I am getting constructive on oil markets, and starting to feel more comfortable with my BAS, VOC and HCLP positions. I may just edge in a little further, in another month or so.
I understand how dark prospects for oil are right now; we have numerous estimates calling for the total dismantling of oil, sending it into the $20’s, and suddenly those forecasts aren’t feeling quite so fanciful. It’s the fear creeping up in people.
But how many of these forecasts existed before last October? Tell me that, will you? Back in July, it was only a matter of how many $10’s we could stack on top of the $100 mark. Nobody I know was seriously calling for sub-$40 oil. Even those of us who were expecting a pullback had the $70-90 range as a guide. Which is why almost everybody long got smoked. Even scaling a position back to half the size wasn’t enough to escape this (trust me I know).
Which leads me to think a lot of these “experts” talking up ultra cheap crude oil are just trolling the public. Goldman Sachs has a pretty horrible record of forecasting commodities, actually. That’s not how commodity storage facilities work – there you have cheap cost to store and opportunistic offerings and purchases. You also have a futures trading desk which you can tie into to cooperate with. But you still don’t know what’s going to actually happen. You just roll with it and make money as you can.
Names like BAS are chopping 8% every other which way. But they are working a floor in, and steadily, slowly, offering higher prices.
And what about the demand for crude globally? Yes there was a (not really that) significant excess supply gap, which is growing. But that gap existed with $100 crude oil and well development pricing in $100 crude oil. We are seeing just massive layoffs as the industry reacts to new facts on the ground. So future supply is being taken offline.
And to boot, oil is cheap now. So cheap.
Look at industrial output in the Eurozone; one part oil prices, one part a cheap currency. Is that killing the US? Nope, we seem to be absorbing the currency strength but still happily putting along. Cheap oil lifts all boats. I was very concerned that oil prices would make a serious headwind to the US – and certainly on some level it is, gross – but net jobs are working out fine as any complications from the Dakota’s are being more than offset.
Currency games are fun, but net economic growth is all that really matters at the end of the day. If a few thousand losses in one spot beget a few thousand gains in another, then activity will continue apace and crude demand will keep growing. You’re only really in trouble if you start getting net losses.
I think the oil market got way ahead of itself as unabashed speculators got their comeuppance. This is drawing to a close and I wouldn’t be surprised if oil abruptly rediscovers that $70-90 range we all sort of guessed was a fair price. I would not count on crude oil hanging out at levels from the 20th century, because that’s just not how extraction costs have trended.
And ultimately, no matter what crude oil does, I think there are going to be limits to how much devastation we see in oil companies. It doesn’t take much to swing the oil market back into balance; the imbalance is really not that significant. If oil sustains these prices, it will be because it is profitable for enough US shale companies to do so. If US shale cripples, you are going to see way more than just US shale cripple. Which is sort of a Catch 22.
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My take on oil prices since prices started falling is that nobody really knows how far it will drop or how long it will stay below the break even levels that some companies are going to need to keep up with their debt obligations. We see $20 price targets and we see $90 price targets, but everyone’s just throwing darts. I’m sure oil will get back into that $70-90 range again, I just don’t know if it’s going to be in 2 weeks or 2 years. The balance sheets of most E&P plays make it awfully hard to really sink your teeth in here, you can take a bite or two but if oil prices don’t recover soon you’re looking at some serious carnage.
I believe you are right, in that this discussion very much begins with what not to buy.
Nice oil commentary! thanks!
Nice Cain. Thank you
What are your thoughts on some of these companies debt?
For instance, BBEP common is yielding 11% and some of their bonds are yielding 16%. Is debt a decent way to play these? If conditions get worse the paper trades down, but the common would as well…and most likely the dividend gets suspended completely before they skip a bond payment.
At these prices, at what combination of events do you see the common trading down but the paper not defaulting?
You could make the claim on a case by case basis, but I think you’d be threading the needle pretty closely there.
I’d rather find companies that I think are definitely going to survive, then buy their common knowing that the gains will be much richer, than go around grabbing a bunch of debt. But that’s just because I suspect the gap between $0 common stock and defaulting on the bonds is very narrow.
I think you just have to look at rig counts. 3-6 months after rig count bottoms I expect shale production to bottom and bankrupcies to end. So many producers are being forced to produce at these prices just to meet financing obligations, so we need that race to the bottom to push players out of the market. I am expecting oil prices in the 35-55 range for the rest of this year, with my bias towards the bottom of the range.