Musings from the Oil Patch July 28th 2015
Comment of the Day

July 28 2015

Commentary by Eoin Treacy

Musings from the Oil Patch July 28th 2015

Thanks to a subscriber for this edition of Allen Brooks’ ever interesting reports for PPHB. Here is a section: 

The scenario Mr. Faber outlines reflects one of our underlying beliefs, which is that the commodity boom of the first decade of the new century has spurred a significant commodity output expansion, fueled by the easy money policies of the United States, and now followed Europe, Japan and China. The capacity expansion is leading to a long-term decline in commodity prices that will benefit consumers rather than producers. This trend is long-term, and at times may appear not to be working because of near-term news and economic events. However, over 5- and 10-year periods, macro trends will drive investment returns. 

In a presentation we gave at a 2010 Decision Strategies Oilfield Breakfast meeting, we offered this view on the macro trend for energy. We suggested that the past trend that benefitted energy producers would shift to benefitting energy consumers. For example, petrochemical companies benefit from lower-priced and readily-available natural gas and natural gas liquids supplies while producers struggle with extremely low natural gas prices. In that presentation, we attempted to crystalize our view by suggesting an investment trade for the next decade even though we were no longer in the business of researching and recommending stocks at that time. Our suggested trade was to buy Honeywell (HON-NYSE) and sell ExxonMobil (XOM-NYSE). THIS SHOULD NOT BE CONSIDERED AN INVESTMENT RECOMMENDATION.] We decided to see how this trade has developed. The chart in Exhibit 9 shows the stock prices for the past five years, in which Honeywell has outperformed ExxonMobil. 

Our point in bringing up this trade is to highlight that what often appears evident in the near-term about industries and companies often changes as time enables new fundamentals to play out. In this case, remember that in 2010 the energy industry had just emerged from the 2008 financial crisis and 2009 recession that cut energy demand and caused oil and gas prices to collapse. In 2010, oil prices had rebounded and were on their way to multiple years of oil prices of $100 a barrel. Remember when the head of Chevron (CVX-NYSE) described $100-a-barrel oil as “the new $20-a-barrel oil”? Presently, that assumption appears questionable, but it is quite possible the statement may still prove accurate. If not, then the future for oil and gas will not be like the past. The challenge is to determine what the future might look like and how best to capitalize on changing energy industry and investment trends. 

Eoin Treacy's view

Here is a link to the full report.

The Supply Inelasticity Meets Rising Demand bull market that began in 2002/2003 succeeded in delivering additional supply and perhaps more importantly the capacity to increase supply. More than any other factor this has contributed to the decline in prices evident in the industrial metal complex as well as energy futures.

For nearly a decade David and I have been banging the drum that unconventional oil and gas would be game changers for the energy sector and that consumers would be the greatest beneficiaries. Nothing has happened to change that view.  

Oil prices are currently towards the lower side of what has the potential to be a large volatile range. At today’s levels the wild card is the extent to which refracking will be used to boost well production without the need to spend large sums on new wells. The ability of shale drillers to achieve this supply growth at a lower cost will be an important deciding factor in how wide the amplitude of, what looks like, a developing base formation will be.

If shale oil companies can cater supply to the price environment they are presented with the peak to trough swings are likely to be less severe and aggregate prices should be lower than they might otherwise be. On the other hand if refracking proves to be technically unfeasible for the majority of wells, additional supply growth will be inhibited without new wells being dug and the equilibrium price of oil will probably be higher than it is right now.

We’ll know the answer to this question over the next 12 months but right now oil prices are short-term oversold and potential for a reversionary rally has increased.  

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