Energy Sector

[LC]

The real unknown here is how various desks will price these assets going forward and the various implications of that (i.e. reduced volumes or higher collateral reqs). Many existing models (e.g. gabillon) do not allow for negative prices. Similarly to negative interest rates a few years back.

 

FYI this lends more color here:

https://www.bloomberg.com/news/articles/2020-04-21/negative-oil-prices-are-literally-breaking-traders-risk-models

 

CME Group Inc. said late Tuesday that the clearing house will switch the options pricing and valuation model to Bachelier -- a model named after the famous French mathematician -- to accommodate negative prices in the underlying futures and allow for listing of options contracts with negative strikes for a certain set of crude oil and energy products. The change is effective Wednesday and will remain in place until further notice.

 

Holy cow--negative strikes.

Bloomberg did some lazy reporting to only focus on BS/options pricing. The real problem is use of Gabillon model which is used as a commodities pricer, mainly for collateral purposes. It will throw collateral requirements out of whack.

[Castanza]

How does this work for pricing below 0?

 

(I couldn't access the article)

[SharperDingaan]

Trudeau and pretty much the rest of Canada (outside of Alberta and Saskatchewan) has moved on from oil. Oil is so hated my guess is completing the pipeline projects will be difficult; more massive protests with many groups doing everything they can to stop it. Meanwhile, the economy is falling off a cliff. But the government is cutting everyone a check so who cares about being ‘unemployed’ or if we have a shitty economy.

 

Agreed, times have changed, but they have also made a national energy policy more of a necessity than it has ever been.

Lack of money, has a wonderful way of concentrating the minds of everyone,

 

Like it or not, there will be climate driven constraints, but it can be done intelligently (ie: orphan well clean-up)

 

The Supreme Court has ruled there is 'duty to consult', not a 'duty to agree'. A sick community cannot veto a pipeline, because it cannot make a decision. The obvious industry 'consultors', are the governments of the day, under a national energy policy.

 

There will be quasi-privatization. Crown corporation in-ground SPR, pipeline company, oil company, rail (oil/grain car) fleet, tanker (nfld) fleet, supply-chain (medical, food) infrastructure, etc. Most likely as oiligarch, crown corp and 1-2 private corps.

 

And perhaps one of the biggest lessons from Covid-19.

All of the above are essential services, with immense value-add, and robust . When the sh1te hits the fan, the gig economy, and non-essential services break down.

 

Interesting times.

 

SD

 

What this says to me is that if you have pipe already, it will become increasingly valuable.  The repercussions for future supply are interesting to say the least. 

 

SA, And to a lessor degree the other large Mideast countries are going to be facing revolution if the oil price stays down for very long.  We saw what happened to Libya’s and Venezuela’s supplies when governments become unstable.  Simultaneously we have a virtual elimination of long tail projects by every major player in the world. 

 

The outcome is likely toppled regimes, and a massive price bounce back, down the road.  It may become more like railroads, with very few players making a lot of money. 

 

We could speed up the rebalance really quick by turning the gulf fields into glass.  China may take exception but I sure Moscow would be on board.

 

Existing pipe will behave, on pain on nationalization. Keep renewing the social license, or lose it.

Most long-tail projects are now stranded, but regimes will continue to produce as they need the FX. Without tariffs, others will shut-in.

Agreed, regime change in most places unless they can collectively raise price, and keep the price up.

 

Game changers

Covid-19 demand destruction is enough to permanently shut-in sizeable global production.

Global agreement to lock up the global inventory, then bleed it out slowly.

Post Covid, demand rises, supply remains constrained, and price rises to some set-point [uSD 62/bbl?]

Thereafter all incremental demand supplied from inventory.

Stability for a long while.

 

SD

 

 

 

[TwoCitiesCapital]

USO will have 8 to 1 reverse split on April 28th.

How will this affect puts and calls?

 

It's my understanding the number of shares underlying each option contract will change to adjust the new share ratio  (i.e. 12.5 shares instead of 100).

 

So both your strikes and underlying # of shares per contract get adjusted, but you will own the same number of contracts.

[BG2008]

Trudeau and pretty much the rest of Canada (outside of Alberta and Saskatchewan) has moved on from oil. Oil is so hated my guess is completing the pipeline projects will be difficult; more massive protests with many groups doing everything they can to stop it. Meanwhile, the economy is falling off a cliff. But the government is cutting everyone a check so who cares about being ‘unemployed’ or if we have a shitty economy.

 

Agreed, times have changed, but they have also made a national energy policy more of a necessity than it has ever been.

