Energy Sector

[Viking]

Good article outlining where oil markets are today:

- https://oilprice.com/Energy/Oil-Prices/Standard-Chartered-Oil-Prices-Likely-To-Head-Higher.html

 

The oil market today has a very interesting set up. It appears to me that price is being driven over the past month primarily by sentiment and not fundamentals. Sentiment is very negative (first recession fears and now banking crisis). Even the CNBC crowd is shifting from wildly bullish to now a little bearish.
 

What has changed over the past month in terms of fundamentals? Very little from a structural perspective (from what i can see). SPR drawdown is largely done. China reopening is happening. Demand from India/EM continues to increase. Perhaps the new news is the historically warm winter in Europe (also US?) resulted in lower demand across a range of products (nat gas / heating oil etc). One could argue with oil prices falling below $70 that this will result in less supply (at the margin).
 

When you weave it all together you get some small puts and takes at the margin but a fundamental story that has not changed all that much. What to watch:

1.) does banking crisis in US stabilize or does it morph into something more serious that causes credit contraction?

2.) as we get into May/June do we see global oil inventory drawdowns (demand for oil start to exceed supply)?

3.) Ukraine war: hard to see how significant escalation results in lower oil price.

4.) inflation: does it remain stubbornly elevated into mid year? Or does it roll over aggressively?

——————

Below is a very short update from Josh Young. Of course he is talking his book. I like Josh because he usually lays out his logic. Recently, he has been very bearish on nat gas. 

 

 

Edited March 25, 2023 by Viking

[SharperDingaan]

Per OPEC+ production reports, Russian production is falling; highly unlikely to be voluntary given the Russian need to pay for the war effort. Various reports suggest that China will be consuming a lot more than it was pre-pandemic. Ordinarily this would not be an issue except that India is also sucking from Russian production, and Iran doesn't have the capacity to compensate for BOTH the Indian and Chinese surplus demand. Add to it that most OPEC+ members are also missing their production quotas ...... and we have a bastard of a grey swan developing.   

 

The trading view is short-term, the SPR re-fill long-term. The smart thing is to keep that demand in reserve, and use it to refill from primarily friendly sources as/when the need arises. 

 

Not a bad thing.

 

SD

[mattee2264]

Re the fundamentals my understanding is currently there is some oversupply which along with recession fears is weighing heavily on prices but markets are expected to tighten later in the year. 

 

It does feel like a buying opportunity as I think that the marginal cost of oil production probably is not that much lower than the current price. Shale is nowhere near as prolific as it used to be. ESG is making it very hard to develop new reserves and companies are much more focused on capital discipline and cashflow. China hasn't had the same rebound that the West had because of the ridiculous zero COVID policy so that should offset any recession driven decrease in demand in the West and people forget that oil demand is more inelastic than demand for other commodities as planes still fly, people still drive cars etc. and also OPEC cooperation has been a bit better since the cartel broke down March 2020 and without US production growth it is easier for them to restrict global supply. And also I think it is dawning on people that the energy transition isn't going to happen overnight and we are going to need oil for at least the next 20-30 years. And of course if you don't have to replace reserves because of the energy transition that is very good for cashflows too. 

[LearningMachine]

Interesting to see Charlie also alluding to the cartel as one of the core reasons for investing in oil companies in his Fireside chat with Todd Combs at https://www.youtube.com/watch?v=aciej48jbFk&t=1s:

 

• #1. "It's the nature of things that a bunch of democratically-elected politicians will eventually print too much money."
• #2. "Nobody thinks it's illegal for a bunch of sovereign nations to have a cartel in producing their own oil, and every reason it can't happen is that, 'Oh, they're a bunch of dumb this and dumb that.' But it could happen, and you could argue if solar would be a good business."
• #3. "The other thing that's similar is that there are only, what three or four players making the fertilizer.  And that's an interesting thing to watch, and I don't know how it's going to play out."
• #4. "Obviously, nobody knows, but there are going to be some sort of cartel-like things done by governments, and nobody will do anything about those.  Somebody will make money by predicting that stuff."
• #5. Todd: "The weak link is always the cartel breakdown." Charlie: "Yes, of course."

