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Category Archives: Energy

What to expect from a potential 10-15 mbd OPEC++ cut

03 Friday Apr 2020

Posted by beyondoverton in Energy, Uncategorized

≈ Leave a comment

Tags

oil, OPEC

After yesterday President Trump tweeted about it, there is today continuous noise about a possible OPEC++ (global coalition of all crude oil producers) meeting next week with the expectations of substantial cut in production, anywhere between 10 to 15mbd. On one hand, if this materializes, it will be an unprecedented (not counting the 1970s oil embargos). On another, it will barely go to match the lost demand from the (almost) whole world going on economic standby for at least a month, maybe much longer on the back of COVID-19.

Let’s put this into context. We got a 25% decline in oil prices (from low 40s on WTI to low 30s) when Saudi Arabia and Russia (OPEC+) could not agree on a 1.5mbd cut a month ago, and Saudi instead announced they ‘might’ increase production by 1.5-2mbd (but as of yet they really haven’t). Arguably, if they had agreed on a cut, oil prices may have rallied a bit, maybe to mid or high 40s.

But then we got another 30% decline (from low 30s to low 20s) when the negative effect of COVID-19 on demand became more evident. In an alternative reality if OPEC+ deal had happened a month ago, prices could have then collapsed to the low to mid 30s (30% off mid to high 40s). Don’t forget that oil had already sold off about 30% YTD at the time of pre-OPEC+ no-deal weekend. These are the milestones to keep in mind when considering the scenarios ahead of a possible crude production cut in the next few days. 

So, this is the way I am looking at this:

  1. The likelihood of ‘everyone’ (not just Saudi and Russia, but OPEC++) really agreeing on a 10-15mbd cut is very close to nil;
  2. But the likelihood of a ‘fudge’ agreement is very high.

‘Everyone’ benefits from a ‘deal’, even the oil importers as crude has become the main sentiment indicator and that would help risk assets: OPEC++ could decide to announce a ‘deal’ simply to stabilize the market with the idea that no one is expected to really cut production (perhaps negative effects of COVID-19 eventually wear off and demands comes back0.

Reality is that, in a similar manner to Saudi Arabia not really ‘wanting’, or, arguably, even being unable to hike production by 2mbd (they have never really managed to sustain production above 12mbd), no one really intends to, or is willing to go the other way (cutting production may actually entail lost capacity for ever). So, in both cases, everybody is playing the waiting game and hopes to do nothing. But the trick is in delivering the right message.

But what could happen to crude prices if there is an announcement of a 10-15mbd cut?

One would expect that the low range point of a bounce would be the low-to-mid 30s on WTI (where prices would have been, had a cut happened between Russia and Saudi Arabia a month ago, and the demand lost we can project at the moment from COVID-19). We are just above 30 on WTI as of right now, on Friday close. But given the much larger cuts this time, the high point of the range could indeed be the low 40s where prices were before the Russia – Saudi deal fiasco.

What happens if there is not even a ‘fudge deal’ in the coming few days? We go back to the low 20s immediately and then we wait to see how much more demand is destroyed.

Oil: OPEC’s Russian Roulette

08 Sunday Mar 2020

Posted by beyondoverton in Energy

≈ Leave a comment

Tags

oil, OPEC

I did not expect the ‘no deal’ from OPEC+ largely because of the urgency of the immediate demand destruction from the Coronavirus.

In hindsight, Russia’s reaction was quite rational. What about the Saudis?While they are still the lowest cost producer, the precariousness of the political situation there (see developments this weekend) makes me believe that they have a lot more to lose from the current status quo. Russia may be at a disadvantage when it comes to cost, but after years of sanctions, it is more prepared to withstand lower prices for longer.

As a result, I see Saudis’ attempt to lower prices on their products as a ‘bluff’, which, if called, they will have to fold. On the long run, lowering prices can only be counterproductive for them. First of all, it will affect their fiscal balance. Second, it will reinforce Russia’s (supposed) game plan (to push US shale out of the game) and hurt US, a Saudi ally. Therefore, this is at best an attempt to gain marginal market share; it would be extremely imprudent to begin a price war.

