Month: January 2016

Submitted by Allen Gilmer via OilPrice.com,

The one given in this industry is that the analyst community is consistently wrong about where the price of oil is going in the near to mid-term. Just as $100 oil was a sentiment driven price that baked in the risk of every potential negative impact on the supply chain, $28, $30 or $40 dollars is equally sentimental, assuming that any and all incremental barrels are and will be available AND demand will slow or stop.

2013 and 2015 forecasts. (forecasting sentiment is hard) Image Sources: EIA

So let’s just step away from the current noise and focus on a non-controversial outcome… that oil will be much more valuable in the future than it is today. What, exactly, will that future look like?

Today’s pricing sentiment is driven by a global economic “Pick 6” today…

 

1. US production rates,

2. Saudi Arabia’s ability to grow production,

3. Iran’s latent ability to produce more oil,

4. Chinese economic slowdown and its impact on consumption,

5. Russia’s ability to add global production, and

6. OPEC’s inscrutable strategy.

*  *  *

Let’s stipulate a couple of assumptions.

First, people will produce existing wells at rates that aren’t sustainable to preserve cash flow or compete for market share, because the cost to drill and bring online is already sunk. Second, new wells will not be drilled if there isn’t at least an outlook to breakeven producing them. That means an expectation of a sustained price over 1-3 years or until the well has been paid out.

U.S. Production Rates

Image Source: Drillinginfo Production Report for Unconventional U.S. Onshore Plays (Combined MBOE 20:1) over last six years. Note the lag in production reporting means Q42015 and even some Q32015 reports are not finalized.

First, let’s look at the U.S., the simplest and most transparent of the “Pick 6” issues bandied about as a price driver. Certainly the unconventional revolution has been a huge factor in global production increases over the last 6 years. The item NOT generally recognized is that production typically lags drilling by some 5 months, thus the drilling in December 2014 is discernible in production records in April 2015. That analysts were alarmed at increasing production and supply during the 1st half of the year suggested that they did not understand this dynamic, nor did the business press. We predicted in April that monthly production would peak in May and then jump around between -100 mbpd and -350 mbpd for the rest of the year. When looking at additional production month over month, it is important to remember that it is building on a sloping foundation of natural decline.

For instance, in 2014, as the U.S. added some million barrels of daily production, it had to produce 2.2 million new barrels of production to do so. The slope of that foundation required 1.2 million new barrels to just flatten it out. First year production in the U.S. has had a blended annual decline that has increased from 41 percent in for 2010 era wells to 47 percent for 2013 era wells. Therefore, 2014 era wells were likely to have declined 49 percent and 2015 by 51 percent in their first year. Second year declines show less of a pattern, ranging from 10-20 percent decline from the end of the prior year. In other words, we will see real production declines in 2016 as the full impact of 2015 drilling reductions are cycled through. Depending on the variability of the second year declines, this could range from -400 mbpd to well over -1MM bpd. So, the U.S. isn’t going to be the bringer of oil glut news going forward. In fact, the U.S. oil patch has severely damaged its capacity to rebound from an oil field services point of view, with companies foregoing normal maintenance to just survive. This deferred maintenance will have permanent consequences. Score: NOT a driver.

Saudi Arabia’s Ability To Grow Production

Whereas Saudi’s rig count is up, so is its production. They are producing record amounts and most analysts believe that there is little if any behind valve production. SCORE: NOT a driver

Iran’s Latent Ability To Produce More Oil

When sanctions hit Iran, they immediately dropped 600 mbpd from their official production levels. That they report the same production to the barrel since cause their official number to be quite suspect. Iran has not been investing in their infrastructure and they require outside dollars to reinvest in existing production, ranging from $30 billion to $500 billion over the next 5 years, depending on the source to maintain what they have. $30 oil is not an environment amenable to outside tender offers. Some claim that there will be no net new production in the near term, that Iran will merely start to recognize the production of oil it has sold in the black market. In any case, 500 mbpd ‘new’ production are baked in as of last week. SCORE: NOT a driver

Chinese Economic Slowdown And Its Impact On Consumption

As the year has progressed, the Chinese economy exhibits signs of extreme duress, suggesting that demand growth could weaken materially. Imports of metals and building materials are down substantively. Oil is not. China continues to import crude oil at increasing rates, most likely taking advantage of the low price environment to strengthen strategic reserves. China’s growing “guns vs butter” investment shift isn’t likely a bearish sign for crude oil, either. The IEA and EIA’s production growth estimates both suggest that the market isn’t going to elastically respond to lower crude prices, in essence saying that lower price will not drive higher consumption for the first time ever and despite the surprise increase in consumption in 2015 SCORE: NOT a driver.

