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How Are You Thinking Bout The Drop In Oil Prices?


Viking
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We certainly are in interesting times. From the little bit I have read today it looks like OPEC is not going to cut production any time soon (they meet again in 6 months). It looks like we could see cheap oil for an extended period of time (sub $70). What are some of the likely economic outcomes if we see cheap oil for an extended period? More interesting to me is where are the great investment opportunities? Given the news today from OPEC, I was just wondering how people are looking at the current environment and the opportunities it presents.

 

The obvious place to look is oil and gas companies. However, to invest in this sector you need to have an opinion on what is going to happen to oil prices (how low do they go and for how long). Do you buy the majors or go for the home run and buy one of the smaller players.

 

Petro currencies: living in Canada, low oil prices will hurt our economy and this should lead to a weaker currency. Low oil prices can't be good for Russia and the Ruble.

 

One the other side of the ledger gas prices are coming down significantly. This is an immediate and very large tax cut to consumers and businesses. In the near term do we see consumer spending in the US increase? My guess is lower oil prices are a net benefit to the U.S. economy? Does this also lead to marginally higher interest rates in the US? Looks like US bank stocks could be in a good position to benefit.

 

Much lower oil prices are having a ripple effect on many industries and companies. The question is where are the no brainer investment opportunities.

 

 

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I am buying Dow Chemical.

 

Cheap valuation statistically. Dan Loeb just joined the board and believes Dow Chemical is significantly under-earning its potential and NOW, we got oil prices going down, possibly massively expanding margins by stimulating demand via economy growth and reducing cost via feedstock.

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I have read the essay by Grantham posted on the other thread.  I dont always agree with his stock predictions, but I am on board with his oil predictions.  Short term is anyones guess.  Long term oil goes way, way up in price.  It really depends how fast the US shale oil drilling gets used up. 

 

The present move by OPEC appears to be geared toward bankrupting more expensive operations.  The long term trend has been price increases for the last 15 years.  So, if the price goes lower yet I will be buying senior oil producers, should they fall in price. 

 

As Viking mentioned it is like a giant worldwide tax cut, or stimulus program.  Lower oil prices will help all non producing countries and those who produce but are diverse such as Canada, and the US.  The upshot for the EU and Asia will be improved economies.  At 80 Million barrels per day a $30 price savings is .25 B per day.  Thats 1 B every four days, 80 B a year.  Thats alot of direct economic stimulus. 

 

I think we need some time to see how this plays out.  Right now the price is caught up in the international gambling business, obscuring what is really going on. 

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I thought his point was that long-term price for oil crashes as solar takes over.

 

From his quarterly letter, loud and clear:

"Oil Costs vs. Oil Prices

(or Oil Profits get Crushed!)

In the long run, when the costs of producing oil rise,

the prices will rise. But in the short run it is not always

the case, and in such occurrences it is easy to confuse

the effects of changes in costs with changes in prices.

When global oil costs rise, as they are currently doing,

global growth must suffer as we are forced to use more

of our capital per unit of oil discovered and thus limit

our capital investments in other growth opportunities.

This is true even if prices simultaneously fall due to a

temporary supply/demand imbalance. The current fall

in price does nothing to offset the squeeze on the total

economy from rising costs. It merely transfers massive

amounts of income from one subgroup (oil producers)

to another (oil consumers), in a largely zero-sum game.

Oil consumers tend to spend more and save less than

oil companies so short-term impacts are favorable.

But we should not be carried away with enthusiasm

because the declining investment from the oil industry

will lower future growth. When, as now, oil costs are still

rising even as prices fall there is of course a particularly

savage effect on the profits of oil companies, squeezed

from both ends. They must and will rapidly adapt by

reducing expenditures and therefore oil production with

the fairly obvious result that prices will rise again.

The only longer-term price relief and net benefit to

the economy will come when either we reverse recent

history and start to find more oil more cheaply, which

will be like waiting for pigs to fly, or when cheaper

sources of energy displace oil."

 

So until oil gets displaced (maybe by solar and other) oil prices rise high...

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I think the Grantham comment we are referring to is the one quoted in the "Canadian oil patch for sale" thread:

 

http://online.barrons.com/articles/jeremy-grantham-u-s-stocks-can-gain-at-least-10-before-crash-1416334236

 

What I’m trying to describe here is on one hand a remorseless and historically unprecedented rise in the costs of delivering oil to the marketplace, which is sapping economic strength globally, and on the other hand (and simultaneously) what will be the beginning of an accelerating transference of demand away from oil under the impact of surprising technological progress in alternative energy. When we add the further complexity of a temporary surge in oil from U.S. fracking, I am willing to concede that the outlook for oil and energy is the most complicated puzzle I have ever come across: it is wheels within wheels, but with each spinning in a different time frame. As Spock would say, “Fascinating!” How this ultra-complicated tug of war plays out in the next 10 years or so is anyone’s guess. My guess is that oil prices will bounce around for most or all of the next 10 to 15 years as first one side of this tug of war moves ahead and then the other, with perhaps another 2008-type spike (or two) in the price of oil, after which prices will plateau and decline as electric vehicles take over and, one by one, oil’s remaining uses are slowly replaced.

