Shale Oil and Gas
Commodity curve purists insist that long-term futures prices must not be confused with market forecasts. People who do that are deemed commodity dummies because long-term futures are said to reflect the price at which market participants are prepared to buy or sell commodities in the future today. That generally means prices that make sense for them right now, but not necessarily those they expect in the future. As a result, certain assumptions can be made about curve structures. If long-dated futures are very much higher than spot prices, the market is offering premiums to those who have the capacity to take delivery today and store the oil until the future. It’s a dynamic that indicates an abundance of oil in the spot market today, rather than an expectation that prices will be higher tomorrow. It’s known as a contango market and is generally a bearish signal.
With Goldman raising the spectre of a $20 crude price, here’s an alternative scenario from Ecstrat strategist Emad Mostaque… ___________ After years of being too high, oil forecasts now appear too low. As supply rolls over we could see prices back at $100, with decade-high geopolitical risks shocking it higher.
Money printing was supposed to cause an inflationary collapse, right? Except, points out Seth Kleinman at Citi on Wednesday, by encouraging investment in risky commodity ventures like shale, easy money has in reality ended up causing a deflationary feedback loop of hell. Here’s Kleinman: The access to cheap financing that low rates and QE generated has been deflationary in two key ways: 1) the growth of shale and the sanctioning of very high breakeven projects that cheap financing made possible has glutted the markets with oil; and 2) the rampant growth of shale, which is located in the middle of the cost curve and has significantly shorter lead times for first oil versus conventional production, acts as a buffer against price rises. Furthermore, given how much of the EM growth story of the previous decade has been driven by the rise of commodity exporters, the negative growth shock from lower commodity prices is compounding the first order deflationary impact in the US and Europe.
We missed this earlier this month, but it is worth a reprise. How do you create a global reserve currency? Some clues by way of a speech by Benoît Cœuré, ECB board member, earlier this month: At constant exchange rates, the euro’s share of global foreign exchange reserves has remained broadly unchanged since 2007-08. The decline in 2014 in the share of the euro at market exchange rates was a reflection of the depreciation of the euro. There is therefore no evidence that global foreign exchange reserve managers actively rebalanced their portfolios away from the euro in 2014, or in 2011-2012 for that matter. This year the euro has been increasingly used as a funding currency by international borrowers, owing to the historically low interest rates in the euro area. Investment-grade corporations in advanced economies, mainly the United States, were particularly active issuers of international bonds denominated in euro, whose proceeds are swapped back into dollars. In April 2015 Mexico became the first sovereign state to issue a bond denominated in euro with a maturity of 100 years. Moreover, the share of the euro as an invoicing or settlement currency for extra-euro area trade remained broadly stable again last year. Finally, the euro is used as a reference currency for the anchoring of exchange rates, mainly in countries neighbouring the euro area and countries that have established special institutional arrangements with the EU or its Member States.
Ever since oil prices started plunging last summer, people have been wondering whether the producers responsible for the supply added since 2010 — mostly in the US and Canada — would want to keep pumping. How many US shale wells, for example, would be economically viable in a world where the West Texas Intermediate price was about $45 per barrel instead of $100? It’s now been long enough to get a sense of the answer. Compared to the peak almost exactly one year ago, the number of US rigs drilling has collapsed by 62 per cent, according to Baker Hughes:
In their latest research note out this Friday, Goldman Sachs’ commodity analysis team headed by Jeff Currie is now so bearish on oil they think even investment grade E&Ps may have to cut production if any sense of balance is to be restored. As GS note: Oil prices have declined sharply over the past month to our $45/bbl WTI Fall forecast. While this decline was precipitated by macro concerns, it was warranted in our view by weak fundamentals. In fact, the oil market is even more oversupplied than we had expected and we now forecast this surplus to persist in 2016 on further OPEC production growth, resilient non-OPEC supply and slowing demand growth, with risks skewed to even weaker demand given China’s slowdown and its negative EM feedback loop.