Russia’s Ability To Add Global Production

Russia found itself in a fun position in 2015 as economic sanctions hammered the ruble down 50%. Essentially, Russia had a half price drilling environment and was effectively hedged by its cratering currency because it pays for new wells in rubles and sells its crude in dollars. This advantage doesn’t exist at commodity prices this low. Russia isn’t likely to spend a buck to get back 20 cents in the first year. SCORE: NOT a driver.

OPEC’s Inscrutable Strategy

Forget all the rest of the “Pick 6”. If anyone assumed OPEC wasn’t in charge of global oil prices, they were dead wrong. And by OPEC, let’s be honest and say Saudi Arabia. Only Russia, Saudi Arabia, and the U.S. technically have the production base to unilaterally affect the price of crude without completely undermining their net production rates, and the U.S. regulatory environment is focused on efficiency and safety and not price, because, alone of these three, the U.S. until recently was thought to be a net beneficiary of low priced crude oil.

Saudi Arabia, tired of being the only player ceding market share in an organization comprised of members that continually and habitually cheat on their production allotments, is flexing their global geopolitical muscle to enforce their control over the organization and to affect the amount of money available to global E&P projects in light of the new beta in crude oil pricing that is recognized today. So, as a result, the U.S. finally sees production declines of the celebrated unconventionals; Iran and Russia are starved of cash, along with the rest of the OPEC members, some to the point of existential crisis. How big a stick does Saudi Arabia wield right now? Very big, I think.

*  *  *

So what about the U.S. oil patch? The global price of crude is as ridiculously priced today as it was at $120 per barrel. A 2 percent oversupply in a world where we cannot even measure within 5 percent with any certainty drops the price of crude over 70 percent and has every analyst that claimed just 2 years ago that we would never see crude below $100 again now claiming that we won’t see oil above $40 anytime soon. They were wrong then, and they are wrong now.

Image Source

What is different is that the cost of capital in the U.S. has gotten much higher. That won’t be changing soon. Banks and other lenders have already started changing the cost of capital. Warrants are being demanded at closings. Even when oil recovers, this will not change rapidly. Watch the industry get a lot better, because their breakeven for cost of capital will have gotten worse. The oilfield service sector has suffered more than a glancing blow. It will not be able to ramp up as quickly as it was laid down. A lot of its equipment is shot for lack of proper maintenance.

The Fed is reported to be advising banks to push for asset liquidation in lieu of bankruptcy. This is actually a good idea if the point is to preserve value for lenders and equity holders. There is nothing more damaging to producing oil and gas assets as a bankruptcy trustee. Great for the eventual acquirer, bankruptcy trustees know how to make sows ears from silk purses by their reluctance to fund what Texas Independent Producers and Royalty Owners (TIPRO) chairman Raymond Welder calls the “recurring, non-recurring” expenses such as workovers necessary and common in the oilfield.

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By now, the China narrative should be familiar to most regular readers. Indeed, anyone who pays attention to global macro should by all rights be able to recount the entire story off the top of their head.

Massive credit expansion (from just a little over $7 trillion in 2007 to a staggering $28 trillion and climbing today) allowed the country to sidestep the economic malaise that followed the financial crisis. To whatever degree global demand and trade “recovered”, that recovery was underwritten by the Chinese, whose insatiable demand for raw materials buoyed commodity producers from Australia to Brazil.

Unfortunately for the global economy, China was sowing the seeds for its own (and everyone else’s) economic demise. Beijing built, and built, and built, creating pockets of acute overcapacity throughout the country’s industrial complex and erecting sprawling ghost cities and other monuments to the idea that “if you build it, they will come”.

When the debt bonanza finally begin to taper off and China stepped back to assess the monster it had created, it was too late. Commodity producers the world over had come to depend on a perpetual bid from China. When demand began to slump as China set off down the long road towards creating a consumption and services-led economy, the world was caught flat footed. A global deflationary supply glut for commodities was born and the more quickly China’s economy decelerated, the larger it became.

As for China itself, authorities are reluctant to allow the market to purge uneconomic productive capacity for fear of sparking social upheaval. That means perpetually bailing out companies that find themselves in trouble, thus preserving unwanted supply and fueling the disinflationary impulse.

