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I have looked quite extensively at the numbers of a few Canadian oil producers, namely Canadian Oil Sand, Whitecap Resources, Baytex. And if oil averaged 75$ a barrel in the future(5-10 years), those stocks are probably fairly priced.

 

What I want to say here is that, 100$/boe was probably too high because this has led to  an oversupplied market. 50$/boe is probably too low because no one is making money (other than the Saudis and few others)

 

That is why I'm coming with price in the middle  ->75$/boe.

 

But in this scenario, even if oil stocks have decreased significantly ( 50% and more) they don't interest me because I can't find the 1$ for 0,50$ that a value investor is looking for.

 

So I prefer to stay on the sideline for now.

 

Just sharing my thinking with you here.

 

Ftr

 

Good post.

 

I'm just watching oil for fun, I have no intention to invest because it's not in my circle of competence and I don't feel like it's possible to time commodities (if someone's call is right but it takes 5+ years to happen, is it different from being wrong?), but I think that one thing that might surprise some people is how shale production costs can keep going down over time as the tech becomes better.

 

On first level thinking, this might seem like a good thing ("hey, we spend less on capex so we'll have higher profit margins"), but what will probably happen is just that a higher total number of wells will produce, keeping the oversupply around longer than if this was all traditional oil (with exploration and development becoming more costly over time, having to go farther offshore and drill deeper, etc).

 

Basically, it's a bit like Buffett's story about the textile industry and more efficient machinery. The textile companies don't benefit from the increased productivity, their customers do. Shale production seems to be getting better over time, but because all the players can't coordinate and maintain discipline on price/supply, all they're doing is driving down the price of the commodity. Nobody wants to sacrifice their production just to see others who didn't cut benefit from the higher price...

 

That's my impression from casually reading about the area. I could be wrong on this, so take it with a grain of salt (a grain of salt from brazil's pre sal sedimentary layer, preferrably).

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In the latest Economist, there's an article claiming the Saudis need $104 oil to not run a deficit. They have three years worth of foreign currency reserves to balance things without cutting spending or finding alternate sources of revenue such as raising taxes. If they are hunkering down for an extended period of low oil, I believe we should expect to see them raising or introducing new taxes within a fairly short time frame (e.g. this year). I don't believe they will cut spending as that is how they avoid civil unrest. Perhaps they will spend down some of their reserves but surely not by a huge amount.

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Jeez,

 

It's oil.  There are always booms and busts.  Oil will be back over 100, but don't ask me when!  It might be in 5 months (doubtful) or 5 years, but it will be back.

 

Remember though you have to think at the margin.  According to the WSJ (Tuesday) US edition, the Alberta oil sand with the high initial fixed cost, are just going to keep producing, (unlike the stripper wells or even the Bakken horizontally drilled wells, with their fast decay) Plus there is debt to service on alot of operations, which can only be served by producing oil, even where the maintenance cap ex is high relative to production.

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It is funny now that this board has so many experts on global oil production or mainly that it will only go up forever no matter what is the price! Where were these people when oil was above $90? It is back then that a prediction about a coming collapse due to an oil glut would have resulted in big profits.

 

FYI, there are about 1 million barrels per day coming from stripper wells in NA. These wells produce just a few barrels per day and have been in place for a very long time. Unfortunately, we are now at a price that it does not even pay the electricity, maintenance and transportation cost for them to continue operating.

 

We also have capex cuts ranging from 25 to 75% at most if not all NA producers. A lot of these are occurring at firms where they are seeing 30% decline rates on their existing wells.

 

Globally, the natural decline rates for existing wells is around 7% and I guess logic would dictate that this percentage will only go up if shale is so important. So that is 6 to 7 new million barrels per day that need to be produced just to maintain current production. On top of that, it is forecasted that the world will consume 0.9 million more barrels per day in 2015 or 93.3 million b/d from 92.4 in 2014 or a lowered forecast from the IEA report in December. So you have to add almost Two Canada's per year just to offset the global decline rate and additional demand.

 

We also have a few countries that will face bankruptcy soon: Venezuela, Russia, Nigeria, Libya, possibly Iran. What do you think is going to happen to oil production or even more important oil development in these countries once unstability both political and financial really takes in?

 

Cardboard

 

I love your top paragraph!

 

As for the rest, what I find fascinating is that most of what you state has been true for years.  Demand has grown, decline rates have always been there (they may have risen but I have done a lot of work trying to prove this and failed), and oil producing nations have always been unstable.  Yet in the last 20 years alone oil has been priced at anything from $10 to $147.  Costs have moved up and down a lot too.  So I don't know how to use these factors, even if they are true, to forecast the price.

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It is funny now that this board has so many experts on global oil production or mainly that it will only go up forever no matter what is the price! Where were these people when oil was above $90? It is back then that a prediction about a coming collapse due to an oil glut would have resulted in big profits.

