Oil boyz to scoop up good US properties when the leveraged small producers crash and burn. XOM may be voting for a short term pain trade of 70/bbl crude so they can keep increasing their reserves without spending to much, or taking geopolitical risks (like drilling in Arctic Ocean with Russia and SDRL http://www.bloomberg.com/news/2014-09-27/rosneft-says-exxon-arctic-well-strikes-oil.html )

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