Oil Won't Stay Down for Long 39 comments
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Before discussing the current conventional wisdom on oil prices, I'd like to direct readers to a previous commentary I posted back in July 2007 - Goldilocks' Housing Porridge Still Too Cold.
Please keep in mind that back then 10-year interest rates were hovering around 5% and the prevailing theme of the financial media asserted the most likely outcome of the housing bust would be a "soft landing." As I said back then, to think that the rest of the world would decouple from the US was a bit of a stretch, but to believe that the US could decouple from its own housing market seemed unbelievable. Today, in hindsight, it's easy to say that a protracted pain period obviously awaited.
I don't bring this up to point out how correct I was (ok, maybe that's a small motivation) but rather, to make a broader point about markets. Many of the analysts who regularly discuss markets and the economy on TV and print live in a bubble-like environment. They are so busy with reading, research, meetings, doing TV appearances, ass-kissing (c'mon of course they do), etc. that it's easy to see how they become detached from real-world conditions. Frankly, one can find an opinion backed by a wide array of model projections, backtested data, etc. but the one quality lacking is simple common sense. While it may seem quaint, a little dose of common sense can save investors a lot of money.
Oil may be headed to $25 but will it stay there or go lower? If it does, one must ask what conditions would exist that would allow oil to stay there? I try to do this with all my investments. If I think a stock is worth $x, then I try to visualize what conditions would exist to allow it to get there. Consider the opposite — if you think a stock is worth $x, try to visualize it dropping 50% in value and what conditions might cause it to do so. So I visualize a few different scenarios, do my best to put very subjective probabilities on each case and use the combined EV to help my investment decision.
So ponder the question, if oil falls to $25/bbl, how does that happen? But what of the rest of the economy? Can you visualize refilled malls, an overflow of Starbucks (SBUX), booming construction, a revitalized Wall Street with oil prices so low? Will the automakers rebound and head back to early-decade sales levels and if so, why does the price of oil stay low? In other words, were oil prices unjustifiably too high due to a speculative bubble or because the global economy came to a screeching halt almost overnight?
Readers know where I stand on this question. I saw a Barron's ad that congratulated itself for calling the oil "bubble" right. Like a broken clock, they called it right but for the wrong reasons. It took nothing less than a Depression-like global financial crisis to humble the energy bull, not the deflation of a speculative mania. After all, commodities are hardly alone in falling in price; every other asset save Treasurys and gold has suffered as much.
When the global economy recovers, energy will come roaring back because quite simply, it takes a lot of energy to do and make stuff. What stuff? Well, pretty much everything requires energy. How do you build an American 21st century energy grid without energy? How do you bring hundreds of millions of rural Chinese out of subsistence living without energy? How will you solve the water and agriculture issues without energy? You can't even build alternative energy without massive supplies of "old" energy. But the current low prices guarantee that when the recovery happens, less energy will be available.
When energy prices recover, who knows? It could take years or it could bounce back next summer. As such, I have been transitioning into solid dividend-payers that can survive even the worst-case scenario. Can Talisman Energy (TLM) survive 2 years of $30 oil and $5 natural gas? I don't know so I swapped TLM for BP. I think Chesapeake Energy (CHK) can survive 2 years of $5 nat gas but swapping out of the common into the preferred made a lot of sense, as I'll get paid 8-9% indefinitely unless a) they go under or b) they rise above $44 in a few years. The preferreds are cumulative so even if CHK suspends all dividends, the preferred dividends will accrue until such time that the company resumes payment. Its huge asset base provides a solid floor in the scenario where the company goes under, as someone would buy them out before then.
Speaking of Chesapeake, like I said previously, CEO Aubrey McClendon has cracked the code on addressing market concerns about his company. After witnessing the market vomit his company's shares after they filed for more possible dilution, McClendon took most of it back. He also accelerated the balance sheet repair and cut capex even more from just a month ago. CHK now projects being free cash flow positive by Q4 2008, which I'll have to see to believe. The company is also projecting at least $2B FCF for 2009 and 2010. The market approves, pushing shares up 30% Wednesday. I would like to see the company suspend the dividend as well (easy for me to say) but if it follows through on its newly conservative plan, Chesapeake Energy looks like a no-brainer to me.
And for readers who don't normally invest in energy stocks (or stocks altogether), maybe consider buying a blue-chip dividend paying energy stock as a hedge against energy prices. Enjoy the low gas prices while they last (road trip, anyone?). Once gas prices start rising again, at least your portfolio will benefit while your wallet suffers.
Disclosure: long CHK, BP, no position in TLM.
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This article has 39 comments:
Energy Guru
energy-guru.blogspot.c...
want to talk about your earlier predictions about how oil wasn't a bubble?
Once again, you are wrong.
Readers: If you followed this guy's advice over the past year, you'd be down 65% over the last 6 months, just like Boone Pickens.
This is just another commodity bubble guy who wishes for the good old days of $200 oil and $4 copper.
The oil market was cornered by none other than big banks and investment banks buying up the price. Merrill, Morgan, Citigroup, BAC etc. One can thank them for the strangle at the pump -- everyone else benefited from convenience.
