Selling oil, waiting for abundance

Executive Summary

A quick (and simplified) overview of the oil price development, including Iran ramping its production, Saudi-Arabia refusing to cut production, overflowing storage and the risk of rogue contango.

What I’m doing about it, i.e., my personal investments – tactical and strategical.

And some ducks… (and doomsday scenarios). And DIKs

walks talks looks like a duck

Readability: Including the summary, and this, it’s a fairly quick and easy read at 2068 words.


Oil

The table below shows my (simplified) view of the oil situation. I assume you are a grown up that understands it’s not the complete picture. I also assume you understand I’m not recommending anything. It’s all just entertainment. Disclaimer here.

Anyway,

To the left are variables supporting higher oil prices

To the right are variables that could cause significantly lower prices again; possibly new lows

Broken oil producer budgets Iran ramping production
Storage situation exaggerated Saudi-Arabia wants shale out
Price momentum Marginal storage left for futures arbitrage
Potential production cut Recession is coming, lower demand*
Capex cuts Dead cat short squeeze bounce ending
Strategic bombing = prod cuts (renewables – long term)
I’m selling oil :)  Bust shale assets bought cheaply

*incl China


It’s all Bernanke’s fault, just as everything else

The story so far: low interest rates and QE drove higher oil prices as well as heavy (mal-)investments* in shale production. (*investments that only made sense in ZIRP La-La land).

Once enough new capacity was in place (it took a few years to complete the malinvestment projects), sub-par economic growth (and thus lower demand) contributed to storage all but overflowing and consequently a sharp drop in oil price.

 

They key is OPEC and shale budgets

Saudi-Arabia, Kuwait and UAE have exacerbated the situation by increasing production in an attempt to fix their broken budgets (they need to sell more at lower prices) while crushing the shale industry at the same time.

 

Oil prices have jumped on hopes alone

Very recently, the oil price has bounced by more than 40%, due to short covering and speculation amid hopes of an OPEC production cut. Several countries, including Russia and Nigeria happily fuel such speculation (to mitigate their budget deficits).

 

Productions cuts are highly unlikely

In the real world, however, Iran is looking to ramp its production back to “normal”. Before that is accomplished, there is very little chance of any production cuts anywhere. This will take some time.

My guess is that oil speculators will be sorely disappointed when production cuts meetings are postponed or cancelled, while storage inches closer and closer to full capacity.

 

The storage crisis haven’t even begun

Nota Bene that storage isn’t full yet; that the storage crisis haven’t even begun. Also note that Iran is just starting to ramp, they aren’t actually producing more yet… It will probably take several more months to reach absolute full capacity in storage facilities, and several quarters or more for Iran to reach normal production levels.

 

Without arbitrage, exploding contango could obliterate ETFs

When there is no more room for front end/next month futures contract arbitrage, through temporary storage (when back yard containers of barrels are full, as well as tankers and ordinary storage), there could and should be a devastating price plunge in the front end contract. The resulting massive contango (Next month’s price less this month’s price; which could be repeated month after month) will erode any investment based on rolling oil futures forward, e.g., through an ETF like USO or Olja S.

 

Just knowing about it doesn’t fix it – that takes time

This situation could go on for several quarters, maybe a year… or more, while Iran is increasing its production and OPEC is falling short of promises of production cuts again and again, perhaps most notably at the supposed meeting on March 20.

 

I’m selling

Due to the reasons stated above, I have sold my Brent ETF (Olja S) as well as the oil junior ShaMaran (which is still waiting for its “first oil” and has some cash flow problems, but trades at what might turn out to be just 1x P/E a few years hence).

I’ve also sold some but not all of my DNO shares. DNO could be a strong Buy for the coming 3 years, but there is a definite risk of a deep downturn before that, even if the company doesn’t have the same financial problems as ShaMaran.

DNO is probably a much better bet already at current prices than any oil futures ETF or derivative.

 

Don’t short what should eventually double

I won’t go short though. And I’m actually not that confident in cancelling my longs either. The reason is that a sustainable oil price probably is somewhere between 60-100 USD per barrel for the coming few years (rather than the current $40), once the current storage crisis is sorted out. In between however, the front end contract could easily fall back to 30 and even below 20 USD/barrel. 

In any case, I’m expecting a quite prolonged storage crisis, up until Iran is content, shale is dead, and Saudi-Arabia, Kuwait and UAE can agree on the necessary cuts. I plan to buy more DNO, ShaMaran and USO long before that of course, but only when Iran has ramped significantly or we’ve hit new lows for oil, oil companies and the stock market in general. This might happen already this April,or as late as April 2017.

We’ll see. I’m not sticking around for the downturn, except maybe with a marginal position in DNO.


 

Ducks

If it walks like a duck, talks like a duck and looks like a duck, it probably is a duck. 

