- In the near term, we could see oil prices pullback further as global refining margins remain under pressure.
- Timeline of when to go long oil appears to be late June to mid-July.
- We will look to buy USL when it gets closer to $12.
- Fundamental reason for our bullish stance has to do with the lack of US oil production recovery.
- This idea was discussed in more depth with members of my private investing community, HFI Research. Get started today »
Welcome to the "when" edition of Oil Markets Daily
Our oil trading portfolio has remained dormant since we attempted to short XOP over a month ago. We still have over $50k ready to allocate on a higher oil price bet, but the timing has not been favorable.
In our view, we believe the oil market rally will be led by a crude deficit, which means that the oil futures curve will shift into backwardation soon. The back end of the curve will underperform the front end in the coming months as demand recovers while the market keeps the futures compressed to prevent shale from hedging.
But to eliminate the risk of timing, we will want to be long the entire futures curve or 12 months. Why?
Because the market is going to artificially compress the curve down and in addition, desperate shale producers will sell even at $40ish WTI practically guaranteeing no supply growth in 2021. This will set-up very nicely for fundamentals, while we get to play the upside thanks to stupid shale hedgers.
When and what to buy?
Buy - USL
Price level we want to buy it at - $12.
Timing - Mid to late June depending on the size of pullback.
There's about a 15% downside from the current price.
Recovery time frame - mid-July.
Target - $18-19 for a gain of ~54%.
Fundamental Reasons - No US Oil Production Recovery Seen Until H2 2021
EIA's latest STEO shows no recovery in US oil production until H2 2021. Our model has a decline steeper than EIA's and a faster recovery than the STEO.
Source: EIA, HFI Research
EIA has US oil production hitting bottom at ~10.6 mb/d, while our assumption shows that May US oil production was already around ~10 mb/d. We do have similar trajectories for the summer months with production rebounding back to 11+ mb/d. But our production analysis shows closer to 10.5 mb/d by end of 2020 rather than the Q1 being estimated by EIA.
The difference isn't large, and the overall delta is really negligible. But what's clear from the latest updates is that US shale growth is all but dead this time.
From what we are hearing on the street, US and Canadian banks are going to be pulling out of the reserved based lending model entirely. Cheap accessible credit for most producers will disappear after 2021. Alternative financing will be needed and given the balance sheet damage sustained during this downturn, most producers will opt to just pay down debt entirely if oil prices rise.
This will likely delay the recovery seen in H2 2021 especially if producers feel far more paranoid this time around. In addition, the OPEC+ price war has left a nasty taste amongst producers. The idea that Saudi can wage war at any time on global oil producers and push everyone to the brink of insolvency is on the top of mind for every board of directors.
Remember that logic has seldom explained the capital allocation decisions for commodity producers. It has always been driven by fear and greed. And based on everything we've heard, fear is going to be dominating capital allocation decisions for a very long time this time around.
So, our projections currently show a recovery starting in Q2 2020 versus EIA's Q3 2020. But if our on the ground understanding of capital allocation decisions is correct, then the recovery may be further delayed to 2022. This will ensure that the global oil markets remain in deficit and higher prices to come in 2021.
Over the weekend, we published our global oil supply and demand outlook. We see a major deficit taking shape for 2021 and 2022 in the oil market. Our oil price projection along with our supply and demand model suggests very good days ahead for the energy industry. For those interested, we are now offering a 2-week free trial for you to see for yourself. See here for more info.
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