There was some speculation on the top side in the summer, but the supply/demand fundamentals still probably justified $100-$120/barrel at that time. But since it takes a long time to ramp up or down production, there's overshoot and undershoot when demand changes suddenly. Sub-$40/barrel is not sustainable, too many suppliers would get out of the market (like Canadian tar sands, which provides about 20% of U.S. imports and Venezuelan heavy crude, which also supplies the U.S.). We're seeing the end of availability of cheap oil, and only a real depression would cause oil prices to go below $30/barrel for more than a few weeks. I bet in six months oil is safely above $50 provided the economy doesn't worsen any further, and above $70 with a modest recovery.
First, I am completely 100% transparent. I post all my trades online (this is my real money portfolio excluding cash + interest):
enlightened-american.c.../
I hold myself publicly accountable on a monthly basis. "Following my advice over the last year" has not cost anyone (least of all me!) 65% over the last 6 months. I went from up 18.8% in June to down roughly the same percentage now. Don't be a jackass and misrepresent or distort my record. Minus 20% on the year sucks ass but it's better than what you're letting on or the S&P500.
Anyone who's "following [anyone's] advice" based on SA should probably not be handling money. Let your spouse handle it. Or learn to think for yourself, take in different viewpoints and make up your own mind.
Readers looking for further explanation can either email me (see my bio page) or comment on the original posts they have issue with at my blog (not SA), where I answer promptly.
BTW, I agree w/ txpenguin -- minimize leverage or use it safely (like options). It seems like just yesterday when I was being insulted for suggesting readers invest with a margin of safety and not rely on oil prices going up. Now I'm being insulted for basically not selling out before the global economy collapsed.
I try not to predict where markets are going over the short-term. My posts regarding commodities have always been eyeing the long term. The SA editors changed the original title of my post, which was "Oil @ $25? Accumulate for the Long Term." I think the new title may be slightly misleading as I don't pretend to know how long oil prices will stay down. I just think the global economy will eventually recover. Any "normal" level of economic activity will renew pressure on energy prices, especially now with capacity being shut in, rigs stacked, etc. I just want to be sure to pick plays that can allow me to hold over a long downturn, if need be. That's why I made the moves I talked about in the post.
Mmmarrk, different services handle preferreds different. google has chk-d for the Prfd D shares (-e for E shares).
OPEC's possible production cut later this month will be a factor in how TLM, BP, and CHK perform. Maybe the sheiks agree with nerfer's estimate that oil needs to be above $40 to be sustainably profitable for producers.
In fact China just announced data on oil purchase -it virtually had collapased.
Conclusion,there still could be a significant downside to the oil prices
what nonsense....
there is always a trigger to the bursting of a speculative bubble. i would also argue, as a bit of irony as well as poetic justice, that it was the parabolic rise in oil that helped burst speculative bubbles in real estate, emerging markets and credit markets. but i suppose you don't think there was speculation there either....
And where were these people hoarding the oil? it sure wasn't in inventory or the SPR.
In order to kil 1% of demand.....price needs to rise 8-20% (depends on how high the price is to begin with).
So things do go parabolic if a perceived shortage might exist in the near future.
But at the same token.....once you start gaining back a supply cushion....things go just as fast in the opposite direction.
It still comes back to supply and demand.......the downside is limited to the cost of production for new supplies.....and the upside is limited to the price that a certain amount of consumers can afford at the current rate of production.
I don't know what the upside is on oil.....but the cost for most of the new oil coming online is between $40-80/barrel depending on where the oil is coming from (deep sea or oil sands). Given a 6% decline rate on conventional low cost oil fields....and a production of 74MBPD.....in 10 yrs thats roughly at 40MBPD........oil is going up long term.
The icing on the cake is the printing press......more dollers = inflation.....we might even see hyperinflation in the future......that is if people go back to the normal spending habits.
saudi oil minister publicly stated there was no unfilled demand for physical oil.
on wall st for every bbl of physical oil destined for a real customer there were 22 bbls of paper oil being shuffled around from one speculator to another.
no long term stability here.
> jack
Come on. Nothing has that degree of price elasticity!
If you are a company that uses gas, airplane fuel or diesel then you better be hedging your fuel consumption for the next 2 years or you will be caught with your pants down when the eventual turnaround comes.
When oil breaks to the up side it will be fast and furious, just as the decline was. And that is because once you kill an oil supplier it takes months of stable prices to bring them back. These marginal suppliers can not afford to start and stop production like the Saudis do. It is just to expensive.
nobody was hoarding the oil because production/consumption was not driving the price. it was the marginal financial buyer who was trading the product that drove the price. consumers had to pay it, given the inelastic nature of short term demand; and producers were glad to accept it, however disbelieving they were of its sustainabiility. the financial buyer never took delivery of the product because he didn't want or need it...he rolled over his contract, riding the price higher until the bubble burst, as did thousands of others. that's called speculation, my friend.
even the saudis dismissed the relentless rise in oil as financial driven speculation. but the true believers....the "we're running out of oil!!" crowd....wouldn't hear it.
what's laughable is they still don't.