Oil prices pass the duck test of a recovery: unsustainably low prices, rising, breaking key levels, talks of production cuts…

On the other hand, so do storage problems (which pointy in the opposite direction): almost full, meaning the real problems haven’t even started, Iran not backing off, neither is Russia or Saudi-Arabia. Shale still lingers as the walking dead.

Another walking, talking, living, sitting duck is the economy. Most pundits talk of low risk of recession. However, a select few, very mart people, point to a combination of factors: duck tail, duck beak, duck feet, duck feathers, duck calling sound etc., all clearly pointing toward there being a recession duck swimming around in plain sight.

I’m squarely in the “dead cat bounce” camp regarding the oil price and stock market, and in the “given these variables, including the stock market there is almost invariably a recession” group of people.

One caveat though: In 2009-2012 I used to say “this won’t be too bad if we normalized rates to 4% and some other things“. Now I’m leaning more and more toward “we are beyond thinking about investments, and more about defending civilized life as we know it“. I’m sure many more make the same assessment, including policy makers.

 

There is no turning back from full retard central bank policies

That means the powers that be truly will do “whatever it takes” (as Draghi’s Full Retard Threat went back in 2012) for as long as they can, thus making the final crash even worse.

As time passes and policy makers venture further and further into retarded measures, I’m becoming less and less certain of my forecast of a “pretty bad but not catastrophical outcome quite soon“. Instead I see increasing risk of a blowout on the upside followed by something on the downside we haven’t seen since the 1920’s crisis in Germany and the Great Depression in the U.S. in the 1930’s. 

The best long term outcome would be a normalization of stock markets, interest rates and debt burdens as soon as possible. There actually are some promising signs in that direction. But then again, there is Draghi (ECB), Ingves (Sweden) and Kuroda (Japan) trying to get into the history books with a particularly toxic variation to the Rio Spread Theme*. Maybe war is the only “solution” after all.

*The Rio Spread means taking a huge bet in the market and going to Rio for unlimited celebration. If it works out, it works out. If not, you stay there. The DIKs (to which Mark Carney of the BOE is very close to being added) will either miraculously save the economy, or (much more likely) ruin it completely. Either way, they will get their place in the history books.

I think the ECB reaction was quite expected (except the rebound afterward). The Fed is more important though. My guess is we’ll get the exact same reaction after the FOMC meeting (except the rebound) as after ECB, i.e., reflexive buying followed by heavy selling.

 

How an economy grows

I listened to a typical economist today (on the Swedish podcast Fondpodden), and she said the same stupid interventionist and illogical things about deflation and growth that most academics do (except that she didn’t defend negative interest rates). I just want to set the record straight as an antidote to the brain poison she helps spreading:

Saving enables investments which lead to better tools and infrastructure and thus increased productivity and falling production costs and selling prices.

Falling prices typically lead to increased consumption, but if it doesn’t, it means more room for even higher savings and investments and higher growth


 

Somehow many economists have misunderstood this completely and think that lower prices (like spring sale, summer sale, Christmas sale etc.*) mean less consumption. And even if it does, what’s bad with that? Nothing! people will buy what they want and need, no matter the direction of prices. And if they were to limit their purchases somewhat that only means more saving and room for investments and even higher growth.

So, saving=>investment=>low prices and high growth=>both increased consumption and investment and thus even higher growth in a virtuous cycle.

Most economists want higher prices, which lead to less room for consumption and investments and thus both lower supply and demand => lower growth, less wealth, even less room for saving and investment, and so on and on in a death spiral.

*Actually, they claim there is a difference between sales and declining prices. They think lowered prices increase consumption while falling prices decrease consumption. Eh? Somehow, falling prices on TVs. cell phones and computers increase consumption, while falling food prices lead to people eating less… Eh*2?!


 

Invest responsibly. Remember that investing is 80% psychology. The other half is patience.


Summary – selling oil, waiting for abundance

In short, I’m selling oil due to the storage situation, that will only get worse until Iran has reached full production and OPEC cuts can be seriously considered.

I don’t dare shorting though. Quite the opposite; I’ll look for (oil company) stock bargains in the expected carnage (blood in the streets).

I’ve gradually had to “refine” my general outlook from “bad” to “binary”. I’m staying short the stock market but even that feels less and less palatable these days. Gold and silver are the only things that feel OK. I’m even leaning closer to getting some physical gold to complement my paper gold. So far, however, I haven’t, and I just don’t want to be that pessimistic.

I mean, the 2020’s promise to be the best era ever (so far) for humanity, with widespread abundance provided by AI (did you see AlphaGo’s victory?), nanotech, biotech, robotics etc. Billions of people coming online, sharing knowledge and using ever accelerating technological tools to create more and better solutions to everything than at any time in human history. And then we haven’t even mentioned the 2030’s!!