Lack of money, has a wonderful way of concentrating the minds of everyone,

 

Like it or not, there will be climate driven constraints, but it can be done intelligently (ie: orphan well clean-up)

 

The Supreme Court has ruled there is 'duty to consult', not a 'duty to agree'. A sick community cannot veto a pipeline, because it cannot make a decision. The obvious industry 'consultors', are the governments of the day, under a national energy policy.

 

There will be quasi-privatization. Crown corporation in-ground SPR, pipeline company, oil company, rail (oil/grain car) fleet, tanker (nfld) fleet, supply-chain (medical, food) infrastructure, etc. Most likely as oiligarch, crown corp and 1-2 private corps.

 

And perhaps one of the biggest lessons from Covid-19.

All of the above are essential services, with immense value-add, and robust . When the sh1te hits the fan, the gig economy, and non-essential services break down.

 

Interesting times.

 

SD

 

What this says to me is that if you have pipe already, it will become increasingly valuable.  The repercussions for future supply are interesting to say the least. 

 

SA, And to a lessor degree the other large Mideast countries are going to be facing revolution if the oil price stays down for very long.  We saw what happened to Libya’s and Venezuela’s supplies when governments become unstable.  Simultaneously we have a virtual elimination of long tail projects by every major player in the world. 

 

The outcome is likely toppled regimes, and a massive price bounce back, down the road.  It may become more like railroads, with very few players making a lot of money. 

 

We could speed up the rebalance really quick by turning the gulf fields into glass.  China may take exception but I sure Moscow would be on board.

 

Are you saying to Nuke the oil fields in the middle east?

 

[Jurgis]

Trudeau and pretty much the rest of Canada (outside of Alberta and Saskatchewan) has moved on from oil. Oil is so hated my guess is completing the pipeline projects will be difficult; more massive protests with many groups doing everything they can to stop it. Meanwhile, the economy is falling off a cliff. But the government is cutting everyone a check so who cares about being ‘unemployed’ or if we have a shitty economy.

 

Agreed, times have changed, but they have also made a national energy policy more of a necessity than it has ever been.

Lack of money, has a wonderful way of concentrating the minds of everyone,

 

Like it or not, there will be climate driven constraints, but it can be done intelligently (ie: orphan well clean-up)

 

The Supreme Court has ruled there is 'duty to consult', not a 'duty to agree'. A sick community cannot veto a pipeline, because it cannot make a decision. The obvious industry 'consultors', are the governments of the day, under a national energy policy.

 

There will be quasi-privatization. Crown corporation in-ground SPR, pipeline company, oil company, rail (oil/grain car) fleet, tanker (nfld) fleet, supply-chain (medical, food) infrastructure, etc. Most likely as oiligarch, crown corp and 1-2 private corps.

 

And perhaps one of the biggest lessons from Covid-19.

All of the above are essential services, with immense value-add, and robust . When the sh1te hits the fan, the gig economy, and non-essential services break down.

 

Interesting times.

 

SD

 

What this says to me is that if you have pipe already, it will become increasingly valuable.  The repercussions for future supply are interesting to say the least. 

 

SA, And to a lessor degree the other large Mideast countries are going to be facing revolution if the oil price stays down for very long.  We saw what happened to Libya’s and Venezuela’s supplies when governments become unstable.  Simultaneously we have a virtual elimination of long tail projects by every major player in the world. 

 

The outcome is likely toppled regimes, and a massive price bounce back, down the road.  It may become more like railroads, with very few players making a lot of money. 

 

We could speed up the rebalance really quick by turning the gulf fields into glass.  China may take exception but I sure Moscow would be on board.

 

Are you saying to Nuke the oil fields in the middle east?

 

Don't give this idea to Orangina in Oval Office.

[LC]

How does this work for pricing below 0?

 

(I couldn't access the article)

 

It doesn't - what happens is most commodity derivative pricing models assume a lognormal distribution; when your spot price is negative it blows up this assumption. The short term fix is a parallel shift to a slightly-above-zero amount but this may violate the lognormality assumption.

 

Just to put it bluntly, a lognormal distribution is: e^(distribution). These values can only be positive, that is, e^(positive value) = positive value, and e^(negative value) = positive value

[Dalal.Holdings]

https://www.reuters.com/article/us-global-oil-usa/u-s-weighs-taking-stakes-in-u-s-energy-companies-other-options-mnuchin-idUSKCN2262TY?il=0

 

The U.S. government is considering taking equity stakes in U.S. energy companies as it seeks to help the nation’s oil and gas sector amid the coronavirus outbreak, Treasury Secretary Steven Mnuchin said on Friday.

 

It’s not socialism if it helps with the reelection campaign.

 

Drill baby drill!

[Dalal.Holdings]

It gets better and better...