While indeed Trump has been very vocal on the benefit of low oil prices to US consumers, the sands started shifting in 2019 as the US became a net exporter of petroleum towards the end of the year: all of a sudden, Trump started extolling US energy independence. Would the US president be eager to keep a campaign promise to end US reliance on foreign energy? If so, he would now need to balance low oil prices with the risk of the US shale oil industry going bust. Therefore, I would not be surprised if the Saudis get a call from the White House should oil prices continue to plunge and that threatens the viability of US energy production.

I think the short-term market reaction this week will be brutal, but this is very different from 2014-2016 when we had similar producers’ dynamics and oil hit $30. First, inventory build-up back then was +230mbd, today it is -1.5mbd. Second, shale was in the upswing then, while now it is on the backfoot: oil-well declines are much bigger, costs are higher, and capital is scarcer. 

I was bullish WTI at $45 last weekend partially because I expected the markets to bounce on sentiment, which they did, but more importantly, because the price reflected a demand-supply imbalance discounting a sharp drop in demand from the Coronavirus effect – there was, I thought, a decent cushion. Moreover, it is my view that either China will use the oil price drop to simply buy more oil, or that economic activity in China, being the marginal swing buyer of oil, will slowly come back – or rather much faster than in the West thanks to the actions the authorities there took to contain the outbreak.

Oil eventually hit $30 in 2016 but did not stay there long. It is much more difficult to model today the demand destruction from the Coronavirus but also there should be some marginal energy demand coming from the digital medium as all these people staying/working from home get online (ICT energy use is now more than half travel energy use, and it is growing very fast). Supply side is always easier to model, and it shows that compared to 2014, inventories are much lower, shale is largely out, and specs are short.

We should not underestimate that lack of liquidity/margin calls work both ways depending on positioning (as per gold sell-off a week ago) That means one needs to watch the newswires and trade rather than invest. That’s what I am doing.

Tesla: No Paradigm Shifts, Yet

18 Tuesday Feb 2020

Posted by beyondoverton in Energy, Equity

≈ Leave a comment

Initially published on MacroHive on February 6, 2020

In light of the vertical rise in Tesla’s share price in the last few months, I thought it worthwhile to revisit an old narrative comparing the Apple’s iPhone moment with Tesla now. My verdict: I wouldn’t get sucked in by any ‘paradigm shift’ just yet. Though there are plenty of possible reasons and even more conspiracy theories, this share price spike is likely nothing other than mad short covering.

Having said that, Tesla might be worth this much – indeed maybe even more. But the story has to change: Tesla is not a car company, and it is not in the mobility business; instead, it is an energy storage company, and it is in the renewable energy business.

The iPhone shifted the paradigm because it distinguished itself as a mobile device, not a mobile phone. Moreover, the iPhone arrived at the very beginning of the internet/social media/digital cycle. Tesla is still a car (you need to drive it!), albeit without an internal combustion engine, and it comes at the end of the mobility cycle. After all, cars have been around in roughly the same form for at least 100 years. Air travel was a much bigger disruptor. If you want an iPhone analogy in the mobility cycle, it’s that, not Tesla. The fact that air travel is a money loser now also supports the idea that we are at the end of the traditional mobility cycle.

The Autonomous Vehicle (AV) could be the next big disruptor in the mobility sector, not the Electric Vehicle (EV) – which is what Tesla currently is. People are much more likely to use an AV than an EV because in an AV they are free to do whatever they want while it transports them. It also has the potential to be cheaper and more comfortable than a driver-operated EV taxi.

The problem with AV, still, is that it is a long way off. Elon Musk had initially set a deadline of fully autonomous driving by the end of 2019. That obviously did not happen. During the company’s Q4’2019 earnings call, Musk said that it might happen in a few months. But he downplayed how well the system would work, clarifying, “That doesn’t mean the features are working well”. This is not just a question of technology (for example, given the complexity of the urban landscape, city driving requires fully Level 5 automation), but it is also a question of regulations and costs. By the time the fully AV is available, probably not before the 2030s, especially in urban settings, the demand for it, will likely be lower simply because the digital medium would have evolved much more, surpassing the physical medium in terms of popularity.