We just have to pass this little “bump” provided courtesy of Draghi, Ingves, Carney, Kuroda etc. (including Yellen of course, but she’s no DI…)

What goes bump in the night?

Mario-Draghi-laughing

Ingves negative interest rates are FUN

Carney

kuroda

Janet Yellen

 

I want to put my wisdom in you

I may have gone overboard with that Will Ferrell-inspired book cover I tweeted the other day (the Tweet, viewer discretion is advised).

The message is the same though. I’m not blogging, podcasting and writing for financial gain, I just want more people to become aware:

Aware of themselves, aware of the world, aware of their career possibilities, of their investment opportunities, of the fantastically bright future that awaits.

So, please share this article, bookmark this site, subscribe to my newsletter and download and read my first e-book about the investment guidelines I picked up during a decade and a half as partner, managing director and portfolio manager at Futuris – The European Hedge Fund Of The Decade.

If you have already downloaded the book but never opened it, try just the first page summarizing my ten most important investment rules. Please.

 

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23 Comments

  1. So, how to survive coming crash if you are not a investor, just some random businessman? :) been feeling this way since 2008 crash, something just wasnt and isnt right.

    • Depends on which business.

      Just stay on your toes and I’m sure very good opportunities will present themselves in the carnage. Just make sure you have enough liquidity to take advantage.

  2. I wouldnt dare stay out of the stock market in THESE times.

    Look, we all know the singularity is going to happen within the coming 30 years.

    We know that when the singularity becomes a reality the size of the economy might start doubling evrey 12 or even 6 months. Having all your money on the bank at 0 % intrest rate when the economy grows at 100 % per year is going to be a bad thing.

    But even before that the economy is going to start expanding rapidly when general AI becomes implemented. And that might happen fast, just look at AlphaGo. Most people thought AlphaGo was another 10 years away.

    I am long Google, IBM, MicroSoft and Apple in that order. One of these companies will lead the AI-revoulotion. I have a hard time seeing any other company getting there first.

    Today you are buying IBM with Watson at PE 10, Apple at PE 10, MicroSoft at PE 20-25 and Google at PE 30. One of these companies will reach singularity first, and when that happens, well, i dont want to be sitting without stocks in that company.

    /Fully invested in american tech.

    • Funny thing is I actually agree with you.

      Actually, even a single share in each of those companies will be worth more than the current world GDP shortly after the Singularity :)

      OK, sorry about that (it is true though). Up until the Singularity normal rules still apply and it’s worth considering which companies will deliver the Sci-Fi future for 2020-2040. I like the same four in about the same order.

      As long as you are okay riding a big cyclical wave downward in the coming few years to be sure not to miss the take off, I’m completely with you.

    • What about saving some hassle and just buying an index fund following (sort of) S&P 500, like “SPP Aktiefond USA”? Apple and Microsoft is actually the biggest assets in that fund right now (3,1 % and 2,2 % respectively). Also, covers your ass if some other company gets there (to strong AI) first! :D

    • Long on Apple? really? The company is popular today but must continually innovate which requires a visionary(he is gone). Sure they have cash on hand and are building a mega campus(This is also waste of money). Of all this, they need to continually innovate while protecting their market-share, they are stagnating on this. Also there too many big players in the same space developing better products at lower cost.

      It is easy to just speculate, but I have dumped Apple from my main portfolio. I certainly could be wrong on this, but the future narrative of this company does not look good.

      Fanboys don’t last forever, they grow up or follow a new fad.

  3. Hi Mikael!

    Thank you for sharing all knowledge on your website!
    What is you outlook on silver, do you expect the metal go lower before it turns up? What does your experience tells you about the big ratio between silver and gold right now?

    • I think both silver and gold will go down initially when the stock market does.

      I’m not looking to time that though, so I’m buying silver already (not going all in at once, but rather slowly scaling up). I have no real view on a target ratio but I think silver could increase more than gold from the current levels. How much more? I don’t know but multiples more I’ve heard isn’t unreasonable.

  4. A bit of an aside to this fantastic article Mikael, but i was wondering what your take on a potential Brexit was? [For Britain & For europe]

    I am not sure where to fall on the whole thing, because while its almost agreeable with all sides that EU institutions are largely corrupt, largesse, power mad and antidemocratic, i’m worried about potential capital flight from the United Kingdom in the event of a Brexit. Also the thought of negotiating 27 different trade deals individually after about 2 years of stagger towards an exit, worries me significantly.

    There’s maths, politics, and culture in some unholy mess and i don’t really know what’s the best call.

    Your thoughts?

    • I don’t think any country should worry about an exit. Sure, some turmoil for a limited time, but communication technology is so good these days that the number of bilateral agreement don’t really matter.