Or, as we put it back in October: “The cherry on top is that China itself is now trapped: it simply can’t afford to let anyone default, as one bankruptcy would cascade across the entire bond market and wipe out countless corporations leaving millions of angry Chinese workers unemployed, and is therefore forced to keep bailing out insolvent companies over and over. By doing so, it is adding even more deflationary capacity and even more production into the market, which leads to even lower prices, and even greater bailouts!”

But even as the Politburo struggles to prevent the entire house of cards from collapsing on itself, signs of the country’s deceleration are readily apparent and Beijing’s anti-pollution campaign has only served to put further pressure on the industrial complex. Below, find a series of images which depict forlorn, abandoned brick factories and worker dormitories in Chaomidian on the outskirts of Beijing, shuttered because they belched too much pollution and because, presumably, the country has all the bricks it needs. 

More here from Reuters

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Submitted by Patrick Buchanan via Buchanan.org,

With the Iowa caucuses a week away, the front-runner for the Republican nomination, who leads in all the polls, is Donald Trump.

The consensus candidate of the Democratic Party elite, Hillary Clinton, has been thrown onto the defensive by a Socialist from Vermont who seems to want to burn down Wall Street.

Not so long ago, Clinton was pulling down $225,000 a speech from Goldman Sachs. Today, she sounds like William Jennings Bryan.

Taken together, the candidacies of Trump, Sanders, Ben Carson and Ted Cruz represent a rejection of the establishment. And, imitation being the sincerest form of flattery, other Republican campaigns are now channeling Trump’s.

This then is a rejection election. Half the nation appears to want the regime overthrown. And if spring brings the defeat of Sanders and the triumph of Trump, the fall will feature the angry outsider against the queen of the liberal establishment. This could be a third seminal election in a century.

In the depths of the Depression in 1932, a Republican Party that had given us 13 presidents since Lincoln in 1860, and only two Democrats, was crushed by FDR. From ’32 to ’64, Democrats won seven elections, with the GOP prevailing but twice, with Eisenhower. And from 1930 to 1980, Democrats controlled both houses of Congress for 46 of the 50 years.

The second seminal election was 1968, when the racial, social, cultural and political revolution of the 1960s, and Vietnam War, tore the Democratic Party asunder, bringing Richard Nixon to power. Seizing his opportunity, Nixon created a “New Majority” that would win four of five presidential elections from 1972 through 1988.

What killed the New Majority?

First, the counterculture of the 1960s captured the arts, entertainment, education and media to become the dominant culture and convert much of the nation and most of its elite.

Second, mass immigration from Asia, Africa and especially Latin America, legal and illegal, changed the ethnic composition of the country.

White Americans, over 90 percent of the electorate in 1968, are down to 70 percent today, and about 60 percent of the population.

And minorities vote 80 percent Democratic.

Third, Republicans in power not only failed to roll back the Great Society but also collaborated in its expansion. Half the U.S. population today depends on government benefits.

Consider Medicare and Social Security, the largest and most expensive federal programs, critical to seniors and the elderly who give Republicans the largest share of their votes.

If Republicans start curtailing and cutting those programs, they will come to know the fate of Barry Goldwater.

Still, whether we have a President Clinton, Trump, Sanders or Cruz in 2017, America appears about to move in a radically new direction.

Foreign policy retrenchment seems at hand. With Trump and Sanders boasting of having opposed the Iraq war, and Cruz joining them in opposing nation-building schemes, Americans will not unite on any new large-scale military intervention. To lead a divided country into a new war is normally a recipe for political upheaval and party suicide.

Understandably, the interventionists and neocons at National Review, Commentary, and the Weekly Standard are fulminating against Trump. For many are the Beltway rice bowls in danger of being broken today.

Second, Republicans will either bring an end to mass migration, or the new millions coming in will bring an end to the presidential aspirations of the Republican Party.

Third, as Sanders has tabled the issue of income equality and wage stagnation, and Trump has identified the principal suspect — trade deals that enrich transnational companies at the cost of American prosperity, sovereignty and independence — we are almost surely at the end of this present era of globalization.

As in the late 19th century, we may be at the onset of a new nationalism in the United States.

A vast slice of the electorate in both parties today is angry — over no-win wars, wage stagnation and millions continuing to pour across our bleeding borders from all over the world. And that slice of America holds both parties responsible for the policies that produced this.

This is what America seems to be saying.

Thus, given the deepening divisions within, as well as between the parties, either an outsider prevails this year, or Balkanization is coming to America, as it has already come to Europe.

For the Sanders, Trump, Cruz and Carson voters, the status quo seems not only unacceptable, but intolerable. And if their candidates and causes do not prevail, they are probably not going to accept defeat stoically, and go quietly into that good night, but continue to disrupt the system until it responds.

