Critical Thinking Failed Oil Bears

| About: The United (BNO)
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Goldman flip flops on their prediction that oil is going to $20.

Many pundits were pushing bearish narrative as fundamentals were improving.

Critical thinking failed bears and presented a rare window of immense opportunity for oil bulls.

As the price of oil was dropping like a rock due to another failed OPEC meeting in early December, 2015, oil bears were taking center stage confidently predicting further lows in oil punctuated by what they referred to as massive supply glut. Two resident SA authors wrote article after article covering various aspects of oil markets and confidently predicting further deterioration in prices.

There were many talking heads/pundits doing the same on various financial channels, such as flip-flopping Gartman, Larry Kilduff, Gary Shilling, and most importantly investment banks, such as Goldman Sachs, Morgan Stanley, JP Morgan, and many others.

Now that the price of oil is closing on $50 per barrel we can confidently state that all these guys are simply trend followers. That's all they are. They have absolutely no critical thinking abilities beyond following the price. It takes brains and guts to be a contrarian in a seemingly endless bear rout and none of these so-called experts including our resident SA experts carry those qualities.

We have positioned our clients with two short DWTI trades in January. We were unable to pick the absolute bottom, but came pretty close with a trade at $245 and another trade at $330. Additionally, we entered a huge September 2016 $50/52 call spread when oil had a temporary pullback down to $35-36 per barrel in early April. Needless to say, that spread has already tripled.

I have outlined our reasoning in my previous articles and hopefully my followers here on SA took our advice. However, I want to talk about weakness in ability to think critically, instead of taking information at face value. After all that is what differentiates an expert from a trend follower.

Below are datapoints that were being widely disseminated since late December of last year, when oil prices began their last and strongest swoon, and are being repeated even today in numerous articles I've been reading over the past two-three weeks.

1) Shale breakevens below $40

Anyone who took a cursory look at shale companies' financial statements over the past four quarters could clearly see that losses were piling up even during Q2-2015 when oil prices averaged nearly $60 per barrel. Shale companies were putting out presentations showing wellhead breakevens at $30-40 per barrel and mass media would then circulate this information as if the company itself was breakeven at that level.

A little bit of critical thinking would have helped realize that nobody can operate at a loss for a long time, thus the only way forward was to bring drilling to a standstill and consequently decrease production. Thereafter, one could simply extrapolate the degree of production decrease from company statements and compare to the rate of seasonally adjusted consumption and seasonally-adjusted storage build. Which brings me to the second point:

2) Supply glut is tremendous

This was probably the single most overused and overhyped phrase over the past six months. OPEC monthly reports and EIA monthly reports were showing slower increases in storage build compared to daily oversupply estimates. The market was obsessed with 1.5-2 million barrels per day of oversupply, whereas OECD storage builds were mostly benign showing very little oversupply. The glut was not being simply propagated, but the idea of ever increasing supply was being put forth as Iran and Saudi Arabia was about to ramp up production, which brings me to the third point:

3) OPEC production acceleration

Once again, a cursory look at past activity of Gulf Coast producers would have showed that production was only slightly higher everywhere with the exception of Iraq, which had a major increase on the back of expanded investment by operating IOCs.

The struggle to increase production levels had to be juxtaposed against lower commodity prices making future drilling even less economic. Anyone with half a brain should understand that oil production does not increase by flipping a switch, especially when countries/companies are pumping at max capacity. Iran's expected increase in output throughout 2016 should have been viewed in conjunction with non-OPEC decline in production, higher demand, and current levels of storage build.

Adding those four numbers together would have showed oversupply dissipating as early as summer of 2016, instead reporting agencies were predicting oversupply lasting deep into late 2017. Talking heads/experts armed with agency dis"information" were making their bold predictions that oil is about to test $20 on the back of massive oversupply and storage capacity constraints. Resident SA authors were perpetuating the mis"information" adding their own two cents' worth of opinion.

Critical thinking failed oil bears as they got too comfortable with their false narrative. One of the most important aspects of their failure has to do with having a very little understanding of how markets work. Prices in high $20s and low $30s were a result of massive liquidation, there was nothing fundamental about those prices as even lowest-cost OPEC and world producers cannot operate at those levels for a substantial period of time.

Markets are a forward-looking instrument, when bears were basking in oversupply narrative, algos and savvy traders were busy calculating future deficits posed by capex being slashed beyond any reasonable degree.

I am neither a bull nor a bear, I'm in the business of making money for my clients, and thanks to bears' ignorance my clients generated triple-digit returns over the past three-four months. My clients and I are extending our deepest gratitude to everyone who took the other side of their trades, especially if they did it while listening to invaluable advice of talking heads and resident SA experts.


Disclosure: I am/we are short DWTI.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.