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.


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.

I used to think, like most value and fundamental investors, that market timing is difficult or impossible. I’m starting to come back on this and considering having a market timing component to my portfolio. It’s too risky to do on the market as a whole — moving one’s entire portfolio between stocks and cash or bonds — because this is undiversifiable (a portfolio dominated by whole-market timing has effectively 1 holding), but there may be opportunities for risk controlled allocations to sector or company specific cycles.

As a starting point I’m building a check list for spotting sectoral cycles. It’s a work in progress but here it is:

Bubble Bull/bear trap Bottoming
Dominant discourse “Paradigm shift” “This is a bubble!”, “This is the opportunity of a lifetime!” “Nobody ever made money investing in this!”
Volatility/volumes High/mid Mid/high Low
(Social) media interest High High Low
Closed-funds discount Premium Small/no discount Discount
Themed ETFs and retail products Launching Closing down

Why isn’t everybody doing it?

Most of these factors are reasonably easy to spot. But it’s that easy, why isn’t everybody doing it? A couple of possibilities:

  • The idea here is to capture sentiment, so it’s subject to errors if there are fundamental change that can kill an industry or are real paradigm shifts involved.
  • Knowing broadly where you are in the sentiment cycle seems straightforward, though imprecise and unlikely to find exact tops or bottom. Waiting for the cycle to turn may take longer than most investors’ attention span. Capturing a bottom or shorting a top may require more patience than most people have.
  • Intermediaries will have a hard time selling market-timing products as most clients behave like the herd (by definition).

Prospective guesses

Bubble Bull trap Bear trap Bottoming
Biotech, Internet retail, Unicorns Small caps, Equities Oil, Energy Metals mining, Airlines, Tankers/Shipping

Now the question is: is this confirmation bias? The Obliquity Portfolios have grown slight under/overweight in most of these themes — before I quite realised I was trading boom and bust cycles. I’ve also opened a little long tankers option basket a few days ago.

Despite having a notional check list for small caps, I’ve not been very careful with checking it formally. It’s also a good time for a review as my small cap investment style is maturing.

Picture of earthquake survival checklist

Earthquake survival checklist (credit: David Pursehouse on Flickr)

Owner business

As a replacement for the vague “useful business”, I’ll now try to answer the question: “would I like to own, and possibly run, this business as a private company?” However preposterous for a pint-size armchair investor, the idea is that it’s a business I must be interested in and understand enough, and would be happy to be stuck in (swapping CEO roles or even a majority stake in a private business is considerably illiquid compared to flipping listed stocks). This should eliminate a whole class of scams, and encompass classic criteria like “do not invest in things you don’t understand” or “invest like a businessman”. Besides, if one likes a business it’s much easier to weather price weakness, as one can emotionally compensate for (potential) financial failure with satisfaction from higher purpose (within reason).

Takeover potential

I’ve realised that since starting the portfolio many of my small cap exits are companies being taken over by larger groups. This is a pretty nice way to manage small cap exits: no transaction costs, usually a price premium, and no decision to take. And it makes a good sanity check new investment, as a company must be in some shape to be worth taking over.

The wallet test

As a simplified version of the executive character test, I have to ask myself “would I lend my wallet to the CEO for safekeeping?”, trying to guess that from hints in CEO interviews, reading reporting narratives between the lines, or interviews by trusted third-parties. (Idea first seen on the Value and Opportunity blog.)

Access to bank lending

This is about finding out whether a conservative banker would lend to the candidate business. This implies a solid balance sheet and somewhat predictable cash flow. It can be inferred from regulatory reporting on credit lines or covenant updates, or guessed from the balance sheet and business model.

Minimum (expected) profitability

Is this business making at least £1 million (or equivalent) profits annually, or, for recovery situations, can it be expected to reach that within the next 3 years? This takes out things that are too small to be listed, or too far away from break-even. Most story stocks (notoriously disastrous as a class) should drop out here.

The pass rate should be at least 4 out of 5.

In the spirit of the obliquity principle there’s no price or valuation test (other than that implied in the takeover test). Looking at the price too closely is probably counter-productive — I’d expect buying blind based on the above checklist should already give appreciable outperformance compared to small caps as a whole. And in any case I can’t help doing it, which is not incompatible with passing the check list, which is just a minimum standard.

A review of the existing Obliquity London Stamps portfolio holdings is now due.

I think the latest Super Mario move is genius, again, notwithstanding the apparently negative trader reaction.

Not only does a subtle move with tricks that have a potential real effect is probably the best to do domestically for the eurozone (balancing monetary firing power and political capital), but it avoids too strong a move being equivalent to a monetary tightening in the dollar zone, which would make it harder for the Fed to finally do a token rate increase — which is long overdue, if only for signalling purposes and to take that¬† uncertainty out of the system.

Super Mario and star CGI

Super Mario at work (credit: phobus on Flickr)

What are we going to do when he’s gone?

Here’s an app idea: make an app, let’s call it Ubercut, that allows Uber users to shortcut Uber and avoid paying the fat commission.

How would it work?

The app would run in the background on a phone and detect if the regular Uber app is running in the foreground. When it is and both a driver and a punter are using it at the same time, and are within pickup distance, it sends a notification of the type “you guys may want to make a deal” to both parties, e.g. doing the ride but for 90% of the fare suggested by Uber (splitting Uber’s 20% comm) and allows them to communicate, thus bypassing Uber before initiating a transaction. A comprehensive hijack would “read over” both user’s Uber screens to send notifications only when there is an exact match. This could be quite tricky or impossible to implement, but a simple passive version (“running the app at the same time and near in space”) can be done relatively simply, at least in Android.

The contracting parties would lose the benefit of the protection afforded by Uber for on-platform rides, but most such platforms mainly work hard on their disclaimers when it comes to cover unwanted trouble. Third party insurers could also offer cover the weary, for a fraction of an Uber commission. The Uber reputation system would still be operational as this is pure freeloading — no ride are initiated in the app directly (in the simplest version of the concept, one could also couple it with a cheaper or peer-to-peer matching platform).

What’s the benefit?

Disruption! Uber and other trading platforms that are dominant collect economy rent due above the cost of operating the service because of the network effect — it’s a winner take all game. This is a classic market failure. The existence of shortcuts would probably contribute to cap such rents.

Would it be legal?

If Uber lawyers haven’t anticipated that, we can be sure they’d add a ban to their terms if such an app becomes popular enough for them to notice. Would people care? Maybe, maybe not. Could they could sue their clients and drivers succesfully? I know not.

Would it be moral?

Unambiguously yes I’d say, as it is merely about applying Uber’s philosophy (disrupt incumbents, ignore the law, etc) to Uber itself.