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Stephen Brocker
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I attended a maritime academy in California and subsequently sailed as an officer aboard vessels all over the world. During my time at sea I thought and invested. I have always been interested in the financial markets and began educating myself about them in college. Formal education will make... More
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  • All About Oil

    Oil Coming Out the Ears

    Whenever you hear the word oil these days you can be sure to hear the words glut, oversupply, strong dollar, Iran and a host of other bearish words not far behind. Listening to the media has me wondering when I will finally get paid to take some of the glut off of the hands of my local gas station!

    Bearish Views

    The bearish case for oil USO is that US output is still near record levels and summer demand is set to fall. Iranian oil is coming to market. Initially with 500k barrels but a million or more soon after. Iran also has 30 million barrels floating offshore set to drown the already flooded world with oil. The USD is very strong and going to get stronger because of the divergence in monetary policy between the US central bank and the central banks around the world. The strong USD is going to slam oil and all commodities.

    All of these could very well send oil lower and are the scenarios that I hear over and over. I think that the thing that will weigh on oil more than any one fact is the bearish sentiment towards oil. When oil was above $100 sentiment was bullish and it wasn't until oil really started falling that the world was going to stop using oil completely and oil was destined to go to zero. This is investor psychology and at the top most are buying and at the bottom most are selling.

    Bullish Views

    Why on earth would oil possibly go any higher? The bullish events that I see developing are that US production is showing signs of flattening and declining. The signs of this in the mainstream media can be seen with the EIA weekly petroleum status report. The lower 48 production has been flattening and is showing declines in recent weeks. The weekly EIA petroleum report does not reflect the true supply picture in my opinion. I have wondered at the inaccuracy of the EIA production report myself and the report has been drawn attention to by a couple of authors here on Seeking Alpha Power Hedge, Zoltan Ban, and Ron Patterson. Most recently there was an excellent article on The Daily Reckoning about you being "Dumb" if you are relying on the EIA numbers.

    Besides declining US supply world supply is decreasing. Jim Cramer had an interesting interview with the CEO of Core Labs recently. The Core Labs Ceo said that US production will fall from 9.5 million barrels/day to 9 million by years end and from 9 million to sub 8.5 million barrels next year if current activity levels remain constant. With respect to Russia and the Middle East the Core Labs CEO doesn't feel that the current production levels are sustainable. It is a very interesting interview. Recently Saudi Arabia also said that it would decrease production after the Summer. Any decrease in production by the Saudi's is a very big deal. The rhetoric out of Saudi Arabia has been to keep market share and increase production. Any decrease in production no matter how big is big in my opinion.

    As to Iran, if Iran comes online it won't be at least for another year. As for the 30 million barrels Iran has floating, nobody wants it according to Gary Ross Pira Energy Group chairman, also a great interview to watch.

    Oil demand is very strong. The EIA estimating global petroleum consumption to grow by 1.3 million b/d in 2015 and by 1.4 million b/d in 2016. I think that demand will actually come in much stronger closer to 2-2.5 million barrels for 2015. Additionally there have been enormous cuts made in future oil supply investment and unless there is a big drop in demand then these cuts will eventually result in a lack of future supply.

    There is much talk concerning oil and commodities being low due to the strong dollar. I think that the cart is being put in front of the horse to a certain extent. There is a commodity cycle and the strong demand by China in past years caused many commodity producers to ramp up production which, due to decreased demand out of China, has resulted in excess supply. Many of the metal miners has lost most of their value because of this. The strong dollar has not resulted in a weak oil price but rather a weak oil price has resulted in a strong dollar to a large extent in my opinion. The USD UUP is called the petrodollar for a reason after all.

    USO Chart

    USO data by YCharts

    Excess oil supply caused oil to fall and this was driven overly low by negative sentiment which drove the USD higher. Divergences in monetary policy between the US and foreign central banks contributed to the currency disparity, but oil was the key factor in my opinion. If oil is driven back up then a fall in the USD will accompany it.