 

President Donald Trump, speaking at a White House event with Mnuchin, said he wants to help industry and suggested the federal government could buy fuel for the country in advance as well as purchase airline tickets in advance.

 

“We’re looking at a whole bunch of alternatives,” Mnuchin said.

 

The oil sector has been hit hard by a dramatic drop in demand as the coronavirus has effectively shut down economies around the globe.

 

“The energy business is very important to me, and we’re going to build it up. This really hurt the energy business as much as any other business because it totally knocked out - the supply kept coming,” Trump said.

 

Airline tickets purchased by taxpayers for flights that are never taken--all for the oil industry. Who would have thought. Surely electing a guy incapable of acting beyond pure self interest to the Presidency would have no negative consequences!

[jmp8822]

Does anyone think that WTI futures will go negative again - this time on the June contract? Why or why not?

[TwoCitiesCapital]

Does anyone think that WTI futures will go negative again - this time on the June contract? Why or why not?

 

I don't think investors will find themselves in the same squeeze again - so minus $40 off the table.

 

I do think that supply/storage issue hasn't been fixed, so watching the futures contract trend towards 0 near each expiration may be expected since it forces people to close the position or to take delivery and no one wants the latter.

[SharperDingaan]

Does anyone think that WTI futures will go negative again - this time on the June contract? Why or why not?

 

I don't think investors will find themselves in the same squeeze again - so minute $40 off the table.

 

I do think that supply/storage issue hasn't been fixed, so watching the futures contract trend towards 0 near each expiration may be expected since it forces people to close the position or to take delivery and no one wants the latter.

 

Squeeze that's earlier, and not as severe. This time around, a trapped trader will be fired. Also incentive to have underfilled contracted Cushing storage on expiry day (reduce filling until expiry day).

 

SD

 

[DooDiligence]

Sounds like a game of musical chairs with a scorching hot potato on every seat & most of the players are pants-less.

[bizaro86]

I'm wondering if one effect of this will be bigger than expected hedging gains for producers. I think it is likely that most producers had closed their May hedge book before prices went negative, but I bet someone was out there with a bunch of sold short May contracts that they closed at negative prices, while selling their physical crude production at positive spot prices.

[Dalal.Holdings]

Turns out it wasn't just U.S. based Robinhood users who bought WTI ETFs:

 

https://www.bloomberg.com/news/articles/2020-04-26/bank-of-china-clients-said-to-have-1-billion-losses-on-oil-bet

 

The losses stem from the bank settling May West Texas Intermediate contracts that underpinned its “Crude Oil Treasure” product on April 20 at minus $37.63 a barrel, leaving Bank of China customers caught in the middle of oil’s unprecedented collapse below zero. Hundreds have taken to the Internet to protest the lender’s handling of the contract rollover and to demand it shoulder some of the losses.

 

The investment vehicle had offered Chinese retail investors access to WTI oil futures without opening an offshore account and was pegged to the flat price of the front-month contract and settled in Chinese yuan. It requires 100% margin and doesn’t allow any leverage.

 

They're asking the lender to shoulder some of the losses...

[KCLarkin]

I don't understand why these futures contracts are allowed to trade negative, especially the cash settled ones. I understand why the price of Oil might go negative. But why not set the floor at $0 for the exchange traded futures? Someone might get stuck with physical delivery of oil they don't want, but that's the risk in playing the game.

 

If you allow negative futures, brokers can't require adequate margin. If you want to buy a June contract at $12, what is a safe level of margin? 500%? Should brokers require $60 in cash to buy $12 of oil? Even $60 doesn't seem safe right now. Maybe $100 or $1000?

[Dalal.Holdings]

I don't understand why these futures contracts are allowed to trade negative, especially the cash settled ones. I understand why the price of Oil might go negative. But why not set the floor at $0 for the exchange traded futures? Someone might get stuck with physical delivery of oil they don't want, but that's the risk in playing the game.

 

If you allow negative futures, brokers can't require adequate margin. If you want to buy a June contract at $12, what is a safe level of margin? 500%? Should brokers require $60 in cash to buy $12 of oil? Even $60 doesn't seem safe right now. Maybe $100 or $1000?

 

If you don’t have access to storage, it will be in your interest to pay someone who does to take the contracts off your hands. Perhaps the negative floor for margin calculations should be the current cost of storage in Cushing.

[KCLarkin]

If you don’t have access to storage, it will be in your interest to pay someone who does to take the contracts off your hands.

 

Yes, but the exchange doesn't need to facilitate that transaction.

 

And can I suggest that if you don't have access to storage, you shouldn't be allowed to trade physically-settled futures!

[Dalal.Holdings]

And can I suggest that if you don't have access to storage, you shouldn't be allowed to trade physically-settled futures!