 

What do folks think he meant by "But it could happen"?  

 

Does he mean it could happen that OPEC+ cartel becomes illegal? 

 

Is he questioning if solar would be a good business in that case, i.e. solar would become a bad business if oil cartel became illegal? 

Edited March 26, 2023 by LearningMachine

[Ulti]

Interesting call

[Ulti]

https://www.bloomberg.com/opinion/articles/2023-03-28/biden-blew-a-winning-oil-bet-after-silicon-valley-bank-collapse?srnd=premium#xj4y7vzkg

[Saluki]

 

 

 

 

 

Some interesting videos from the Capital Link conference (Russian Oil Price Caps, LNG, VLCCs, Product Tankers).  Some of these videos have double digit or low triple digit views, which makes me think that the energy sector is still not on most people's minds and has more room to run.  

 

[mattee2264]

What I struggle to understand sometimes is the influence of traders on the oil price.

 

Obviously right now they are massively pessimistic as they think that with the banking sector travails we are heading for a deep recession and that is driving the price way down. Just as prices went to the moon when Russia invaded Ukraine. 

 

But demand is quite inelastic so won't fall massively during a recession and you'd imagine that OPEC would cut production if it did. Meanwhile China have reversed zero COVID and the SPR releases should halt. 

 

Also if it is a lot harder to get money from the banks and everyone is worried about a recession that is a disincentive to drill and therefore production is likely to fall which will offset to some extent any decrease in demand. 

 

But tell that to the segment of my portfolio in oil stocks! 

Edited March 28, 2023 by mattee2264

[Sweet]

19 minutes ago, mattee2264 said:

What I struggle to understand sometimes is the influence of traders on the oil price.

 

Obviously right now they are massively pessimistic as they think that with the banking sector travails we are heading for a deep recession and that is driving the price way down. Just as prices went to the moon when Russia invaded Ukraine. 

 

But demand is quite inelastic so won't fall massively during a recession and you'd imagine that OPEC would cut production if it did. Meanwhile China have reversed zero COVID and the SPR releases should halt. 

 

Also if it is a lot harder to get money from the banks and everyone is worried about a recession that is a disincentive to drill and therefore production is likely to fall which will offset to some extent any decrease in demand. 

 

But tell that to the segment of my portfolio in oil stocks! 

 

I don’t think it’s possible to understand the traders.  I’ve seen commentary that the futures market has increased oil price volatility recently rather than reducing it.  Huge swaths of the market is just speculation and evidence for that view is large swings in prices despite little to no change in fundamentals.  That’s also appears to be why the collapse of Silicon Valley Bank seemed to be correlated with oil prices, risk off means traders reducing their exposure.

[mattee2264]

Makes sense. Hedge funds tend to crowd in and out of positions. Amazing to think people are willing to pay their fees when they have such a herd mentality. 

[Viking]

Well, a bit of a shocker… Looks like OPEC wants higher oil prices.

 

OPEC+ Makes Surprise 1 Million-Barrel Oil Production Cut

- https://www.bloomberg.com/news/articles/2023-04-02/saudi-arabia-makes-surprise-500-000-barrels-a-day-oil-output-cut?srnd=premium-canada

 

• Saudi leads cartel with its own 500,000 supply reduction
• Members including Iraq, Kuwait, UAE, Russia also contribute

OPEC+ announced a surprise oil production cut that will exceed 1 million barrels a day, abandoning previous assurances that it would hold supply steady to maintain a stable market.

 

That’s a significant reduction for a market where — despite the recent price fluctuations — supply was looking tight for the latter part of the year. Oil futures weren’t trading when the cut was announced on Sunday, but the inevitable price reaction could add to inflationary pressures across the world, forcing central banks to keep interest rates higher for longer and amplifying the risk of recession.  

 

Saudi Arabia led the cartel by pledging its own 500,000 barrel-a-day supply reduction. Fellow members including Kuwait, the United Arabia Emirates and Algeria followed suit, while Russia said the production cut it was implementing from March to June would continue until the end of the 2023. 