 

What happened with oil is really not that hard to understand:

 

1) If you look at the EIA statistics for supply and demand, 2015 year-end is the magic tipping point where US motor gas demand peaks, and then projects to head down in 2016.  Against overall barely-growing demand, you have rapidly expanding domestic supply.

http://www.eia.gov/forecasts/steo/tables/?tableNumber=9#

 

2) It's a fools errand to predict a commodity price, but I think this backdrop had insiders knowing that price of oil needed to settle lower than $80 within the next few years.  Markets simply played with the price within support levels for the last year, no one willing to make a firm call about timing for lower pricing. 

 

3) The price finally did break support around $82, at which point every professional investor in that sector understood immediately that the day of reckoning was here, so they just sold.  EVERYTHING.  IMMEDIATELY.  It's not that anyone believes the price will be $40 in the long term.  It's more the sound of professional money leaving the room and just not caring what the price settles at.  They will come back only after the dust settles.

 

What happened to oil is a perfect example of why I hate commodity investments.  People who watch their investments once every few weeks woke up one day to see their smallcap oil companies down 60% to 80%.    These markets never have organized and slow market downturns that give casual investors time to react.  When the party ends for a commodity, all the professional investors are out in a few days time, and the momentum of all of that money quickly leaving devastates the commodity, the illiquid smallcaps, and the entire sector prospects for a few years.  The only way to navigate this market would have been if you had realized the overall supply/demand dynamic and had been watching futures contracts for oil like a hawk with an alert set to $82.  And then you would have to have the discipline to exit at losses quickly as the stampede developed.

 

All of this argues against the success of the small investor in these markets, who typically does not understand the industry supply-demand dynamic, does not like to admit mistakes, and does not like to cut losses quickly.

 

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So, basically what you are saying is that these so called professional investors are smarter than Harold Hamm, the Saudis and countless oil & gas executives who did not further hedge their production? Who never anticipated for prices to collapse so much?

 

To me, and the way you are describing it, it sounds like that they are entirely behaving as a herd rather than anything else. They are traders and are probably short now to make money where they lost it or on the long side. They are not "insiders" as you mentioned unless for some oil trading houses or the Saudis if they played the short game in secret.

 

Regarding commodities and small investors, it is not much different than them investing in the general stock market. They will lose big also in any market if it comes down hard.

 

Relative to your U.S. statistics, it is only one data point in the picture of countless data.

 

By the way, I like your $82 figure and that is where I believe oil needs to be around over the next couple of years to balance supply and demand.

 

Cardboard

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just a question, I have heard again and again until I and probably most other people just take it as a fact that shale oil wells produce almost everything they are going to produce in the first 2 years. But I have never seen any raw data on this just the fact stated in article after article. Does anyone have any good hard data on the depletion rates of shale wells?

 

I know they are still new and the tech is changing rapidly but do we know anything beyond 2 years?

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Cardboard,

 

Good points.  It really points to the fact that where oil goes is anyone's guess.  Probably not down at these levels though.

 

And no discussion of the forward strip which doesn't see oil getting back to $100.  It is under $70 out to 2024.  If you think it's going back to the moon it should be relatively easy to make a killing by speculating on futures. 

 

I have also yet to see anyone say the words "permanent loss of capital".

 

I've experienced what I consider a permanent loss of capital in oil investments recently. I had a couple of distressed debt positions in companies I thought would muddle through/raise new capital, with the assumption that oil prices would be at strip or slightly below. When they got destroyed, those leveraged producers got killed, and will likely all declare bankruptcy with near 100% losses on their debt.

 

 

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Smallcap,

 

You will have to do research on your own from mineral resources departments as stated in this article which is a very good one IMO:

 

http://news.yahoo.com/column-breakeven-shut-prices-oil-wells-kemp-000100628--business.html

 

However, I know from the producers that I own that decline rates are very real and right in line with what you have heard. I also know that these so called cost reductions or new efficiencies that people are now talking about on this board are a joke.

 

The reality is as follow: producers have introduced newer drilling and fracking technologies (I say newer because fracking has been done for decades) on their best prospects first since it was risky and oil prices were lower back then. So the cherries have been picked already in NA. On average what is left are tougher reservoirs. So sure water flooding, gas injection, multi-stacked drilling and other techniques will be implemented faster now since they are better known, but it will only offset higher costs from these tougher wells.

 

These techniques also cost a lot of money. Even after assuming reduced rates from drillers and service companies, I doubt very much that much of NA is worth drilling at current prices. EOR will be a better option, but it is nowhere near enough to offset decline rates.

 

There is a reason why WTI is about to surpass Brent.

 

By the way, I was wrong about the Global decline rate at 7%. It is actually 9% as per this article. So the math gets even more interesting.

 

Cardboard 

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I saw some data on investment costs for oil wells in NA, and it went from 5$ in the 70's- 90's to like 35$ now. Growing exponentially in 10 years. Wish I could find it again. Makes me think this is not a second 1980 where oil will crash for 20 years. (als demand was pretty much flat in that time).

