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Monthly Archives: February 2016

I’ve been an oil bear since last year, which has worked out quite well so far. It may be a good time to summarise my case. I should have written about it earlier, as it’s starting to become mainstream!

Demand and supply

On the demand and supply front, the big shock is increased from US shale. This is well known, but it seems to have taken some time to make an impact. Besides, many US exploration ventures are funded by a lot of debt, so not flexible as they could be — they’ll keep pumping as long as operational cost are break even. Exploration and setup costs are sunk costs, and leveraged structure prevent waiting for better times. Rapid technological improvements in extraction add to the price pressure.

Shale also applies to natural gas, which has seen it’s own supply boom, likely taking market share for some oil applications (NG vehicles?). For electricity, renewables have been getting from insignificant to a minor player, which is also more competition.

On the demand side, it seems merely steady, or facing downward pressures (“China”, austerity). With all that no surprise the price has to come down.

Besides known reserves are vast on a human lifetime scale. If we keep facing static or slowly increasing demand, speculative exploration could be totally suspended for thirty years or more, and the world would be unlikely to run out. This is a challenge to new exploration, which is merely adding to the glut.

Politics

On the politics side cartel agreement seems harder to obtain than in past cycle bottoms. US producers and OPEC agreeing seems very improbable. Even the recent partial deal between Russia and Saudi Arabia — keeping production at the current relatively high level — might be difficult to maintain as producing more to compensate for lower revenue per barrel will be a temptation difficult to resist.

Climate change policies may work out in reducing demand (at least some).

Cycle timing

Commodity cycles — over-investing when prices are high and under investing when they are low — tend to be quite long (5-10 years) as it requires project planning to flow through to reality on the ground and there’s lot of inertia around.

There are several signs of not being at the bottom, like high volatility, media interest, bullishness of traditional oil sector investors although this may be turning.

A strong contango (higher prices on contracts for future deliveries) is a sign of probably excessive hope, and keeps supporting production at above-spot prices — until it doesn’t.

The money shot

Not making any precise forecast, but let’s say that WTI is probably going to stay in a range $20-$35 until at least the end of 2017, with perhaps short lived escapades on both sides of the range.

Back to the trading floor

This post is really just an excuse to make a portfolio update less boring: in addition to selling BP and Total, as previously discussed, I’ve sold Petrofac. Although they seem well equipped to survive a downturn, the market will probably ignore that for a long while (the name of the company may be a curse). I’ve added more Amec Foster Wheeler, which is a more diversified (and further diversifiable) engineer at a distressed price (hence being underweight in the portfolio).

This is despite not being supposed to do significant sector bets in the Obliquity portfolios, but I make an exception in order to minimising regret: I’d be pissed if I’m right on oil while owning sector losers. It’ll be easier to accept missing a sector rebound (if possibly costly).

On the trading front, I’m short contango and long crude carriers (the speculators will need storage, while the carriers’ share prices have been moving down with oil) via options.

Monetary policy’s impact is made relevant by sticky prices. The stickier nominal salaries and fixed prices for products and services are, the greater the impact of changes in nominal money quantity.

Thing is, prices are getting less and less sticky.

Long gone is the time where the price of flights was printed in a paper catalogue updated once a year. Dynamically priced flight can include changes in fuel cost, or demand and supply pressures, every few minutes, and people got used to it. You have a ballpark idea of what a flight cost, but known that the exact price will only be known at the time of booking.

Anyone who buys tech gadgets and shops around using internet comparison engines will end up paying the producer country price, as lean distributors with little stock and tight margins pass through currency impact, and this model dominates — sticky price competitors are structurally more expensive because they need  to add a buffer to both hedge currency risk, and to prevent adverse selection (people buying from them only when the exchange rate has moved favourably since the last sticky price was set). Even supermarkets now have dynamic price labels that can be updated in seconds.

What’s left of sticky prices? Wages and property are perhaps the main markets where stickiness still applies, though this too is challenged by short term rental contracts and short term employment (be it old school or gig-economy style), or variable compensation (bonus or commission based long term employment) where the net wage becomes decoupled from the notional sticky base salary. This is still a strong force, but for how long? I suspect the writing is on the wall: prices will get less and less sticky.

A possible danger for monetary policy is that backward-looking simulations use datasets from olden times, when prices were stickier than they are today, and thus unless a gradual decrease of stickiness is embedded in the model, will make increasing false predictions. More generally, monetary policy may become less and less important as nominal effects reduce, as changes to nominal quantities get absorbed by reality faster. Another reason to give fiscal policy a greater role in macro-economic management.