So, if Tesla is not at its ‘iPhone’ moment, what could justify such a high share price?

Source: Nasdaq

As a car company, the $150bn market capitalisation makes little sense given comps in the industry. Though the last three quarters have finally been cash-flow positive, if the latest number of $976mm is properly discounted by the stock-based compensation of $898mm (accounted as a non-cash cost), the free cash flow (FCF) is not that big. And bear in mind that to get to it, Tesla had to halve its initial 2019 CAPEX from $2.5Bn, projected in Q1’2019, to what came to be the real 2019 number of $1.3bn. With one of the lowest CAPEX as a percentage of revenues in the business, it is difficult to imagine how Tesla will compete with the other car producers.


Tesla as a software company (similar to Uber and Lyft, i.e. turning into a utility as a platform) could possibly push the valuation up a bit, but hardly to where we are now given that Uber’s market cap is less than half of Tesla’s. The only way to get to the escape velocity we have been experiencing in the share price now is to completely exit the mobility sector and to focus on energy storage as the missing link in our society’s transition to a renewable energy future.


There is an argument to be made that this could have been Elon Musk’s initial idea. In 2004, less than a year after founding Tesla, Musk and his cousin thought of starting SolarCity during a trip to Burning Man, realising solar power’s potential in countering climate change. Tesla acquired SolarCity in 2016 and, in that same year, the company’s mission statement changed from ‘transitioning the world to sustainable transport’ to ‘accelerate the world’s transition to sustainable energy’.


But still, to get to today’s valuation, Tesla would have to put on a smart PR exercise talking about this mission statement shift in detail. To go higher from here, Tesla would need to align its vision statement, ‘to create the most compelling car company of the 21st century by driving the world’s transition to electric vehicles’ to its mission statement above. i.e.Tesla
needs to completely drop the transportation angle (where margins are only going lower) and invest a lot more in CAPEX and R&D with a focus on developing the best renewable storage options.

If then the market understands where Tesla is committed to going and believes in its technological abilities, it will drop all its requirements for near-term profitability and start pricing the stock with a much higher multiple – one more in line with other near-monopoly companies with a first-mover advantage. Barring any such efforts, Tesla’s stock is probably heading down as soon as the short covering is finished. At the end of the day, valuations are a matter of perceptions and assumptions first, and only then a question of whether the numbers fit. Wednesday [February 4] saw the start of this correction with a 17% drop. The only question now is whether the selloff will be as fast as on the way up.


Who has done what in the major asset classes: real money flows since 2008*

06 Wednesday Nov 2019

Posted by beyondoverton in Asset Allocation, Debt, Energy

≈ 1 Comment

Tags

corporate bonds, households, mutual funds, pension funds

Households have massively deleveraged: sold about $1Tn of US equities and bought about $2Tn of USTs. The have also marginally divested from corporate bonds.

Banks have deleveraged as well: bought about $0.5Tn of UST while selling about the same amount of equities. The have also marginally divested from corporate bonds.

Insurance companies have put on risk: bought about $1Tn of corporate bonds and small amounts of both equities and USTs.

Mix bag for pension funds with a slight deleveraging: bought $0.5Tn of corporate bonds but sold about $1Tn of equities. But also bought $1.5Tn of USTs.

Mutual funds have put on risk: bought about $1Tn of corporate bonds and small amount of equities. Also bought more than $1.5Tn USTs.

Finally, foreigners have also put on risk: bought $1Tn of corporate bonds, $0.5Tn of equities and $4Tn of USTs.  

Overall, the most (disproportionate) flows went into USTs, followed by US corporates. Demand for equities was actually negative from real money.

What about supply?

Issuance of USTs was naturally the dominant flow followed by US corporates and US equities.

