Oil Update (Including a Chart of the Decade)
Back in July, I noted that we had exited many energy positions, and would like to see Oil pull back to $105-110 to re-enter them.
This was a tactical, not secular, repositioning.
Why not secular? Well, for a few reasons. Commodities rallies tend to run decades, not years. And the rise of China and India means huge new demands on global energy reserves are going to keep prices elevated far above the old days of $30 oil.
But the biggest reason is this simple chart, via ITF Interim Report on Crude Oil:
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Sources: Federal Reserve, IAE, ITF
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Note that these aren't projections, but are actually based upon data.
You don't have to be a technician to look at that chart and recognize something new is going on. Back in 2003, global GDP began pulling away from Oil production. Note that Oil broke out over $32 shortly thereafter, and never looked back. In the annual BusinessWeek forecasts (2004), I was one of a handful of strategists that picked energy as my top sector.
Its also pretty clear that all of the hullaboo on Off Shore drilling is just so much political nonsense. Yes, we should be drilling. No, it wont make much of a difference in prices. Here's the usually circumspect John Berry, explaining why:
"It's absurd to argue that ending the moratorium on drilling off parts of the U.S. coasts would quickly bring down the high price of gasoline.
This chimera is being touted by President George W. Bush and other Republican politicians, including the party's presumptive presidential nominee, Senator John McCain of Arizona, to deflect blame for what it's costing for a fill-up.To get around the fact that it would be a decade or more before any oil would be likely to flow, a few partisan analysts have said that the cost of gasoline would fall right away. They argue that the prospect of additional oil supply in the future would lead oil companies to produce more oil immediately because they would expect prices for crude to be lower later on.
Well, wouldn't that depend on whether a producer had the capacity to pump more oil today, and whether it thought lifting the moratorium would add a significant amount of oil to future supply relative to future demand?
There are good reasons to question whether another 1 million or 2 million barrels of crude a day would make much difference in prices when world consumption is running at 85 million barrels a day.
About a fourth of all U.S. oil production is already coming from offshore wells, primarily in the central and western portions of the Gulf of Mexico that aren't covered by the moratorium."
Such silliness.
We should be doing more of everything -- alt energy, nukes, conservation, tax credits, solar, etc. Focusing on this one issue is simply to the exclusion of all else is childish ignorance. In this country, we keep refusing to make the difficult decisions. Everything requires a quick and painless fix. (We better wise up fast).
Hence, the pullback in Oil may be viewed as a short term trading opportunity.
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Sources:
ITF Interim Report on Crude Oil
Interagency Task Force on Commodity Markets
July 2008
http://www.cftc.gov/stellent/groups/public/@newsroom/documents/file/itfinterimreportoncrudeoil0708.pdf
Offshore Drilling Claims Are a Political Hoax
John M. Berry
Bloomberg, Aug. 1 2008
http://www.bloomberg.com/apps/news?pid=20601039&refer=columnist_berry&sid=air._Othgtuc
CFTC Report on High Oil Prices - "Speculation My A$$"
Nate Hagens
The Oil Drum July 23, 2008
http://www.theoildrum.com/node/4334
Tuesday, August 12, 2008 | 07:00 AM | Permalink
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so where do you buy back in? What factors will affect your decision and your buy signal? How important is the dollar rally affecting your buy signal? Where do you see oil going?
Posted by: Noah | Aug 12, 2008 7:17:40 AM
BR - there is a difference between buying oil companies and buying the underlying commodity itself.
I follow many of the EP companies and most of them have declining production. I was surprised at how much the cost of production has risen in the last 2 quarters. I do think many of them are sandbagging earnings to avoid bad press and build accounting reserves for the future.
The bulk of production growth is occuring in non-public enterprises.
So I would argue that over a long term horizon, a pair trade of long oil and short US oil companies might be worth considering..
Posted by: Vermont Trader | Aug 12, 2008 7:22:01 AM
Noah said: How important is the dollar rally affecting your buy signal?
Is the dollar rally causing the drop in the price of oil, or is the drop in the price of oil causing the dollar rally?
Posted by: DownSouth | Aug 12, 2008 7:25:53 AM
Vermont Trader,
I too follow the stocks of some of the domestic oil and gas producers. They struggle just to keep earnings comensurate with the rise in the price of oil and gas. Oil is up almost 4-fold from five years ago. Natural gas almost 2-fold. (Avg. price 1st 6 months 2008 v. avg. for 12 months 2003). Yet the increase in earnings of many oil and gas producers (Chesapeake, EOG, Anadarko, Devon, ConocoPhillips, Apache) barely kept up, or did't keep up, with the increase in the price of oil and gas.
This is so not only because the cost-per-foot-drilled is on the rise, but, also because more and more feet must be drilled in order to find the same amount of oil or gas.
To satisfy Wall Street's dual demands of increased earnings and increase reserves/production is almost an impossible task.