Unlike previous elections in our time, save perhaps 1980, this appears to be something of a revolutionary moment.

We could be on the verge of a real leap into the dark.

Where are we going? One recalls the observation of one Democrat after the stunning and surprise landslide of 1932:

“Well, the American people have spoken, and in his own good time, Franklin will tell us what they have said.”

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Yesterday, courtesy of Bank of America, we showed an extensive catalog of how a trader could, in case the market “were to crash tomorrow”, hedge said crash risk crash using the cheapest derivative instruments.

But the real question of course is whether a crash is indeed coming?

As Bank of America notes, a traditional telltale sign of crashes is a surge in correlation among various otherwise uncorrelated assets.

Which is notable because as we showed earlier, the correlation among two key asset classes, namely stocks and oil, have soared to record highs…

 

… while the respective vol correlations is likewise surging, as one would expect, soaring.

This, to many traders, is the first clear sign that something is seriously wrong and a broad selloff may either be imminent or necessary to short circuit a market in which all correlations are converging.

And yet, as BofA shows with the chart below, option markets always underestimate the severity of market shocks, and to different degrees. In 2008, currency and equity vols were the most optimistic ahead of the Lehman crisis and the most surprised after. This time around equity vol is modestly elevated, but it is rate vol – the vol which many say is at the core of the entire financial system – that is surprisingly depressed.

 

So for those who are inching closer to the “crash is imminent” camp, we suggest taking a look at the chart below showing the stress levels, or rather lack thereof, 2 months prior to every major crash in the past decade, and extrapolating how far said “stress” may soar to in the coming 8 weeks if, as Citi, JPMorgan and Deutsche Bank today suggest, central banks are on the verge of losing control…

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On Monday we brought you the latest from the main train station in Stockholm, where “gangs” of Moroccan migrant children have “taken over” the terminal.

If you believe The Daily Mail, dozens of children, ages nine to 18, are dug in at the station where they wonder about in a drunken stupor attacking security guards, “groping” girls, and “slapping women in the face.”

This rather surreal development comes as Europeans struggle to cope with what they view as the disintegration of polite, Christian society in the face of a deluge of Arab asylum seekers fleeing the war-torn Mid-East.

Many Europeans feel as though their countries have been invaded, for lack of a better word.

Well according to Sweden’s Major General Anders Brännström, being overrun by refugees isn’t the only invasion Swedes need to concern themselves with.

“The global situation we are experiencing and which is also made clear by the strategic decision leads to the conclusion that we could be at war within a few years,” Brännström is quoted as saying in a brochure for representatives attending an annual Armed Forces conference in Boden next week.

(Brännström)

“Since the end of the Cold War the Swedish Armed Forces have focused mainly on providing assistance to international missions abroad, but according to Brännström the strategy has now changed to ‘capability of armed battle against a qualified opponent’”, The Local reports, adding that “Sweden has made moves towards stepping up its military capability in the past year, with Defence Minister Peter Hultqvist extending cooperation with other neighbouring countries as well as Nato allies in the face of rising tensions in the Baltic region.”

Of course by “rising tensions in the Baltic region,” The Local means rising tensions between Russia and the West. “Sweden’s Security Service Säpo said last year that the biggest intelligence threat against Sweden in 2014 came from Russia [and] its stern words are largely credited with sparking increased Nato support in the traditionally non-aligned Nordic country.”

Defence Committee chairman Allan Widman echoed Brännström’s sentiments. “My take is that the situation is now so serious that even Sweden, with more than 200 years of peace, must prepare themselves mentally that we can get violent conflicts in our neighborhood and conflicts involving us,” he tells Expressen before delivering the following assessment of Vladimir Putin and Russian “aggression”:

It will come sooner or later a time when Putin becomes pressured politically. The question is what he does in that state – if he apologizes and runs from the Crimea, or if he takes other measures. We’ll have to prepare ourselves for him to take different actions he has shown himself capable of before.

Earlier this month, a poll in Dagens Nyheter showed nearly three quarters of Swedes support reintroducing compulsory military service. “The Swedish Armed Forces are currently short of around 7,500 soldiers, sailors and officers – around half of the total organization – despite running large recruitment campaigns with television ads and billboards in the past few years,” The Local said.

If Brännström is to be believed, Sweden may need the soldiers.”One can draw parallels to the 1930s,” he later told Aftonbladet, before adding that although Sweden “managed to stay out” of World War II, “it is not at all certain that the country would succeed this time.”

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