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I saw some data on investment costs for oil wells in NA, and it went from 5$ in the 70's- 90's to like 35$ now. Growing exponentially in 10 years. Wish I could find it again. Makes me think this is not a second 1980 where oil will crash for 20 years. (als demand was pretty much flat in that time).

 

I find it very difficult to analyze this type of data properly.  If the market has an appetite for high oil prices, then operating costs will naturally be inflated.  I'm sure all sorts of costs (in constant dollars) have gone up. It's just hard to strip out all the confounding factors to figure out which costs are rising because of technical challenges etc, versus which costs are higher simply because of oil-boom momentum. For instance, everyone knows labour costs in the patch are astronomical. I have no idea of their per cent contribution to operating costs, but labour will come down dramatically with lower expectations regarding crude prices.  In fact I expect we'll see some magical improvements in operating metrics for many E&P companies if the crude price continues to wallow.  Always easier to cut waste when your ass is on the line.

 

Alas it's safe to ignore everything you just read.  This oil rout has finally allowed me to complete a multi-year proof that I have absolutely no capacity for investing in commodities!

 

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So, basically what you are saying is that these so called professional investors are smarter than Harold Hamm, the Saudis and countless oil & gas executives who did not further hedge their production? Who never anticipated for prices to collapse so much?

 

To me, and the way you are describing it, it sounds like that they are entirely behaving as a herd rather than anything else. They are traders and are probably short now to make money where they lost it or on the long side. They are not "insiders" as you mentioned unless for some oil trading houses or the Saudis if they played the short game in secret.

 

Regarding commodities and small investors, it is not much different than them investing in the general stock market. They will lose big also in any market if it comes down hard.

 

Relative to your U.S. statistics, it is only one data point in the picture of countless data.

 

By the way, I like your $82 figure and that is where I believe oil needs to be around over the next couple of years to balance supply and demand.

 

I think you are distorting what I said.  I think the market did NOT have inside information.  I think the market did not even care where oil price would settle.  Professional money simply knew that oil needed to reset within the next few years, and once the price broke support they all abandoned the market within days.  Yes, it was pure herd behavior, and I was describing the technical conditions that the herd was watching to trigger the stampede.

 

Don't argue this on subjective grounds.  Just look at the commodity chart pricing, in this case the Feb 2015 WTI contract:

 

http://www.barchart.com/interactive_charts/futures/CLG15

 

Put that on a 3 year view and it is obvious that oil was trading in a very technical range, around $82 support.  Now - once that support is broken - see how the market quickly sells off.  That is pure ignorant "herd" behavior, and the point of my post was to explain the reasoning of the herd.

 

Look at any underfinanced smallcap oil stock, and they all begin a massive selloff 50% or more corresponding to the break in that oil support.

 

The lesson for us would be to understand the price channels commodities trade in, and to understand - whether we believe it is rational or not - that once a commodity sharply breaks down in price that this can result in a stampede.  Commodity markets break down quickly, much more quickly than people can rationalize or understand logically.  I would say you are committing a fundamental error in trying to "reason" about what the price of oil needs to be or should be.    Wait for the oil price to stabilize before re-investing in the sector.  THEN you can reason about why price needs to be higher in a few years.

 

And I don't think anyone - investor, producer, or country - has a clue where oil will trade in the future.  Guessing commodity prices is a fool's game.

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The same "professional investors" are now ganging up against copper and its producers since yesterday.

 

What was the magical support price on copper?

 

I don't trade copper, but two minutes looking at the Feb 2015 High Grade Copper contract:

http://www.barchart.com/interactive_charts/futures/HGG15

 

suggests to me there was moderate support at $2.95.  It broke sharply from that around late November.  I trace all of the current selloff to that event.

 

If I were trading that market, after commodity broke sharply (with volume!) from the support price, I would have sold every copper holding I owned within days.  (Yes, there will always be exceptions to the general rule, but it would have needed to be some extraordinary situation.)

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http://www.independent.ie/business/world/traders-betting-on-a-recovery-stockpile-cheap-oil-on-the-high-seas-30914150.html

 

Some of the world's biggest oil traders have booked supertankers to store at least 25m barrels at sea in recent days, seeking to take advantage of the crash in crude prices and make a profit down the line.

 

a strategy that was last used in 2009 when prices slumped and led to more than 100m barrels of oil being parked on tankers at sea before stocks were sold off.

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http://www.independent.ie/business/world/traders-betting-on-a-recovery-stockpile-cheap-oil-on-the-high-seas-30914150.html

 

Some of the world's biggest oil traders have booked supertankers to store at least 25m barrels at sea in recent days, seeking to take advantage of the crash in crude prices and make a profit down the line.

 

a strategy that was last used in 2009 when prices slumped and led to more than 100m barrels of oil being parked on tankers at sea before stocks were sold off.

 

So, what if they are wrong? 

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So, what if they are wrong?

 

I suspect they are selling futures today to fix their spread.  Jan 2016 futures closed at 55.34; so buy today in the cash market at 48, fill your tanker, and take a year off.  $7 per barrel on 2 million barrels gross, less vessel expenses.

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