      A Brexit is a good thing.

      • Thanks for your reply Mikael!

        Definitely value your feedback as you’re in a much better position to understand any potential impacts to the city of London than I am.

        Thanks again

  5. Hi! thanks for your goldmine of information and sharing your personal experience. I agree on all your reasoning, but one piece of (highly debated )information have got me to consistently short (buying otm puts on /cl) since spring 2011. You sort of mention it as the “long term – renewables” argument, but my question is; have you at all considered the possible implications of a LENR black swan breakthrough? Since you cover so much of my other areas of interests and views on society/health/psycho-philosophy etc. I believe you might find it interesting to google (don’t trust wikipedia though) and get an opinion. Energy abundance could be closer than we think; and with that premise, some future prognostications needs to be reconsidered. Fun thing is; John Galt might be very real. Regards Torkel (http://sifferkoll.se)

    • Things like LENR, or runaway AI for that matter are very enticing. I’m sure we will reach energy abundance within 30 years, but I have a hard time believing things like cold fusion making oil obsolete within just 5 years.

  6. Agreed. Oil will not be obsolete in five years, maybe not even 15, but does it matter if there is an verification (verifications are plentiful on small-scale, but we lack general awareness of industrial scale so far) of LENR and there is an idea that oil in the ground will become worthless eventually. My theses is that it is already happening in Saudi Arabia (+Iraq/Iran) where they have maybe 10-15 (more?) years of really cheap access oil in the ground. In that case it sort of make sense to sell as much as you can now at $37 all the way down to $10. What do you think? I’ve been getting some response on this since my oilprice.com, but in general it’s pretty hard to get through… (http://oilprice.com/Finance/investing-and-trading-reports/Why-Are-the-Big-Financial-Institutions-Selling-Oil-BIG.html)

    • Agree. The sell “now or never” theme was part of my reason for not going long-term long when I first caught the oil knife more than a year ago. I’m sure the big producers have realized oil has an expiry date and want to get as much out of their reserves as they can. However, in the short term demand/supply balance is still more important than long term concerns.

      Oil is used for greasing, for plastics, for fuel where batteries don’t cut it etc. Production above 60 USD/barrel is going away, leaving a 10-15 year supply-demand imbalance up to that level (60 USD +/-20) I think. But, hey, it’s anybody’s guess; and yours is probably better than mine.

      Anyway, I don’t own any oil or oil stocks now, and won’t buy any unless there is a major sell-off in both.

      • Yes. At current sentiment I believe you’re correct. Or, I would probably go for the $20-$50 range short term (<1y).

        However the assumption that LENR in MW scale is a fact right now (first hand information as well as a four year "obsession") makes it more interesting. LENR will also enable cheap synthesized fuels that replace more expensive oil in most applications still utilizing refining and distribution infrastructure of Big Oil I believe, which is sort of verified by their oil field divestment strategy.

        Anyway, that's the scenario I've been betting on buying cheap otm puts. I've been expanding it lately with puts in solar and oil exploration which I believe are still vastly overpriced considering the above … We'll see …

        Have a really nice day!

  7. Hello Mikael. I enjoyed your interview on ‘Chat With Traders’ particularly the part about technological singularity. Anyways I am curious about how you decided on DNO and ShaMaran as opposed to other petroleum and gas exploration companies. Specifically did you choose DNO because of how much it has declined in price since 2014 when oil was at its peak, where its fields are (Middle East), headquarters being based in Europe (Norway), or some other reason? The reason I ask is so I can use the same criteria to pick a similar type company based in North America. Finally, are you worried that DNO fields are all located in high conflict areas? In the event that tensions escalate in the region or a large scale war begins would it not affect DNO’s ability to operate these sites? Thanks for posting this information, especially on contango which I had previously thought only pertained to leveraged etfs.

    • Very low cost of production and very high geopolitical risk (that can fall) were my main reasons.

  8. “Somehow many economists have misunderstood this completely and think that lower prices (like spring sale, summer sale, Christmas sale etc.*) mean less consumption. And even if it does, what’s bad with that? Nothing! people will buy what they want and need, no matter the direction of prices. And if they were to limit their purchases somewhat that only means more saving and room for investments and even higher growth.”

    “Most economists want higher prices, which lead to less room for consumption and investments and thus both lower supply and demand => lower growth, less wealth, even less room for saving and investment, and so on and on in a death spiral.”

    If you can buy that TV at a higher price on credit, the price won’t fall according to ability to pay but on the availability of credit. No one whom relies on credit and is in debt can save or invest in anything, even when prices fall.

    Those who do benefit from higher and higher prices are money lenders, even if they push the economy into a death spiral. So of course, against all decency, higher prices are always “better.” It isn’t consumption that falls when prices go down – it’s borrowing, and that is what they seem to be worried about.

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