    Conclusion and Where I am Investing

    There are factors that could drive the price of oil up and factors that could drive oil down. Ultimately no one truly can know as sentiment and speculation will be the factors that drive the price of oil to either extreme. Because of the factors that I have outlined above I believe that the price of oil will have to eventually head higher.

    Personally I am long Chesapeake CHK, Conoco PhillipsCOP, and Ensco ESV for the long term for the eventual return to higher oil prices. CHK is a turnaround story being driven by management as well as extreme negative sentiment. With CHK's large foot print in US shale and greatly depressed share price, as well as ~ 30% short interest higher oil prices would very likely make CHK double from current prices. Additionally CHK is also largely a natural gas producer and the US is set to begin exporting natural gas in late 2015/early 2016. The US is already sending natural gas to Mexico and is bringing more pipeline capacity online. Natural gas is also being used more in the US for electricity production with natural gas having recently overtaken coal as an electricity producer in the US. COP has also been making investments to stabilize its oil portfolio with a large weighting in the US. A recent positive development for oil producers in the US is talk of lifting the 40 year US oil export ban. ESV is the best of breed offshore oil driller. Management at ESV is prepared for the oil downturn and if an offshore driller survives it will be ESV. The offshore drilling sector has been hit very hard with the decline in oil prices. High oil prices brought rig over supply in the offshore drilling market. The offshore drilling market has been consolidating rapidly this past year, and the strong players like ESV will emerge stronger when oil prices recover.

    There are countless oil companies that have been impacted by the recent down turn in oil. If you believe that the world will continue to use oil in the future and that the above factors will effect the supply/demand dynamics of oil and lead to higher prices, then an investment in the beaten down oil sector now is a prudent decision.

    Aug 03 7:40 AM | Link | Comment!
  • The Iranian Nuclear Deal And The Unexpected Implications For Oil

    A Deal Is Announced

    World powers have been negotiating a deal to lift economic sanctions from Iran. The negotiations have gone on for a long time, but a deal recently was reached.

    Headline Concerns

    In recent weeks the negotiations have brought concern to the oil market that Iran would flood the world with oil USO and exacerbate the world oil "glut". Once the sanctions are lifted Iran is expected to increase oil exports by 500,000 barrels as soon as sanctions are lifted and an additional 500,000 barrels in the following 6 months. This in itself is concerning but much more concerning is the reported 30 million barrels of oil being stored at sea by Iran.

    Middle East Turmoil

    The additional oil supply could weigh on oil prices. What would have the opposite effect on oil prices is a major conflict in the Middle East.

    85% of Muslims in the world are Sunni Muslims. The other 15% of Muslims are Shia Muslims. Shia muslims are in parts of Iraq, Lebanon and Bahrain as well as all of Iran. Iran and Saudi Arabia don't get along. During the recent negotiations to lift sanctions Iran was reportedly backing militants fighting in Yemen that threatened and were fought by Saudi Arabia. Besides a conflict between Sunni and Shia Muslims that dates back to the death of Muhammad, Muslims and Jews also share differences with one another going back to biblical times. Israel's Prime Minister Benjamin Netanyahu has spoken before congress warning about the talks with Iran. Now with the deal done Israel has called the deal "one of the darkest days in history". Senator Lindsey Graham has said that the Iranian deal is "akin to declaring war on Israel and the Sunni Arabs".

    Conclusion and Investment Implications

    The lifting of sanctions from Iran have had implications beyond bringing additional oil to the market. Whether the deal with Iran is seen as good bad or otherwise it is currently having a large impact on the Middle Eastern region. The deal with Iran has caused turmoil in the Middle East and has created a potentially more explosive situation in the future. Rather than the prospect of oil prices plunging due to increased supply coming to the market the potential for Middle Eastern conflict and the disruption of supply and much higher oil prices is now more possible.