Back in November we meandered through the possible implications of there being no more petrodollars in the system (on account of US shale oil energy liberation). Since then, we’ve also been thinking about the possible implications of there being no more sweatdollars in the system (on account of US re-shoring and digital manufacturing trends). So what happens if key dollar recycling pathways were to be significantly closed off or contracted? Privately, we’ve speculated the situation could over time lead to the rise of a new international funding currency front runner. (Though, certainly not because the US is losing influence. More because, shale oil and a labour surplus means it may not be in America’s interest to defend reserve-currency status at all.)
A quick post to update readers on an interesting debacle that occurred in the world of oil stock data analysis this week. Philip Verleger, veteran independent oil analyst, launched a scathing attack on the quality of the EIA’s data on Monday, claiming the agency had been overestimating US output by some 1.6m barrels a day. The accusations in his note were brutal to say the least: “The explanation for the mistake indicates a gross dereliction of responsibility on the EIA’s part. Rarely if ever has a US agency charged with collecting data made a miscue of this magnitude. The EIA administrator should be dismissed immediately for gross incompetence.”
Solo Oil plc today announces that it has raised £2,000,000 gross proceeds through the issue of 363,636,364 new ordinary shares of 0.01 pence each in the Company (“Placing Shares”) at a price of 0.55 pence per share (the “Placing”). The Placing Shares which were issued at a discount of approximately 8% to yesterday’s closing bid market price represent approximately 6.59% of the Company’s enlarged issued share capital. Solo Oil will be using the money to fund working capital as it works with partners on such projects as Horse Hill in the Weald Basin. One partner is David Lenigas, director at Solo as well as UK Oil & Gas Investments PLC, the company which prompted some rather fevered press coverage about Gatwick’s potential as the new Saudi Arabia. Do note the clarification which followed a week later:
This guest post is from the co-authors of UBS’s white paper for the WEF meeting 2015 in Davos, which started on Wednesday. Note that one of the co-authors, UBS Investment Bank’s chief economist Larry Hatheway, will be fielding questions on the energy chapter on Friday at 11:30am during Markets Live.
$80 oil, $70 oil, $60 oil, $50 oil and counting… If you suspect the structure of the oil market has fundamentally changed, you may be on to something. There was a time when all you needed to balance oversupply in the oil market was the ability, and the will, to store oil when no-one else wanted to. That ability, undoubtedly, was linked to capital access. For a bank, it meant being able to pass the cost of storing surplus stock over to commodity-oriented passive investors and institutions happy to fund the exposure. For a trading intermediary, that generally meant having good relations with a bank which could provide the capital and financing to store oil, something the bank would do (for a fee) because of its ability to access institutional capital markets and its reluctance to physically store oil itself.
If history really does repeat itself, then the upside of the oil glut of 2014 could be some top quality kitsch TV drama moments in the not too distant future. We’re going by Season 3, episode 7 of Dynasty, which first aired December 8, 1982. The episode features Blake Carrington, CEO of Denver-Carrington, despairing about the prospect of becoming an oil tycoon in distress due to the 1980s oil glut and having to rely on ex-wife Alexis Colby (Joan Collins) for a bailout if his loans go bad. Check out the opening two minutes and later at 24.30 for the scene between Carrington and the chairman of the subcommittee on energy policy and technology.
In their latest oil note, Goldman Sachs describe the oil market as having a “dominant firm/competitive fringe” structure, in contrast to say a monopolistic or perfect competition structure. This is basically the description of an oligopoly, in which a dominant firm (for decades, Saudi Arabia) only differs from a monopolist in one key aspect…
Earlier this month Goldman Sachs put out a note arguing that whilst their overall view was still bearish, the oil price sell-off thus far had been too much too soon. The spot market fundamentals, they noted, were in balance — meaning that if anything was driving a “change” in demand it was curve repositioning, mostly by overly anxious speculators who had decided an exit was warranted despite the balanced fundamentals. This, however, is no longer Goldman’s view.