If an oil and gas producer elects to produce legacy reserves, investing little in finding and developing new oil and gas, then it can show substantial profits. However, if an oil company wants to grow production and reserves, or even maintain them, it appears $110/barrel oil and $10/MCF gas (avg. price first 6 months 2008) are insufficient to cover the costs of finding and producing that new, incremental production. The earnings of more aggressive companies therefore often fail to keep pace with the price of oil and gas. Some smaller producers maybe can beat the odds, but it seems the larger the company, the less liklihood of this.
Posted by: DownSouth | Aug 12, 2008 7:37:52 AM
Overlay oil price on that chart and it loses a lot of it's luster of an argument for current oil prices. A 700% price increase for a 30% increase in world gdp?
then I point you to this more telling chart that actually conveys a real point:
http://subrealism.blogspot.com/2008/05/oil-supply-vs-demand.html
not my blog nor do I know who's it is, but the numbers look right at a glance.
Posted by: steve | Aug 12, 2008 7:52:38 AM
actually noticed a peak oil skew to that chart so take it with a grain of salt. point is, supply doesn't oustrip demand by that much and will most likely fall back in line after all the recent demand destruction.
Posted by: steve | Aug 12, 2008 7:55:47 AM
downsouth - there is also the massive benefits of buybacks.
The other thing about oil companies is that they are cyclical companies.
Peter Lynch (maybe my favorite of all time) said you buy cyclicals when they are expensive and sell them when they are cheap (on a P/E basis). It seems counterintuitive but in the up cycle earnings rise faster than the stock and on the downside the reverse is true.
I see this unfolding in the energy space right now.
Posted by: Vermont Trader | Aug 12, 2008 7:56:50 AM
You are right. We should be doing more of everything. At the top of that list should be reforming the commodities market internationally to keep investors and crooks out of the market - some legitimate and some manipulative. Want to make a bet on your commodities thesis of lasting decades? What is that based on? A general consensus on Wall Street? History? Fundamentals? What? It was easy to see hard assets were going to outperform starting in the late 1990s but don't be surprised to see the entire thesis Wall Street has ramrodded come crumbling down. And, the expectation of future returns turn out to be an entire bust.
Posted by: bdg123 | Aug 12, 2008 8:30:44 AM
barry-
yes, the more gdp grows, the more oil the world needs. however, you can't ignore the other side of that... the higher the price of oil, the slower gdp growth all else equal.
what has happened with oil up 5-6x in less than 5 years... demand destruction for oil in many parts of the world. do i think this outweighs the growth factor... not necessarily in the short-run, but top selling cars are no longer s.u.v.'s and companies are seeing the benefits of higher initial cost / energy efficient plants.
Posted by: Jake | Aug 12, 2008 8:31:48 AM
Umnhhhh...
That GDP/Petro line will merge again, albeit the price of Petro will be higher. There are plenty of efficiencies which industry will find, given the pain of the price.
But it won't be next week.
Posted by: dad29 | Aug 12, 2008 8:34:32 AM
Only Islamosexuals believe we don't have enough oil at our beaches to end our dependency on India and China.
This summer, every school child in this fare nation should be given a job, a shovel, and one of those advanced swim suits that we're using to sweep the medals in Peking so they can dig, dig, dig. That would:
1) End Barack Hussein Obama’s lies about teen military re-deployment rates
2) Re-balance the so-called trade export credit issue and stop those Bavarian swim suits imports (that look like a couple of shoelaces tied together with string.)
3) Teach these non-home-schooled future-Weathermen Underground members about work and not relying on government handjobs.
4) Get some sun: A little exposure to SUV rays never hurt anybody, no matter what Maureen Dowd, Marc Rich, and the rest of those New York Times Journal of Medicine liberals - that Clinton pardoned - say.
5) And while we're at it, bring back the Corvette (how does Ralph Nader feel now about disbarring this gas efficient car from America's highways, bridges, and infrastructure?)
Posted by: VennData | Aug 12, 2008 8:44:30 AM
I would love to see the relative price overlaid on that chart, just for interests sake.
Also, I dont know how much once can trust a lot of the GDP numbers, esp china and usa.
Posted by: Gavin | Aug 12, 2008 8:57:59 AM
I would love to see that chart going further back, say to 1990.
Posted by: Gerg | Aug 12, 2008 9:05:39 AM
I don't have much respect for a chart that purports to graph "supply" and "demand". By definition those are going to be the same number -- for every buyer there's a seller.
Any attempt to measure hypothetical demand were circumstances different will only show the biases of the person calculating the numbers.
Posted by: Gerg | Aug 12, 2008 9:07:11 AM
Ok, let's say we drill every where and up out production by a million barrels/day. Isn't there a likelyhood that one of the large oil producing regions will cut their output by the same ammount, thus keeping the price and the supply the same?
