Thursday, February 4, 2016

Can Cheap Oil Trigger a U.S. Recession?

Historically, major drops in oil do not equate to causing a U.S. recession. However, cheap oil can tear down an over valued stock market, which is what is happening right now.

For recent evidence, look at Black Monday in October 1987.  Twenty-one (21) months after the Saudis started a similar oil pricing strategy as the market faces today, where the Saudis raise production to maintain market share, the U.S. stock market plummeted 40%. But there was no U.S. recession.

Fast forward to 1998, oil prices plummet 55% over a two year period (1997-1998) as emerging markets faced a currency crisis. Russia defaulted; however, there was no U.S. recession. The stock market swooned in sympathy intra-year by over 20%, with the peak of the decline happening 20 months after oil prices began to crater. We are now at month 18 of the time frame in which oil prices started their decent starting in August of 2014. I estimate that $20-$25 per barrel in oil would force a similar emerging market crisis today, and trigger a similar U.S. stock flash crash as experienced in 1998.

Wednesday, February 3, 2016

Oil Prices Bottoming? – What Changes in the Futures Curve Say

The oil futures curve over the past half year, dating from August 2015 to the end of January 2016, has undergone a radical downward move.

In August 2015 the current March contract level was priced at over $48 per barrel. By mid January the contract dipped below $28 per barrel concurrent with the point in time the February contract expired. After expiration, the futures curve rallied over 25%, with the front month contract increasing to about $33 per barrel. The rally overall has been uniform across the entire contract spectrum, with mid-term longer dated contracts faring better.

For this price rally to hold, signs should continue to become evident that future supply relative to demand is tightening, forcing the longer dated contracts to become more expensive while the front-end of the curve exhibits volatility as traders maneuver to make money in the process of clearing excess oil in storage

Why the Current Oil Rally has Stronger Legs 


Thursday, January 28, 2016

Fed Powerless to Solve Current Stock Market Valuation Problem

On January 27, 2016, the Fed announced its decision not to raise interest rates.  The policy statement with the decision was considered slightly more dovish than when the Fed raised rates in December.  In particular the statement made reference to international market unrest which if continued would likely delay the ability of the Fed to raise rates as often in 2016 as previously forecast.  Post announcement, Fed Funds futures moved to a price which predicted only one additional rate hike in 2016.  And, the DOW (DIA), which initially traded up after the announcement due to a perceived more dovish stance by the Fed, ended the day down 223 points.

The only take away investors should have from the Fed statement is that they don't see any reason to raise rates - yet.  However, it is clear the FMOC does not anticipate lowering rates or using QE anytime soon.  Going slow is really their only option right now because the primary ingredient that will stoke inflation and tighten labor market conditions, the two mandated variables which dictate Fed policy, is still not strong enough, or even highly visible when it comes to inflation.  And what, you ask, is the primary ingredient?  Answer, a major change in U.S. fiscal policy.

Wednesday, December 30, 2015

Is OPEC Still Relevant in an Oversupplied, Low Price Oil Market?

  • The world oil market is estimated to be over-supplied by 1.5M BBL/d, yet Saudi Arabia and OPEC continue to maintain higher rates of production.
  • Prices of oil have plummeted since mid 2014 from highs above $100 per barrel to recent lows below $35 per barrel in December 2015.
  • This article reviews the oil supply and pricing dynamics since the Arab Oil Embargo, including 5 other points in time over the past 40 years when oil prices went up or down dramatically.
  • The data reveal that if you inflation adjust prices back to a time pre-Embargo, using 2015 prices, $50 per barrel is currently the point that prices are likely to stay below until over-supply clears.
  • Additionally, market price and supply levels post 1986 provide valuable investor insight into the geopolitical landscape changes required to change the current market trajectory.

Market discussion was heated after the December 4, 2015 OPEC meeting about whether the organization was “losing its relevance”.  The argument was that since the price of oil continued to free fall after the meeting because the Saudi led cartel did not scale back production to support the price, that somehow the organization had lost its grip on the world oil market.  The inability of the group to agree on an official quota left organization members producing at a rate of 31.5M BBLs a day.  The result of the meeting was not received well by the market.  Subsequent to the meeting the prices of crude dropped below $35 per barrel for WTI and $40 per barrel for Brent and show little sign of quickly rebounding.

To understand the relevance of OPEC today, I believe you need to review the history of points in time that the price of oil moved significantly, both up and down.  And, since oil is priced in U.S. dollars, the prices need to be normalized for U.S. inflation through time so that changes in the supply of oil relative to demand can be better understood.  With this framework in mind, I went back to the point in history when OPEC was arguably at the peak of its power as an organization, the Arab Oil Embargo, and examined 5 major price discontinuity points since that time.  The results of the research are shared in this article I recently published on Seeking Alpha.