How long does it take for an oil-exporting nation to burn through its cash reserves as it waits for oil prices to turn around? Naturally, it depends on which oil exporter we’re talking about and the size of their existing cash-pile. Differences between countries can be monumental. The Oxford Institute of Energy Studies picks up on the theme by citing a chart from Deutsche Bank which shows the varying cash buffer rates between Saudi Arabia, Russia and Nigeria (H/T Marc Ostwald).
Ever the market-moving contrarians, Jeff Currie and team at Goldman came out with a note on Thursday doing for oil markets what Bullard and Haldane have been doing for markets in general. When it comes to the oil price decline it is, they say, too much too soon. And, critically, the issue is on the expectations side NOT on the current market supply side: The recent sell-off in oil has been mostly driven by positioning based upon expected fundamental shifts as opposed to currently observable shifts. While looking into 2015 we have sympathy for these medium- to longer- term bearish views that have driven prices lower, we believe it is too much too early. Prices have also likely overshot to the downside particularly as the lower we go the tighter the near-term balances become. This leaves us near-term constructive despite being bearish as we look further out.
That Saudi Arabia and the Opec cartel were going to be “disrupted” by North Dakota millionaires was hardly difficult to foresee. What was always harder to figure out, however, was how Saudi would react. Would Opec’s most important swing-producing state cave in and give up on market share for the sake of price control? Or, conversely, would it be more inclined to follow along the lines of the Great UK Supermarket Price War, and enter a clear-cut race to the bottom? So far, it seems, the strategy is focused on the latter course. Which means people are finally beginning to wonder just how sustainable a path that really is. More so, to what degree does such a price war potentially disrupt the average break-even rate for the entire industry and compromise energy security more widely? What exactly happens to prices when the cartel effect is stripped out?
In our last post, we referred to John Kemp’s argument that cash-flows in the shale drilling sector are not a good indicator of shale’s long-term commercial sustainability. This, he argued, was due to the regular conflation of gas and oil in the metrics, justified by the fact that most companies produce some variety of both. In the last few years, however, producers have shifted their efforts increasingly towards oil production — due to the better margins — improving cash-flows as a result. And that, in some way, is the great thing about the technology. Switching between carbon fuels is much easier than with conventional upstream projects. (Not to put everything in bitcoin terms, but it’s a bit like switching processing power to mine dogecoin instead of bitcoin whenever the margins are more cost effective.) Nevertheless, peak oilers still contend shale isn’t long-term sustainable because of the rapid decline rates for wells. These, they claim, are being depleted much more quickly than conventional wells, speaking of the problem in hand.
The FT’s Ed Crooks reported this week that fears over the long-term health of America’s shale industry could be put to rest thanks to news that independent oil and gas companies have now substantially improved their financial positions. From the story: Cash earned from operations by 25 leading North American exploration and production companies is expected in aggregate to exceed their capital spending next year for the first time since 2008, according to an analysis by Factset for the Financial Times. As Crooks recounts, the longstanding fear was that the industry was shaping up to be a Ponzi scheme, relying on nothing more than excitement over shale to continuously attract new investment, with every likelihood that things would cave in on themselves once the financing for more drilling ran out. Thanks to a shift to more profitable oil extraction over less profitable gas, however, it now looks like shale companies’ finances have improved enough to make the business sustainable.
We said to keep an eye on Dow and that advice hasn’t changed. With one activist out there in public (Loeb), the possibility of another lurking, and a little over a week until the window for director nominations opens, this could all move rather quickly. The reason is the very limited amount of room available to Dow’s chief executive. He is no pantomime villain – that would be to have Andrew Liveris backwards. But shareholder dissatisfaction is palpable and weighty, while it will be hard to avoid the request to appoint outside advisors to consider a split from Dan Loeb (who we understand has a more than $1bn stake).
As we’ve noted before it’s all feeling a little 1999 out there. Lombard Street ‘s Dario Perkins agrees. He’s just released research entitled “Party like it’s 1999″, in he notes: