Get Ready For The Second Leg Down

I had thought, before Thursday evening, that we were preparing to end this correction. I cannot in good faith believe that now.

The sheer level of devastation – and devastation is in no way hyperbole – that hit the tape Friday does not just flutter away. We are in pure panic mode, based on an as of yet still unseen enemy.

That I can’t see what is causing all the panic frightens me more. The only thing – the only thing – that even comes close to setting off alarm bells for me is the EURUSD and reports out of Europe. The market is trading like it’s 2010-2011 again. That actually makes sense to me. I had figured Europe’s troubles had been masked but not addressed.

But there’s not much data here to back up the fear. It’s not like European yields are blowing out again. The EURUSD is the only visible piece to the puzzle. There’s some churning GDP numbers as well. How can I sell out based on a single indicator and what is still just noise?

The oil blowout itself doesn’t make any sense. I spent the weekend reading through research reports analyzing the situation. The main takeaways are that oil could go a lot lower, no one thinks oil can stay a lot lower for long, no one saw this coming, everyone is pretending like they aren’t surprised by it, and sell everything just in case.

That’s crazy. I can’t follow that kind of logic. And that’s exactly why every worry presented is going to happen.

We are so far past logic on the road to crazy at this stage, it’s almost illogical bringing up logic at all. We just blasted oil 40% based on 5% excess capacity, the only second largest supply build in five years, a conspiracy theory, and a sneeze.

How can you possibly hope to plan for that!??

So here’s the deal; don’t follow me. I’m not your financial adviser, I’m a guy on the internet who’s trading his own net worth for real. And like a real person, I sometimes choose to do stupid stuff. Today, I’m deciding to hold my death basket a little longer. A wiser man, seeing the pack of lunatics closing in on him, might opt to retreat. But I just can’t; maybe I’m too tired of this nonsense to move.

When will I retreat?

I made (I can’t recall exactly) 25-28% last year. I’m down a little more than 15% right now. A complete retrace of 2013 puts me at (20%)-(22%) to breakeven. I’m willing to go there, back to last year, because that would be okay in my book. I’ve been buying most of my old positions back for far less than I sold out in August. Hell, I’ve been buying some of them back for less than I bought them in the first place…

Breakeven at 2013, and I’ll regroup. That’s actually not bad, considering I’d be way past that had I not sold down at the end of August. If we bottom between then and now, I’m still up for 2013, which would be kind of remarkable in and of itself.

Last night, following the second round of feasting, I took a minute to flip open my phone to see how the OPEC meeting went. Looking at the price of oil, I hit a sudden case of indigestion. That was when I knew how bad today would be.

And it hasn’t disappointed. My entire book is down 10% right now. I’m down almost 15% for the year. The energy & gas sectors are solely responsible for this slaughter, taking me from +25% to -15% in a quarter.

Jim Cramer wins, folks. This is brutal. But I’m going to hold fast through it.

I can’t believe that Saudi Arabia is actually waging a price war against the USA. Why the hell would they? We don’t even export, and don’t use barely any of their oil.

If I were Russia or Venezuela or an Iran puppet nation, I’d be looking at the Saudi’s with crazed, lunatic fringe conspiracies ringing in my ears. I don’t know who Saudi Arabia is trying to kill off, exactly. But the most prescient answer may just be “tomorrow’s oil and gas projects”.

The projects that are online now are set for a few years. Hedging has been erected to support them. None of my positions have seen any change in business – that’s the only thing keeping me sane and focused right now. I want to panic, but I just can’t yet.

Check out this report on oil in the Permian Basin (page 14). Average cost per barrel has declined to $55 per barrel. The $80-90 number only applies to new projects.

The average cost per barrel of the Bakken, Eagle Ford, and Permian formations together is estimated at $60 per barrel.

Business Insider posted this graphic awhile back (by Morgan Stanley) that breaks down the extraction cost per barrel (presumably as of 2013-2014, BI is notoriously horrible about leaving off critical information). You can see the first victims of the oil price decline are Arctic drilling and oil sands (read Canada).