 

Perhaps it boils down to one's definition of "long term".  :)

 

Edit: fixed the quote

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I think the price depreciation is due to political reasones, namely russia (oil exorts ~ 45% of Russias revenues) and, is why opec is not reducing production of 30m b/d. Norway also refuses to cut production. Deutche Bank has calculated the breakeven price for Russia’s fiscal situation at an oil price at $102/bbl and a cut of 1.5m b/d is needed to put a floor on price.

 

Will price go up in future? I copy past from John Hess

 

Fact No. 1: Eighty-five percent of the world’s energy comes from hydrocarbons. While renewable energy will be needed to meet future energy demand and contribute to reducing our carbon footprint, hydrocarbons will fuel the world’s economy for decades to come. Renewable energy does not have the scale, timeframe or economics to materially change this outcome.

 

Fact No. 2: Once the economy recovers, oil demand is projected to increase by 1 million barrels per day each year, as world population grows from 6.8 billion today to 9 billion by 2050. The introduction of higher mileage standards in the U.S. and the gradual phasing in of electrical power into automotive drive trains will only moderate growth in automotive fuel demand. That is because nearly one billion vehicles on the road today could grow to approximately two billion vehicles in the next 30 years. Keep in mind: The U.S. has 1000 cars for every 1000 people; China has 10 cars per 1000.

 

Fact. No. 3: Supply. We are not running out of oil. The issue is not our endowment of oil resources, it is the world’s production capacity. Additions from exploration last replaced annual production in 1987. The easiest oil has been discovered. Costs are increasing for new barrels, where wells can be drilled in water depths of over one mile to targets up to six miles deep, and discoveries can take over a decade to develop.

 

Oil field declines are running at more than 5 percent per year. That means we have to add at least 4 million barrels per day each year just to keep production flat. Yet non-OPEC production is in the process of, if not peaking, reaching a plateau. The U.K. Energy Research Centre just published a report that there is a significant risk that worldwide production of conventional oil could peak before 2020 and enter terminal decline. If we do not act now, we will have a devastating oil crisis in the next 5-to-10 years.

We will need the courage to act to prevent this crisis and make the commitment to change our behavior – not just in demand; not just in supply; but both.

 

The United States must take a leadership role. With five percent of the world’s population but 25 percent of its oil consumption, the United States can no longer blame oil producers for rising prices. We need to have the courage to demand 50 miles per gallon as the national standard for all vehicles; gasoline hybrids and diesel could get us there. A gasoline tax of $1 gallon would boost conservation and help pay down the federal deficit by $120 billion per year.

 

In non-OECD nations, energy subsidies that the International Energy Agency (IEA) estimates cost $310 billion per year unnecessarily inflate world oil demand and obscure the true cost of energy, resulting in wasteful energy usage.

 

In terms of supply, the petroleum industry spends about $400 billion a year to find and produce oil, but that is not enough. With 80 percent of global reserves essentially off limits to outside investors and only 6 percent of OPEC’s oil revenues reinvested in energy infrastructure, something has got to change. The role of the national oil companies is critical; they need to invest more or allow others to partner with them.

 

We need a balanced approach going forward. It is not a decision of “either/or” but “and.” In addition to more oil supply and energy efficiency, we need a greater role for natural gas AND cleaner coal AND nuclear energy AND renewables.

 

Meanwhile, we must also establish realistic objectives for reducing greenhouse gas emissions that do not throw the world economy into reverse. Many governments want to limit global warming to no more than 2 degrees Centigrade. To meet this target, annual CO2 emissions would have to be reduced from today by more than 80 percent by 2050. But is this realistic? With world population growth and rising living standards, holding global CO2 emissions flat by 2050 would be a huge achievement in itself.

 

As the global system gets increasingly stressed over competition for resources, there is more and more protectionism among consuming nations and resource nationalism among producing countries. Nations are building walls to disengage from one another when they should be building bridges to collaborate.

Going forward, we need new models of collaboration. Over many decades, international oil companies and producing countries have worked together in a way that has been purely financial – through contracts that are either tax and royalty or production sharing. In the future, we need to build stronger bonds of trust. The investment model needs to be focused not only on oil resources but building the capabilities of host country’s human resources. We must redefine what it means to get a return on investment.