Wednesday, December 16, 2015

Oil Prices Lower for How Long? You decide

The business media is currently full of year end predictions, and many concern the future price of oil.
Goldman Sachs lead the charge in predicting much lower prices for oil back in September of 2015 when analysts for the firm published a report saying prices could drop as low as $20 per barrel.  here

And now that oil spot market prices have dropped to the $35 range in mid-December, the market is now set-up for an epic battle for the game of “who is going to be right?”  Ron Insana injected his view on 12/8/2015 that an Oil recovery by 2017? Not likely.  He foresees price levels approaching $20 per barrel and shale oil drillers surviving through higher productivity.  Alternatively, on 12/4/2015 Daniel Yergin, Vice Chairman of IHS, explained his view on Why oil prices cannot stay this low, here.  He sees a range bound trade of $40-$60 for oil over the intermediate future.

Not one to be satisfied with just following the news cycle to assess the probable direction of the market, I gathered some useful facts about the current oil market.  I share them in this article to help investors make their own informed decision about their energy market positions and investment strategy.

U.S. oil market prices on a roller coaster ride since 2008


Oil prices hit an all-time high over $147 per barrel in the summer of 2008, and 6 months later were below $40 per barrel as the U.S. financial crisis left no asset class unscathed, with the exception of sovereign government bonds like U.S. Treasuries.  The price of oil experienced a similar downward juggernaut from June of 2014 into early 2015, dropping from over $100 per barrel in June 2014 to below $40 per barrel by the winter of 2015.  The price of oil has since stayed stubbornly on average below $50, and now seems to be making $40 the over / under zone.


Wednesday, November 25, 2015

Chesapeake Energy Haunted by a Bad Deal, Bankruptcy Looms?

  • Shares of Chesapeake Energy have fallen from over $24 in November of 2014 to the present traded value of just above $5 per share.
  • Chesapeake Energy’s senior unsecured debt has also plummeted over 50% in traded value in just the last 6 months.
  • This report analyzes Chesapeake’s financial health and ability to withstand the oil and gas market price collapse.
  • The findings expose critical issues concerning company production results, non-competitive cost structure, expiring derivative positions and royalty owner litigation.
Over the last year the shares of Chesapeake Energy (CHK) have been on a constant spiral downward, falling from over $24 in November of 2014 to the present traded value of just above $5 per share.  The rapid share price decline and volatility has been relentless.  After a brief share rally in early October the shares have dropped 50% in value with bids being hard to find for the stock.

We all know the market prices for oil and gas are very depressed at present, approaching the lows reached in the depths of the 2008 financial crisis.  Chesapeake bottomed at $15 per share in the 2008 market carnage, but now is on a direct line toward $0.  Why is the 2nd largest gas producer in the U.S. having such difficulty coping with the present market circumstances, whereas it survived the 2008 crisis?

Tuesday, October 27, 2015

Scorpio Tankers - Undervalued Gem in an Over-Supplied Oil Market

The business model of almost every oil related business has been tested as the dollar price per barrel has fallen from over $100 in June of 2014 to the present $45 price in October 2015.  As stock prices of energy sector firms have plummeted, many investors are currently playing a nervous game of trying to call the bottom in the hope of catching upside gains in the event the tide turns quickly.

Loading up for an eventual sector rebound may require extreme patience given the level of over-supply in the production pipeline worldwide at the present moment.  The tide will turn, but in the meantime, most investors still want to make money.  And, like most industry sectors, just because a bear market has set in for the near-term, it does not mean that opportunities in the oil market for upside gains and cash returns are not possible – just that they may be a little harder to find.

The current opportunity in the over-supplied oil sector is simple – look for marine based petroleum transport companies like Scorpio Tankers (STNG) which in my opinion is substantially undervalued given the current market dynamics.  Why?

Export driven oil counties like Saudi Arabia, Russian, etc. have flooded the market with crude over the past year and the excess supply has to go somewhere.  Presently the somewhere is primarily China and other Asian emerging market, driven by currency pegs held high relative to the strong dollar and a oil futures curve contango with a favorable low dollar front end price level.  The ancillary beneficiaries of this situation are companies like Scorpio Tankers which specializes in the transportation of oil via tanker ships worldwide.  And, as the current flow of oil into storage becomes saturated and the North American shale oil business model implodes as it is presently doing, the benefits will continue to accrue to shippers like Scorpio because the U.S. will return to greater dependency on imported oil and related petroleum products.

Monday, October 12, 2015

Has Oil Finally Found a Bottom?

Over the past 5 trading days post the Friday morning October 2nd 8:30 jobs report, investors with exposure to the energy sector have been treated to a major rally.  As seen in the graph below, the Energy Select Sector SPDR ETF (XLE) has risen 14.5% from $60.62 at the open on Friday to the closing price of $69.41 on Thursday. 

Compared to the S&P 500 (SPX) (SPY) aggregate index, which has posted a 4.5% gain over the same period, the out performance of the energy sector is substantial, and worth taking a closer look at to understand what is driving the significant divergence in the returns before diving into just any energy stock at this point in time. 

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