On the US equities side, however, there is a very clear distinction between US non-financial corporate issuance, which is net negative (i.e. corporates bought back shares) and US financial and US corporate issuance abroad, which is net positive. In other words, the non-corporate buybacks (more than $4Tn) were offset by the financial sector (ETF) and ‘ADRs’ issuance.

The opposite is happening on the corporate supply side. Non-financial corporates have done the majority of the issuance while the financial sector has deleveraged (reduced debt liabilities).

In other words, non-financial corporates have bought back their shares at the expense of issuing debt, while the financial sector (ETFs) has issued equities and reduced their overall indebtedness.

No wonder, then that financial sector shares have underperformed the overall market since 2009.

Putting the demand and supply side together this is how the charts look.

On the equities side, the buying comes mostly from ETFs (in ‘Others’ – that is basically a ‘wash’ from the issuance) and foreigners. The biggest sellers of equities are households and pension funds. The rest of the players, more or less cancel each other out.

 So, households and pension funds, ‘sold’ to ETFs and foreigners.

On the corporate bonds side, the main buyers were foreigners, mutual funds and insurance companies. Pension funds also bought. The main seller were the banks. ‘Others’ (close end funds etc.) and households also sold a small amount.

So, here it looks like foreigners, mutual funds and insurance companies ‘bought’ mostly at new issue or from the banks.

Finally, on the USTs side, everybody was a buyer. But the biggest buyer by large were foreigners. Mutual funds, pension funds, the Fed and households came, more or less, in equal amount, second. And then banks, ‘Others’ and insurance companies.

Kind of in a similar way, everyone here ‘bought’ at new issue.

Conclusion

It’s all about demand and supply.

In equities, real money has been a net seller in general, while the biggest buyer has been non-financial corporates themselves in the process of share buybacks. The financial sector has been a net issuer of equity thus its under-performance to the non-financial corporate sector. Equity real money flow is skewed mostly on the sell side.

Real money flow in corporate bonds is more balanced, but with a net buying bias.

USTs real money flow is skewed completely on the buy side.

Overall, since 2008 real money has sold equities, bought a bit of corporate bonds and bought a lot of UST: it does not seem at all that real money embraced the bullish stance which has prevailed in the markets since March 2009.

*Data is from end of Q4’08 till Q4’18, Source for all data is Fed Z1 Flow of Funds

Not all oil is ‘created equal’

28 Wednesday Feb 2018

Posted by beyondoverton in Energy

≈ Leave a comment

  • Not all oil is ‘created equal’: US WTI and European Brent are light and sweet, most of OPEC is heavy and sour, Russia’s is kind of in the middle. These distinction matter not only because of the different qualities, but more importantly, because of whether the oil is refinery-ready.

Diagram 1

  • Therefore, direct comparisons between OPEC and US Shale Oil, for example, is like comparing apples and oranges -> same category but very different at the same time. Instead, US Shale Oil’s direct competitors are the ones in the circle above (see also Chart 4, see below).
  • If we grossly oversimplify and break world oil production into two categories: Light/Sweet are all US competitors (circled above), with API>35, and Heavy/Sour are mostly OPEC/Russia/Canada with API<35, as per above diagram, this is how it would look over time.

Chart 1

  • US’ main oil competition started reducing production at about the same time the US shale revolution first geared its head above the horizon post the 2008 financial crisis; then, as US shale production really took off in 2011-12, the rest of global Light/Sweet production dutifully collapsed.
  • Heavy/Sour Production is the dominant feature here, equal to 63% of total world oil production, vs 37% for Light/Sweet. However, it is off the peak reached in 2011 when US shale oil production really took off.

Chart 2

  • The recent rise of Light/Sweet oil production relative to Heavy/Sour is a combination of both OPEC cuts since November 2016 and a continuous in increase in US Shale Oil production. However, the increase in US Shale Oil since the 2008 financial crisis is more or less offset by the decrease in rest of the world Light/Sweet production.

Chart 3

  • In fact, Norway peaked in the early 2000s; Nigeria: in mid-2000s; UK in the mid-1990s; Algeria, Angola et all, all peaked towards the late 2000s. But the one that really stands out is Libya: before it collapsed in 2011, Libya was one of the largest Light/Sweet oil producers.