 

The initial impact of the cuts, starting next month, will add up to about 1.1 million barrels a day. From July, due to the extension of Russia’s existing supply reduction, there will be about 1.6 million barrels a day less crude on the market than previously expected. 

[SharperDingaan]

Always nice to see a big cut, but keep in mind;

• 500,000 bpd is from Russia, unable to make deliveries under the USD 60 price cap. Of course the oil is still flowing, but it is going through China/India/Iran instead. https://www.rferl.org/a/novak-russia-extend-oil-production-end-year/32346054.html
• OPEC+ (rest of OPEC+ ?) underproduced by 70,000 bpd in March; implying that current production is not sustainable in the present climate. https://oilprice.com/Latest-Energy-News/World-News/OPECs-Oil-Production-Drops-In-March.html
• Should Russian supply now experience a 500,000 bpd 'accident', Saudi has the spare 500,000 bpd capacity to cover the shortfall, and mitigate the price spike. 

SD

[LearningMachine]

Where else do you get such gifts in life. 

 

Rights to boundaries marked on earth are actually generating FCF, and you can buy them indirectly for over 10% unleveraged FCF yield, and the price of the product generating FCF is guaranteed (with some lag) by a cartel of governments.

 

People get unnecessarily worried about volatility during that "lag", and end up thinking it is safer to buy boundaries marked on earth that either don't generate any FCF, or buy rights to boundaries that generate much lower FCF yield where the rights are funded with short-term debt exposed to interest rate risks and where the price of the product is not guaranteed by a cartel of governments. 

Edited April 2, 2023 by LearningMachine

[Stuart D]

If Biden wants to refill the SPR in the future at lower prices, could he just buy futures, which, due to backwardadtion are priced lower?

[Spekulatius]

10 minutes ago, Stuart D said:

If Biden wants to refill the SPR in the future at lower prices, could he just buy futures, which, due to backwardadtion are priced lower?

Yes. Having free unused storage capacity is actually a huge advantage if you want to trade crude (buy low, sell high)

[lnofeisone]

1 hour ago, Stuart D said:

If Biden wants to refill the SPR in the future at lower prices, could he just buy futures, which, due to backwardadtion are priced lower?

In theory, yes. In reality, it's more nuanced. SPR facilities (4 of them) are located in TX and LA. USG would need to contract out the oil (getting the right quality) + actual transport. Trading mechanisms are also nuanced. 

[SharperDingaan]

On 3/15/2023 at 6:03 PM, SharperDingaan said:

 

Gear Energy was selling at < 0.95 today, in quantity, has very little debt, and pays a .12 dividend (12.7% yield). If you believe that WTI averages around USD 85 this year, and that the risk adjusted yield should be around 7.5%, you will be reselling at around 1.60 (or better) - or a 68% return, before dividends. 

 

It was a lovely day for shopping 

 

SD 

 

Tombstone post: Gear Energy closed at 1.15, April 06.

 

SD 

Edited April 7, 2023 by SharperDingaan

[Paarslaars]

Thanks for the headsup on that one, bought a few days later at 0.93.

[TwoCitiesCapital]

On 4/3/2023 at 7:55 PM, Stuart D said:

If Biden wants to refill the SPR in the future at lower prices, could he just buy futures, which, due to backwardadtion are priced lower?

 

That's supposedly been the plan for months, but they haven't purchased the contracts yet. 

 

They could've bought as they were releasing into spot for a positive spread and locked in a win for tax payers. They didn't. 

 

A someone who believes recession is on the horizon, I don't want to be too critical as they MAY get a better price, but gov't officials playing oil trader isn't what I want. Lock it in! 

Edited April 9, 2023 by TwoCitiesCapital

[Saluki]

Just zooming out and thinking about energy from a econ and game theory perspective: 

 

SUPPLY

SPR is depleted and must be refilled.

OPEC announces production cut

Russia supply impaired b/c of sanctions.

Oil companies don't seem eager to ramp up supply, preferring to pay down debt and increase buybacks and dividends.