    A conflict in the Middle East would send oil prices higher and everything oil related would rise with the higher crude oil price. There are many oil related stocks that have had their share prices more than halved due to the recent oil bear market. Besides the great reduction in future oil production investments that have already occurred and the current falling supply in the US, any supply related concern from the Middle Eastern region would greatly increase the price of oil. Personally I am long Chesapeake CHK, Conoco Phillips COP, and Ensco ESV for the long term for the eventual return to higher oil prices. CHK is a turnaround story being driven by management as well as extreme negative sentiment. With CHK's large foot print in US shale and greatly depressed share price, as well as ~ 30% short interest higher oil prices would very likely make CHK double from current prices. Additionally CHK is also largely a natural gas producer and the US is set to begin exporting natural gas in late 2015/early 2016, is already sending natural gas to Mexico and bringing more online to send and natural gas is being used more in the US for electricity production with natural gas having recently overtaken coal as an electricity producer in the US. COP has also been making investments to stabilize its oil portfolio with a large weighting in the US. ESV is the best of breed offshore oil driller. The offshore drilling sector has been hit very hard with the decline in oil prices. Higher oil prices would also send ESV higher.

    The time to buy stocks when looking for value and potential outsized returns is not at the top when recommended by analysts, but when fear is still in the air. A conflict in the Middle East would make oil prices head higher very quickly. The decline in the US rig count as well as large quantities of oil coming out of the Middle East are important to current and future oil prices. A decline in oil supply from the Middle Eastern region could not be immediately replaced by the shale producers in the US. The resulting supply/demand imbalance price shock would be large. The supply/demand imbalance is already reaching equilibrium with strong demand being seen and the EIA estimating global petroleum consumption to grow by 1.3 million b/d in 2015 and by 1.4 million b/d in 2016.

    Jul 16 7:26 AM | Link | Comment!
  • Oil Market Extremes And Opportunities

    USO - Since June/July 2014 oil has fallen ~ 60% from ~ $110 to ~ $43 a barrel.

    This fall can be attributed to a plethora of reasons including: an exponential increase of oil supply by US shale oil producers, Saudi Arabia's desire to retain market share by maintaining output, the vertical rise of the USD and investor sentiment towards oil.

    The above factors for oils decline have been answered by factors which will ultimately lead to much higher oil prices over the next several years including: oil rig count declines of 50+% and continuing to decline, US oil production declines over the past several weeks, increasing oil demand driven by the low oil prices and company capex cuts of 20-50+%.

    Opinions on the future price of oil vary widely. I hear fears of the US reaching maximum storage capacity which would send the price of oil to $30, $20, $10. Iran looms with 30+ million barrels of oil stored in supertankers ready to flood the WORLD with oil! Analysts have been competing with one another to have lower and lower price targets. Over the past several weeks you are no longer hearing calls for 30 and 20 dollar oil though.

    The oil inventory builds in Cushing, Oklahoma have slowed dramatically due to declining oil production and increasing refinery utilization. In the coming weeks I expect to see oil inventories in Cushing start to draw and the draw to accelerate thereafter. Iran is on the horizon but we are still a long way from reaching an agreement that will lift sanctions. Let's not forget that Iran is a member of OPEC; a regulated oil cartel.

    Much bigger than short term oil storage issues or the Iranian concerns being focused on by the media; Oil is a finite resource. (It is especially a finite resource at a lower price)

    (click to enlarge)

    Yes; there have been new sources of oil discovered in recent years. Technology has advanced, and is continuing to do so, which has led to more efficient ways of extracting these new sources of oil. At the same time these new sources of oil are labor and resource intensive to extract; Canadian oil sands, US shale, deep offshore oil. The additional resources, labor and risk to extract the new sources of oil makes them more expensive to extract.

    World demand is growing with two of the most populous parts of the world just beginning to "come online" in regards to oil; India and China. This demand requires the new sources of oil to be used in order to be met.

    Where would the price of oil be today if there was no US shale oil revolution, Canadian oil sands or deep offshore oil?

    Looking back to July 2008 when oil was ~ $145, what drove the oil price to such a lofty price? The answer is increased demand and market sentiment.

