tnii vol 1
TRANSCRIPT
Andrew Schenkel The oil market is very noisy. Analysts disagree as to its direction in the short and medium term. As of this writing (February 26, 2015), the price of NYMEX crude is $49.50 per barrel. What those bull analysts are not seeing is the change in the structure of the market since the large US banks exited the market last summer. What the bears are not seeing is the time bomb a persistent low price of crude means for the high yield market. The unintended consequence of those two conditions means trouble for the bondholders and the credit markets in what appears to be an implied U shaped recovery.
I n f e r e n c e P a r t n e r s , L L C 2 8 8 O l d F o r g e C r o s s i n g , D e v o n , P A 1 9 3 3 3 I n f e r e n c e P a r t n e r s @ g m a i l . c o m
The Oil Bear and Bank Implosion
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The Oil Bear and Bank Implosion
The oil market is very noisy. Analyst forecast for its price ranges from $49 (JP
Morgan) for WTI on the low end to $69 (Moody’s) and $71 for BoA ML on the high
end. Mr. El Badri the Saudi OPEC Minister said that oil could be $200 per barrel if no
investment were made. According to a Bloomberg Intelligence survey of 86
analysts, the range in average price for oil is $35 and $80 per barrel for 2015. No
one has clarity on whether the oil market will persist below $50 or shoot back up to
$100. (NYMEX crude was priced at $49.50 as of 2/27/2012). In the disagreement
over price lies opportunity in its unintended consequence.
Over the last five years (2009-‐2014), the total investment in oil exploration,
development and production has been $5.3 Trillion. Over that time frame the
average price of oil was between $35 (2009) and $140 (2008) per barrel. Industry
analysts attribute the rise in the price of oil to China participating in the global
economy—with the purchase or cars, the paving of roads, and the making of plastic
goods and fibers etc. The high price of oil enticed speculators to build rigs and dig.
Demand for oilrigs from 2009 to the present rose 400%, according to data from
Baker Hughes.
Oil traders such as Vitol are betting on a V shaped recovery to take advantage of the
contango that exists in the market. The V shaped recovery’s perspective is based on
the perception of a quick absorption of the excess oil, which has been estimated at
between 1.2 and 1.6 million barrels per day. Vitol, in fact, has the largest crude
carrier anchored off of Singapore ready to deliver its oil. Five small crude carriers
are moored in the Delaware river just a short distance from Carlyle Group’s
Philadelphia Energy Solutions, which runs the refinery complex at Marcus Hook. All
told, some 30% of the global fleet now has oil ready for sale anchored off of ports.
(In 2009, by contrast, upwards of 70% of the global crude carrier fleet was used to
absorb the excess supply in oil after the prices collapsed. So this condition is normal
when the market and price are under duress.) The contango, now valued at about
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$6 per barrel, makes good margin for the physical trader like Vitol, who can place
the oil in a short amount of time.
Dodd Frank forced the big US banks to exit the oil futures market during the
summer of 2014. JP Morgan sold its oil trading desk to Mercuria while Morgan
Stanley sold its to Rosneft. Goldman Sachs and other EU entities remain. Physical
traders are partnerships and cannot match the big banks deep pockets and talent
for taking risk. Liquidity in the oil futures market has dried up as these players have
left…and so has its upward bias. One role big banks had in the commodities markets
was to attract others to the market. Demand from China created less risky trading
opportunities for the speculators in oil futures.
The high price of oil attracted speculation in shale oil exploration and production.
Unlike conventional oil production, shale oil fracking requires constant and
renewed participation in capital markets to perpetuate to drilling operations.
Producers hedge their inventory exposure through selling futures, and now that the
banks have left, hedging is more difficult and costly. US oil production has risen
from 5.6 million barrels in 2010 to 9.3 million barrels today. The big banks financed
these operations through high yield debt and derivatives.
The energy sector represents 17% of the high yield market or approximately $2
Trillion, funding rigging operations. The six largest banks also have $3.9 Trillion in
commodity derivatives contracts still on their book according to sources.
Structured Credit expert Tom Adams writes, “Much of the recent energy boom has
been financed with junk debt and a good portion of that junk debt ended up in
collateralized loan obligations.…In addition, over the past 6 months banks were
unable to unload a portion of the junk debt originated and so it remained on bank
balance sheets. That debt is now substantially underwater.” According to Fortune
Magazine, the breakeven cost for U.S. hydraulic shale is $65 per barrel, which its
article cites from a study by Rystad Energy and Morgan Stanley Commodity
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Research. Overseas the situation for investment in production is the same.
“[G]oldman Sachs found almost $1 trillion in investments in future oil projects at
risk. They looked at 400 of the world’s largest new oil and gas fields — excluding
U.S. shale — and found projects representing $930 billion of future investment that
are no longer profitable with Brent crude at $70.”
Because of sunk costs and other factors, conventional oil drillers continue to extract
oil even during conditions of unprofitability. Some shale oil operators sold future
production to finance their drilling. Baker Hughes reported this week that the rig
count has dropped to 986, which is the first time the rig count has fallen below
1,000 since June 2011. The Wall Street Journal reports the decrease in rig counts
was not enough to have a “substantial effect” on oil’s oversupplied condition.
China’s PMI was last reported below 50 and is expected to be below 50 this month
too. (A reading of under 50 suggests a contracting economy.) Demand does not
appear likely for a V shaped recovery.
When China was busily producing goods after the oil shock in 2009, it took oil about
2 years to recover from its lows. What’s different today from 2009 is the amount of
high yield debt and other instruments that financed the oil boom in addition to the
exit of the large US banks participating in the oil market. A U shaped recovery of oil
or persistence below $65 for US drillers and $70 for overseas producers means the
holders of the high yield debt and other instruments that financed the boom have
significant problems.
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About Inference Partners:
Inference Partners, LLC is a research and consulting firm specializing in seeing
unintended messages and alerting clients to change in markets or competitors
before they disrupt business plans or diminish opportunity share. Alerting clients
can take two forms: a workshop entitled Turning Noise Into Insight and its
companion service Red Team. Turning Noise Into Insight trains investment
professionals on inference. Red Team is a service that challenges or validates the
assumptions and inferences an investment professional makes. In addition,
Inference Partners also generates industry landscapes and corporate profiles.
Inference Partners has worked with public & private companies, foundations, hedge
funds and governments.
About the Author:
A former strategic intelligence analyst, Andrew Schenkel founded Inference
Partners, LLC, a research and consulting firm specializing in analyzing competitive
behavior and offering its clients insights into the structure of competition in an
industry. His private entity clients have included ExxonMobil, Ford Foundation,
Symantec and VWR among others. Mr. Schenkel works with the Academy of
Competitive Intelligence Onsite War Games programs as the lead analyst for writing
the competitor briefs and the industry outlooks. Mr. Schenkel is also a partner at
TargetProof, a start up IT security firm. A graduate of Hamilton College, Mr.
Schenkel was the panelist at the Mid-‐Atlantic Hedge Fund Association’s 10th Annual
Conference.
For more information, please contact: Andrew Schenkel +1 610 247 4977 [email protected] This report has been independently prepared by Inference Partners, LLC as a matter of general information and is not to be construed as a specific recommendation. Inference Partners, LLC may invest in areas mentioned herein.