New production takes years to bring online

Windfall taxes discourage reinvestment in new production

 

DEMAND

Despite the push for clean energy, every airplane, ship and almost every car on the road use fossil fuel.  So most demand is inelastic. 

Marginal consumer of inelastic demand determines the marginal (market clearing) price. 

 

PRICE SIGNALS

• Oil Prices climbing and the market clearing price will always be where supply and demand intersect. 
• In order for the price to come down, there will have to be more supply, but see above.
• The other way oil prices come down is if demand comes down.  The green alternatives won't impact that in the short term, so the way oil prices come down is by less demand due to some dramatic increase in fuel efficiency or demand destruction due to a recession.
• the government is unlikely to willingly cause a recession when there is an election next year, so they will likely loosen up monetary policy if high energy prices increase the odds of a recession.
  • money printing causes inflation which causes commodity prices, including oil, to rise.
  • assets purchased by borrowings and investments  in yesterday's dollars are being sold in higher (nominal) dollars which gives you a big boost in ROIC until you must replace depleted assets with new reserves. 

I'm no mathemagician, but if I had to bet on higher oil prices a year from now or lower oil prices a year from now, I would take the former. 

 

 

 

[Sweet]

Anyone looked at natural gas as a potential play?  I’m probably not going to take any position but I have been looking at it.

 

Reasons:

 

- It’s at close to rock bottom prices with the excess storage and milder than normal weather - mostly in Europe.

 

- It will take time for the the storage to normalise, but natural gas is in demand and that is likely to increase as we transition to cleaner energy.

 

The trouble is how to actually make a play for this.

 

Those products that try to tracks the futures are crap IMO.

 

Many of the companies that produce gas are also oil companies so it’s hard to get a pure natural gas play.

 

I remember at the bottom of covid you could pick up LEAPS on oil companies with premiums that were incredibly low - silly actually - and I wonder if such opportunities exist right now.

[KPO]

31 minutes ago, Sweet said:

Anyone looked at natural gas as a potential play?  I’m probably not going to take any position but I have been looking at it.

Definitely thinking about this. Nitrogen fertilizer exported to Asia, and really anyplace with natural gas arbitrage opportunities, is a possible way to exploit the low North American natural gas prices at the moment. What’s the best instrument is the question. CF maybe? 

[Blake Hampton]

51 minutes ago, Sweet said:

Anyone looked at natural gas as a potential play?  I’m probably not going to take any position but I have been looking at it.

 

Reasons:

 

- It’s at close to rock bottom prices with the excess storage and milder than normal weather - mostly in Europe.

 

- It will take time for the the storage to normalise, but natural gas is in demand and that is likely to increase as we transition to cleaner energy.

 

The trouble is how to actually make a play for this.

 

Those products that try to tracks the futures are crap IMO.

 

Many of the companies that produce gas are also oil companies so it’s hard to get a pure natural gas play.

 

I remember at the bottom of covid you could pick up LEAPS on oil companies with premiums that were incredibly low - silly actually - and I wonder if such opportunities exist right now.

I bought a bit of Epsilon Energy and have wanted to start looking into Chesapeake. It’s my first time getting into commodity businesses and it seems a bit daunting due to the volatility. Fundamentally the companies seem solid but you never know. Have a cousin that was telling me about Chesapeake’s future contract with a LNG shipping company and really makes me think that this will be an interesting transition concerning Europe’s natural gas supply chains. Russia is out and USA is in.

[modiva]

I like Epsilon and have 5% position.

 

No debt. High Cash (about 35% of market cap is cash). Hedged till October (sell gas at high prices). They could buy back all their shares with current cash and 2 years of earnings (Assuming earnings remain same as the last year).

[Sweet]

@KPO I don’t see the discount on the CF that I would have hoped for - just a cursory glance at price.  Fertiliser companies probably benefit from low prices I would think.

 

@blakehampton Chesapeake energy was a badly run company that only recently came out of bankruptcy.  Looking at price again, I’m not sure that the really low prices are reflected in the share price.

 

It might simply be that nobody believes these low gas prices is likely to last, therefore no compelling opportunity.