 

Haha—that would put a lot of traders out of work!

[randomep]

 

 

I believe that the futures contract specify physical delivery.

It’s not cash settled like your Emini futures.

So come expiration, you don’t just get some dollar amount for the contract (like a $20 spot)

You get a barrel of oil (or however many the contract specifies)

 

If you do not have the ability to take delivery of the oil, and put it in storage, then you will be forced to close at market.  I’m guessing that you as an investor don’t have the ability to take delivery of physical oil.  That is why people roll the futures a day or two before expiration.

 

Liquidity is provided by those that can take delivery, store the oil and short a further out contract, pay the storage fees, and make the spread.  If there’s no storage available and storage costs skyrocket then the spread between the months blows out.

 

Hi thanks for the explanation. Since the negative oil price, there have been several articles explaining how that can happen.  It seems to be buyer side of the trade couldn't find storage, like you said.  I found the following explanation of how the contract actually works, it even describes how the oil should be physically moved from buyer to seller.  But the most interestnig thing is that the May contract expires on April 22, and the delivery must happen from May 1 to end of May.  So the buyer has no storage and also has no way of finding storage from April 22 to May 1 and so pays someone $35 take the oil off their hands.....

 

My other question is , is any oil sold at spot at Cushing? If so what is the ratio of spot transaction vs futures transaction on the physical delivery?

 

https://www.cmegroup.com/trading/energy/crude-oil/light-sweet-crude_contract_specifications.html

[opihiman2]

https://www.reuters.com/article/us-chesapeake-enrgy-bankruptcy-exclusive/exclusive-chesapeake-energy-preparing-bankruptcy-filing-sources-idUSKBN22B31M

 

So it begins.  Looking forward to seeing another board favorite, Sandridge Energy head into Ch.11 as well.  What a stupid ride that was.

[JRM]

A better question is which supermajors don't survive this, if any?  My guess is XOM.  $60 per barrel break even and maintaining the dividend? looks like GM circa 2006.

[SharperDingaan]

A better question is which supermajors don't survive this, if any?  My guess is XOM.  $60 per barrel break even and maintaining the dividend? looks like GM circa 2006.

 

They will just cut dividends, take massive write-offs, and extend debt maturities - but they will survive.

The good news is that they are integral to the global economy, so after the cuts/write-offs/negative press ... they will be the ones to own. Mean reversion becomes your friend.

 

SD

 

[thepupil]

A better question is which supermajors don't survive this, if any?  My guess is XOM.  $60 per barrel break even and maintaining the dividend? looks like GM circa 2006.

 

what is the source of your $60 breakeven?

 

I think that number is the revised (lower) breakeven at which they can maintain their dividend and invest aggressively without borrowing, not their breakeven on profitability/earnings. I think you're misinterpreting a quote from the recent bloomberg article.

 

On March 16, S&P again downgraded Exxon’s credit rating, to AA from AA+, and said it could happen again “if the company does not take adequate steps to improve cash flows and leverage.” A week later the stock closed at $31.45, the lowest since 2002. Investors started to wonder whether Exxon might end its string of 37 straight yearly increases in its dividend. To cover that $14.7 billion payment—third-highest among S&P 500 companies—along with its aggressive capital spending, Exxon needed crude to fetch about $77 a barrel, the highest breakeven among oil majors, according to RBC Capital Markets.

The stock began to recover in early April, but it was all too much. On April 7, Woods said Exxon would cut 2020 capital spending to $23 billion—a drop of an additional $10 billion, or 30%—and shave operating expenses by 15%. The bulk of the cuts would be aimed at the Permian. Exxon would defer some activities in its Guyana project while postponing investment decisions elsewhere. “They cried uncle,” says Rice University’s Medlock. With the cuts, the breakeven dropped to $60 a barrel, still tops among the biggest companies.

 

XOM is potentially overvalued (depending on one's view of long-term oil/gas prices, refining margins, and chemical demand/margins), but I think they will survive. they have ~$50 billion of debt at very low cost and very termed out.

 

they may get downgraded, have to cut the divvy, or invest less aggressively, but I struggle to see them not surviving.

 

I'd also point out that XTO (the gas portions of XTO in Pennsylvania/Arkansas etc, not the permian oil/associated gas) should start earning a little more now, but I'm not super hopeful on that until we get a clearer picture of gas demand. Supply is obviously heading in that right direction if/when Permian production starts to really go down

 

[Jurgis]

@thepupil - what do you think about OXY debt? I bought some close to the bottom, but not sure if it's worth holding as it has bounced to $80s. Still ~9% yield, but clearly not as attractive.

 

I also hold some GPOR debt, so there goes my any credibility in energy debt investing.