    With world demand increasing (additionally to the world demand report below the 4/22/15 EIA report showed a 2+ million gasoline draw with US refineries operating at record levels), US production falling and Saudi Arabia production at a 30 year high, oil company capex cuts of 20-50%+ the recipe for a tremendous increase in oil price is in the cards in my opinion. Ref 1,3,4,5,6,7

    "All right Steve you have convinced me! So how can I take advantage of an increase in the price of oil?"

    There are many ways to take advantage of an increase in the price of oil. These methods include ETF's that trade with the price of the underlying oil futures contract such as USO, UCO, BNO, DTO, and DWTI.

    These are a few of the ETF's that trade with the price of the underlying futures contract. USO tracks the price of WTI, BNO the price of Brent and UCO, DTO and DWTI track the price with leverage in the direction of and in the opposite direction of the underlying crude oil futures contract.

    A major risk in trading these ETF's that track the price of crude oil is because you are racing against time; by this I mean that you are facing the effects of contango. As seen here via the CME you can see the futures contracts going out to 2023. As of this writing the June 2015 futures contract, which is currently being traded, is $57.74. The July 2015 futures contract is $59.26. This difference is almost 2.5%. Contango is where the later futures contracts are trading at a premium to the earlier futures contracts.

    Because the oil market is in contango the ETF's that are tracking the underlying futures contract must be sold and bought for the following month at the higher price which will result in a loss each month.

    There are many excellent articles on contango and backwardation (the opposite of contango) trading and the risks and rewards here on Seeking Alpha. I personally DO NOT invest in futures tracking products.

    I prefer to invest in oil companies that go up and down with the price of oil. This way there is no race against time as long as the oil company invested in is sound. Not only are you not paying a premium of 2.5%+ each month as a result of contango, most oil companies pay YOU via a dividend!

    For investing in the rebound in oil prices there are many choices as just about anything oil related has taken a severe beating. One must be selective when investing in oil companies in the current environment because there are many small oil companies that are over levered and may not survive. There are several oil investments that have already declared bankruptcy.

    Some of the oil majors such as Exxon XOM have fallen only about 20% from July 2014 to March 2015. Let's face it the oil majors are going to be around so a stock such as XOM could be a very good investment for someone wanting to participate in the recovery in oil prices without a tremendous amount of downside risk. XOM pays a nice dividend while you wait for oil prices to recover.

    Personally I have investments in COP and BP in the oil major space. COP because of it's exposure to US shale oil and BP because of the additional value in it's shares that has been created by the oil spill in the Gulf of Mexico that it is still dealing with. Both COP and BP pay a higher dividend than XOM as well.

    Moving up the risk ladder I am invested in HAL. Good fundamentals as well as a stock price that has fallen off of a cliff. Additionally it's recent merger with Baker Hughes BHI should create additional value going forward.

    Next we have Chesapeake CHK. CHK has an excellent management team and has taken significant steps to clean up it's balance sheet. Notorious raider Carl Icahn has a sizable stake and there has been tremendous insider buying. Fundamentally CHK trades at roughly half of book value, and much of it's oil and gas is hedged. The US is set to start exporting natural gas in 2015 and everywhere else in the world natural gas prices are significantly higher.

    Then we have Ensco ESV. ESV is an offshore oil driller. ESV in what I call "best of breed". I invested in ESV just in case something like what has occurred happened with the price of oil. ESV has a very conservative management team and if one offshore driller is still working when the dust settles it will be ESV in my opinion. ESV has one of the least levered balance sheets, some of the newest drilling rigs and has been rated the best offshore operator five years consecutively.

    I have written on the above stocks in my instablog for anyone interested in further reading.

    Good luck investing and remember "The future is cheap now"

    Stephen Brocker

    1 World oil demand

    2 2008 high price

    3 Refineries running at record levels

    4 EIA

    5 US production falling

    6 Saudi Arabia 30 year high production

    7 Oil company capex cuts

    8 OPEC members

    9 Cushing build has slowed

    Apr 24 3:44 PM | Link | Comment!
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