 

Second, we also need a global forum dedicated to energy policy. Without a common framework on energy, sustainable economic development will be impossible. I would suggest this challenge for the G-20, which represents represent six of the seven biggest oil producers and the 14 largest oil consumers. Its mission is sustainable economic growth. Energy not only fits this objective, it is essential for its success.

 

In conclusion, what kind of world do we want to leave to our children? If we do nothing, there will be severe consequences. Skyrocketing prices could become a way of life in a crisis-led world.

In a world where we all make concessions and put global interests first, we will all win. If consuming nations led by the United States commit to conserving energy, we could save 5 million barrels per day of incremental demand over the next 10 years. If producing nations led by OPEC commit to building more oil production capacity, we would add over 5 million barrels per day of incremental supply over the next 10 years. In this world, prices would be stable and our global economy could prosper. Does this scenario sound impossible? I do not think so.

The stakes have never been higher. We must build a balanced and comprehensive approach to energy security and protection of the environment to ensure sustainable development. We must unite and work together as an industry, communicating one message, having the courage to act and collaborating for the global good. In this world, there will be a bright future, not only for oil, but for many generations to come.

 

John Hess has been Chairman and CEO of Hess Corporation since 1995. Headquartered in New York City, the Hess Corp. is an integrated oil and natural gas company with operations in 18 nations. The company explores, produces, transports, and refines crude oil as well as natural gas.

7-oilprices-deficits.jpg.428a3fe73dcefbf56d96eb025c2ab228.jpg

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Al,

 

Isn't Seadrill your long time O&G baby, or am I remembering that wrong?

 

Stating the obvious, it is getting walloped but I like the owner/operator nature of the stock. Tiho of Short Side of Long mentioned it in a recent communication, and I thought of you. So curious what your thoughts are here if you don't mind sharing!

 

Thanks.

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It seems strange that a lot of basic materials stocks dropped today.  I mean with lower energy prices you should have more demand, their energy input cost goes down, their transportation cost goes down, in Canada labour cost and the dollar will go down, it is all a huge positive.  Yet you have HBM.to, MND.TO, PKX, probably many more dropping today.  What is going on with these companies?

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It seems strange that a lot of basic materials stocks dropped today.  I mean with lower energy prices you should have more demand, their energy input cost goes down, their transportation cost goes down, in Canada labour cost and the dollar will go down, it is all a huge positive.  Yet you have HBM.to, MND.TO, PKX, probably many more dropping today.  What is going on with these companies?

 

It might be linked to China slowing down. There was an article stating that like $6.8 trillion (yes) was 'wasted' on China infrastructure.

 

http://www.macrobusiness.com.au/2014/11/ndrc-china-has-wasted-6-8-trillion/

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Al,

 

Isn't Seadrill your long time O&G baby, or am I remembering that wrong?

 

Stating the obvious, it is getting walloped but I like the owner/operator nature of the stock. Tiho of Short Side of Long mentioned it in a recent communication, and I thought of you. So curious what your thoughts are here if you don't mind sharing!

 

Thanks.

 

I think you thinking of Seaspan, the ship leasing company, my largest position.  Will have a look at your idea though:-). 

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I think the best way to think about the drop in oil prices is perhaps in a Templeton manner. 

 

Identify a dozen or so of the better capitalized companies and put 10 k into each instead of looking for a single big hit, assuming a couple will go down with the ship.  So, the question then becomes simplified as to when to invest. 

 

On the aspect of timing, we will either have time or we wont.  My personal feeling is to wait a while, and watch it swing way down,if it does, rather than scrambling to invest right now.  If it goes back up quickly, we lose nothing.  As a value investor my tendency is to often be too early too a party.

 

So, some well capitalized energy companies:

 

The obvious are the super majors such as Chevron, XOM, Royal Dutch, internationally.

 

Canada: Encaca, Cenovus, ARX, CNX, SU (last two depends on how you feel about the viability of the tar sands - I dont think they are viable long term).

 

Others to look at?

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Uccmal why should one invest into an O&G company? There is no competetive advantage, and it looks like there is no permanent low cost operator either.

Is there a way to value an O&G company that is not dependend on the oil price? If not, is not every investment into an O&G company a speculation?

 

 

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Leaving aside the impact on single stocks for a moment,  this decline doesn't make me bullish at all for the world economy. First and foremost I think of deflation spreading to the U.S. depending on how China develops. If China's financial crisis expands there seems to be quite a risk for a deflationary spiral developing.

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this is why you have cash, FFH and no debt.

 

countering that is QE in Japan, Euro zone and stimulus in China. Not sure when it could start. Relatively in that scenario US should still fair better than most of the world because it has the reserve currency.

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