Monday, February 23, 2015

A Primer on Oil's New Math

We are more bearish than the interviewee, although like him we were (quite publicly) bearish, albeit early.
We are expecting to see thirty-handles before oil turns decisively upward.

At present the price is determined by three factors, overproduction, the strength of the dollar and financializations and other dark arts. This means that something I'm not putting great weight on, maybe, say, final demand, will probably trip the balance.
Front (April) futures: $49.14 down $1.67.

From Fortune:

How oil's dramatic plunge has changed the energy equation
With prices down by 50%, the world’s foremost experts are reworking their assumptions about crude’s calculus. Here, a primer on the new math.

Jonathan Goldberg was one of the few who saw it coming. Early in 2014 the rookie hedge fund manager noticed something unusual: The amount of crude oil being stockpiled around the world was building much faster than normal for that time of year. The growing excess in supply wasn’t yet reflected in the market, however. Benchmark oil prices continued to hover around the same lofty level they had occupied for the previous few years—near or above $100 per barrel. Increasingly this was considered the new normal.
Goldberg had just launched his BBL Commodities Value Fund the previous September, but he was hardly a newcomer to oil markets. He had spent the previous decade as a trader, first for Goldman Sachs and then for Swiss commodities giant Glencore. His strategy for BBL was to trade oil “across the barrel”—refined products as well as crude itself—and to stay focused on short-term opportunities while keeping one eye on the horizon. “Our views are three months, six months, maybe a year,” says the 33-year-old Goldberg. “And we

are very sensitive to day-to-day, week-to-week fluctuations. I’ve never understood the point of putting a position on until I actually thought it was going to make money.” That January he rode bullish bets on natural gas and U.S. distillate prices to a 7% monthly gain. But he began to realize that something bigger might be brewing in crude.

Goldberg and his team watched closely as the stockpiling accelerated. By the end of the first quarter, the trend was clear. A gusher of new supply driven by the stunning growth in U.S. shale oil production—accounting for most of the 80% spike in overall U.S. production since the end of 2008—was beginning to overwhelm demand. And yet oil prices continued to defy gravity, propelled by fears of supply disruptions. Russia’s conflict with Ukraine and the emerging threat of a new Islamic state in northern Iraq caused crude to hit new highs in late June. 

The trader stayed patient, waiting for a catalyst that would spur a drop. By the early fall Goldberg noticed that the cash prices being paid for physical oil were significantly lower than even the suddenly weakening futures prices. He became more confident that it was time to be short oil.
INT1-03-01-15
Then the bottom fell out. On Nov. 27, the Organization of the Petroleum Exporting Countries announced that, contrary to the assumptions of much of the oil industry, it would not cut its production to defend higher prices. Crude went into free fall. The price of a barrel of West Texas Intermediate (WTI), a benchmark for so-called light sweet crude oil, tumbled from its June high of $108 to a low in January of $44. Goldberg was well positioned for the crash. His fund made 26% in December alone and finished with a return after fees of 51.3% for the year, pushing assets up to $540 million.

Now the question for Goldberg and others is, what happens next? What are the implications of a 50% markdown of crude—in terms of cost structure, demand growth, and production? Will prices remain low for a sustained period or rebound quickly? To answer that, you have to study oil’s new calculus. For the near term anyway, expect volatility, not consensus. “The only thing that there’s agreement on is that it’s a lot more challenging than the old math,” says Dan Yergin, the vice chairman of information and analytics company IHS and the author of the essential oil-history tomes The Prize and The Quest. ...MORE

HT: Abnormal Returns