You will also notice that North American shale is not so different from so much oil and gas production elsewhere in the world. Yes, the “average” cost of production is higher. But look at the band; it is contained inside the same maximum range as so much else of the world’s oil and gas production. After Arctic and oil sands plays get cut in half, the next round of production cuts will presumably fall fairly even handed, across the highest cost developments, globally. That hardly spells the end times of the USA fracking boom.

Here’s a supporting set of data from Business Insider, provided by Citi. This post is more interesting, because there is a second graphic that shows the cost of every international oil and gas project, by location.

All this trouble for what really isn’t even a problem in the first place. The EIA short term outlook for crude consumption vs. production shows what can hardly be called an issue – a million barrel a day surplus in historical context. The largest gains in the oil supply surplus came from the first two quarters of 2014. You can hardly call those unprecedented; we experienced a much worse supply shock back in the first half of 2012.

Also look at the historic unplanned crude shortages from the Middle Eastern countries (page 15). In the past year alone, half a million barrels a day came back online after having been unexpectedly dropped off. You can see the effect of two separate war times breaking out in Libya. Saudi Arabia is suddenly popping up. Add another country to the mix, or an expansion in lost production from one of those already on this list, and pretty quickly the million barrel global surplus is absorbed.

But the best blessing of all may just be the effects of low oil prices themselves. Globally growth has been terrible and Europe has been our poster child. But with the euro so low and cheap energy prices coming, we may just finally see old mother Europe do something…anything.

This is going to hurt very badly. I was too quick to add back to positions and far to willing to take on margin. But I’m going to stay calm, and wait to see what comes up next.

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.

China’s big rate announcement and other saber rattling from central bankers sent the market higher this morning, but now the gains are starting to retrace into the afternoon.

This is classic central bank trading.

After all the other rate and QE announcements I can recall, we experienced the same behavior – a big immediate push followed by a strong settling (and even occasionally the markets correcting lower). Historically, this lasts for about a week before we take off like the Hounds of Hell are hot on our heels.

On the news Brent is back above $80, and WTI is following. We’ll get about a week (half week for the holidays?) of puttering around, probably lower. This is going to suck all the shorts and panic money into the fade (“They failed!”). Right in time for next Tuesday or perhaps the Monday thereafter, when approval to increase allotments gets pushed down from management and markets begin the happy process of murdering anyone caught short. Just in time for Christmas.

See you in December.

Alright, today was a big day. I was up almost 5%. Strong moves in the oil and energy space and shorts unwinding. Leverage pressed the envelope. Almost everything I had ended higher, in a big way.

But it’s too early to celebrate. BAS is down almost 60% from the top. I sold out quite a lot of the position at the top, which is the only reason I’m still alive. HCLP is flirting with $50 again, but that’s a 30% drop from the highs (again, I was lucky as hell selling out near those). VOC is down 50% from the highs.

This isn’t enough. Big up days need follow through to repair the charts. Short sellers need to be checking their backs at every street corner. That’s the only thing that will scare the carrion birds off the backs of these stocks. And we need the price of oil to carry us along. We need Brent back above $80 and WTI needs to tag along playfully behind (but can’t get too close or the spread will be damaged).

The rest of the market is acting healthy and, despite the exact same concerns about the economy that have been there for five years now, there doesn’t seem to be a fresh wave of cascading data to fret over.

I made purchases of SXCP for $24.64, adding to my position.

My current account balance stands at 118% margin.

My wash sale of NADL was total luck. I got pissed off at them for failing to close the deal with Rosneft so I spiked the ball and stormed off the field. That locked in a 15% loss. Well, the stock is down another 42% from that point. That would have been another 5% loss on the account. Not pretty but I’ll take it.

There is good strength in my positions this morning. BAS is up almost 8%; I’d take that with a grain of salt, it has been flipping 10% week over week, lately. But HCLP and VOC are both up about 4%, CCJ is up another 1%, and BTU is higher by 2%. AEC is taking a breather, now nearing $22. So is ETP, pushing on $68.

My holdings are AEC, CCJ, HCLP, BTU, BAS, ETP, VOC, SXCP, and physical silver.