Posted by: doug champion | Aug 12, 2008 9:10:26 AM
is anybody aware that saudi arabia dillutes petro storage with H2O to inflate inventory? apparently Flour
Posted by: Verus | Aug 12, 2008 9:11:24 AM
Ditto, I'd need to see a lot more historical data back to 1973 or at least the last big oil shock in 1980.
The US used to use something like 6 cents of oil for every 1 dollar of GDP but that ratio has moved down to 3 cents. So it is NOT unusual for GDP to run faster that oil production. But obviously the break points on oil production take a while to force efficiency gains in GDP, so there is always pain.
More data please, if possible
Posted by: Michael Donnelly | Aug 12, 2008 9:29:47 AM
I read the REST of Berry's column. Where he says that releasing the SPRO would lower gas prices.
This guy needs to change dope suppliers.
Releasing the relatively insignificant SPRO supply MIGHT reduce gas prices for about... an hour.
This type of "thinking" invalidates anything else he has to say.
Is he a Gore-worshiper?
Posted by: Tim Vincent | Aug 12, 2008 9:41:18 AM
Vermont Trader,
The problem with the expensive/cheap dichotomy you describe is that we currently find domestic oil and gas company stocks all over the map.
ConocoPhillips, for instance, is selling for 6.6 x earnings (based on 1st half 2008).
EOG, on the other hand, is selling for 27.6 x earnings.
Large companies like ConocoPhillips that have chosen conservative exploration and development budgets, and therefore flat or declining production and reserves, sell for a low P/E.
Companies like EOG that have opted for aggressive exploration and development in order to grow reserves, however, sell for a high P/E.
Who knows which will prove to be the more prudent strategy. Granted, companies like EOG have grown production. But at what cost? Will future oil prices justify the huge costs required to find and bring new prodction on line these days?
Like I said before, I don't think $110/barrel oil and $10/MCF gas are going to cut the mustard.
It's all highly speculative because future oil prices will be determined by what plays out in Russia and the Middle East, China and India, and not by anything that domestic oil and gas producers do.
Posted by: DownSouth | Aug 12, 2008 9:54:06 AM
Barry,
I am glad to see that you linked to that story from The Oil Drum. Nate Hagens really nailed it.
(In fact, I really love TOD...they deserve to get a lot more attention than they do, just my opinion.)
QW
Posted by: Quincy Walters | Aug 12, 2008 10:20:00 AM
This quoted ITF report is designed to rule out speculators as driving oil prices to the levels we just saw and was issued around the time the prices were peaking. Since then we have to say that whatever fundamentals were causing the spike, are still mostly intact. However the prices are in a downward trend suggesting a bubble is bursting.
I would not be surprised, this is an election year, that oil will go down further than $105 during the next two months and equity prices will go up at the same time. But after the election it's going to get even more interesting.
Posted by: Carmen | Aug 12, 2008 10:27:57 AM
If GDP is over stated in (Fuzzy Numbers; B's previous post) then is this chart less than it appears to be?
Posted by: AlladinsLamp | Aug 12, 2008 10:32:08 AM
Wouldn't shock me to see oil in the 80s.
I don't think we've seen the real oil bubble yet. In fact, I don't think we've ever seen anything in history approaching a bubble in something civilization needs to function.
Bubbles tend to run in factors of 20. Nasdaq, 300 to 5100. Gold from '76-80, 35 to 800. South Seas trading company: 5 pounds to 100, almost to the dot. And so on.
One characteristics is that they tend to get cut in half just before their parabolic run. Gold from 200 to 100 before going to 800, for example.
Just this crude historical parallel would put oil at just about 80. Plateau production or whatever, it's still a cyclical, subject to the business cycle. If we really are at plateau, you'd expect higher lows and higher highs until a replacement is found.
80-ish would be where I'd be looking to reenter. The guys who will be golden are those with huge reserves. DVN with its share of Jack/Jack II. PBR with its maybe-33 billion barrels.
Posted by: zackattack | Aug 12, 2008 10:49:57 AM
Good Call Barry,
We need some good Fear in the Oil Trade. It can barely hold 114. The bounce at 120 was hardly strong. maybe a Bear Trap sub $100, in the fall or spring.
But... one could get more optimistic with the other materaials.
"Focusing on this one issue is simply to the exclusion of all else is childish ignorance. In this country, we keep refusing to make the difficult decisions. Everything requires a quick and painless fix."
that was very good.... but in our Mcdonalds/ADD world.... We don't like tough choices. Never have.
Posted by: Eric Davis | Aug 12, 2008 11:10:03 AM
That was a great call. Would you care to comment on why you picked energy back in 2004? From the graph it looks as if the break came at the end of 2004. Boon Pickens picked energy and oil in 2000 because two Texas oilman took residence in the White House. That was a rather bold approach but proofed to be very effective.
Posted by: Alfred | Aug 12, 2008 11:43:11 AM
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