On Dec 12 08:20 AM Andy1234 wrote:
> If oil was such a speculative bubble.....why didn't production increase
> over this mania?
>
> And where were these people hoarding the oil? it sure wasn't in inventory
> or the SPR.
>
> In order to kil 1% of demand.....price needs to rise 8-20% (depends
> on how high the price is to begin with).
>
> So things do go parabolic if a perceived shortage might exist in
> the near future.
>
> But at the same token.....once you start gaining back a supply cushion....things
> go just as fast in the opposite direction.
>
> It still comes back to supply and demand.......the downside is limited
> to the cost of production for new supplies.....and the upside is
> limited to the price that a certain amount of consumers can afford
> at the current rate of production.
>
>
> I don't know what the upside is on oil.....but the cost for most
> of the new oil coming online is between $40-80/barrel depending on
> where the oil is coming from (deep sea or oil sands). Given a 6%
> decline rate on conventional low cost oil fields....and a production
> of 74MBPD.....in 10 yrs thats roughly at 40MBPD........oil is going
> up long term.
>
> The icing on the cake is the printing press......more dollers = inflation.....we
> might even see hyperinflation in the future......that is if people
> go back to the normal spending habits.
What do you believe inspires the intrinsic price of oil versus the 'speculative component'?
Purely inventory? A supply curve is easy enough to estimate, but how do you estimate how elastic demand is?
I think we've all heard, anecdotally, through this latest bull run that a lot of long-term production projects with costs as low as $60-$70-$80 / bbl didn't come online, even as oil flirted with the $150 mark. Is this indication of sentiment amongst producers a reasonable gauge of the measured wisdom of experience?
Is there a real data source that keeps an investor up-to-date on dollar-per-bbl cost estimates of big projects that are coming online?
What's wrong with the oil market is a few idiots trading for their own benefit are impacting the entire world population. Some oil trader gets a burr up his ass and suddenly oil is $140 a barrel. That is bullshit.
And supply and demand for energy does not fluctuate significantly over the near term. Rapid escalation in oil prices is not based on any rationality other than the insane wall street cult-like mentality that magically projects some small erroneous or meaningless facts into some imaginary fairy tale of grotesque proportions fueled by self-congratulatory mutual admiration taken to a religious fervor.
Your 2007 story refers to decoupling. And what we need now is a decoupling of oil prices from wall street.
We need another way, a more orderly market for the trading of oil. Fewer, more informed traders, perhaps.
Or go the other way and shift the market from bidding on crude to bidding on refined gasoline and let the consumer bid at the pump and cut the market manipulators on wall street out of it - an eBay for gas.
FYI, in July I published (in seekingalpha comments) that oil would see $20 before $200. I was told "the market would have to collapse" for that to happen. I said "yeah, that's right."
I wonder what this guy was saying in July.
Oil reaching almost $150 was CLASSIC speculation. There were no changes to account for the runup and just a few months earlier everyone was amazed when it hit $100. I am surprised that this blogger, who seems so lucid on other topics, refuses to see that oil was in a classic speculative bubble and that most bubbles takes many years and often decades to boom once again.
--Fred Voetsch
For once I thank OPEC that it exists. The arabs, indonesians and Venezuela are already the punching bag for the west, they don't want to jack up prices and become the next military invasion target of the pathetic western economy.
Let's see, $8 TRILLION being created by the Central Bank, with more to come, guaranteed.
Dollar devaluation? Uh, yeah. Big time. Oil is priced in dollars.
Price will skyrocket when the dollar is devalued into oblivion, which is about to unfold. Welcome to the Weimar Republic.
There's your prediction.
sperculation drove the bubble in technology stocks, one of the biggest bubbles of modern times, and there was obviously never a supply/demand imbalance in technology stocks. neither was it elasticity of demand that drove this bubble.
housing is another, though less dramatic, example of speculation having an undue influence on prices. buyers ignored fundamentals that historically helped contain home prices, e.g. rent equalivancy, cost/income ratios, etc. the "ignition" for this shift may have been exogenous influences on the market, e.g. relaxation of credit requirements, government mandate of more broad ownership in housing, lower mortgage rates, more financing options (e.g. adjustable rate and negative amortization mortgages), etc., but it was all designed for the same purpose: to stimuilate investment in housing which, by definition, attracted speculative money.
the bottom line: a bubble is created by speculation, whether the trigger is misguided public policy or fear and greed. it has nothing to do with market fundamentals.
2) I disagree on your past bullishness but expect oil prices to rise eventually.
3) Quit wearing sunglasses on ID pics, it looks like you're hiding somehow.
:6)
If oil goes much above $100 (in 2008 dollars) it's overpriced and should be shorted (via DTO for those of us who don't run hedge funds). At these levels, declines will be more likely than rises.
If oil goes below $30-40, it is underpriced, and should be bought long (via DXO). At these levels, increases will be more likely than declines.
Between $40 and $100, it's a crapshoot and prices will be nearly unpredictable. The risks are too high compared to the rewards, relative to all the other options out there. Investors should leave the market to the gamblers.