Chart 4

  • Because US used to import a lot of heavy OPEC oil in the past, most of US refineries are suited to low API oils. In fact, the average API of oil that enters US refineries is about 31. This is lower than European refineries, used mostly to Brent, with API of around 36.

Chart 5

  • The problem is this adjustment is far from easy. Only a very small portion of US oil is refinery-ready. And that proportion is decreasing as more lighter shale oil is produced year after year: majority of US production is now in the 40-45 API range; only 13% is refinery-good.

Chart 6

  • So, US refineries need to keep importing more Heavy/Sour oil just so that they are able to refine the domestic shale oil. The other alternative is to export the crude shale oil directly to be refined abroad. But there are very few refineries even abroad that can accommodate Light/Sweet.
  • Why is US oil getting lighter and lighter? Because of shale oil and specifically because of Texas: it is the largest producer of US oil, a title it took over from the Gulf of Mexico in 2011 when US shale oil production took off.

Chart 7

  • And Texas oil production continues to rise thanks to the Permian Basin: Eagle Ford is off the peak and barely rising. In fact, the Permian Basin and the Gulf of Mexico are now the only two major oil producing regions in the US really growing.

Chart 8

  • The problem with Texas oil production rising is that only 2% of it is refinery-ready. In fact, of the three largest oil producing regions in the US, two are below their peaks, and only one, Gulf of Mexico, has a low enough API to be refinery ready.

Table 1

  • New Mexico shale oil production is rising but none of it practically is refinery-ready; North Dakota and Oklahoma are below peak and only 1% and 8% of their oil, respectively, is refinery-ready; California and Alaska, which are producing more conventional oil, have been on a decline for a while.

Bottom line:

  1. US and OPEC are not really in competition because they produce completely different crude oils. Moreover, US refineries and a large number of other refineries around the world are more suited to OPEC oil than to US shale oil.
  2. US shale oil API is rising because the old shale oil wells are depleting much faster and the new ones, where the oil is even more difficult to reach, have a higher API->that will put further strain on US refineries (increased Heavy/Sour imports).

Chart 9

What happens when oil production in the Permian Basin also starts to decline?

How energy efficient is the US economy?

26 Monday Feb 2018

Posted by beyondoverton in Energy

≈ Leave a comment

  • How energy efficient is the US economy? At first glance – very: total energy consumption reached a high in 2007, before the financial crisis of 2008, and currently it is below even the pre-Dotcom crisis of 2000. GDP, on the other hand, is up 35% and 90%, respectively, since then.

Chart 1

  • However, we measure energy in energy units, BTUs, but we measure GDP in monetary units, USD. So, the picture changes if we account for the cost of energy indeed: as it rises above GDP (as during the 1970s oil crises, and post the 2008 financial crisis), the economy collapses; when it is lower (1990s), the economy prospers.

Chart 2

  • The energy ‘efficiency’ of the US economy may be just another way of looking at the increasing costs of energy. The economy is ultimately not just an energy system, but a surplus energy system, i.e. what matter is the net energy available: if it takes a lot more energy to extract the new energy, then a lot of that energy is wasted in the process (that is another way of saying that the energy return on energy invested, or EROI, is increasingly decreasing).

Diagram 1

  • Shouldn’t energy be part of the Production Function, Y(L,K)? What about n(et)E(nergy)? In other words, if it takes increasingly more energy to generate the energy needed for output to grow, then energy costs will also be rising and this may cause potential GDP (and productivity) to decrease.
  • In the past, energy consumption would dip after every single recession and subsequently rise, but that trend changed after the Dotcom bust and today we are still below those levels, 18 years ago. Yes, GDP is substantially higher, but GDP growth rate is also substantially lower (see Chart 1).
  • The fact that US has become a major producer of shale oil is not helping because there’s been no corresponding decline in the cost of energy. In fact, the opposite is true, as EROI of shale oil is much lower than conventional oil (see Diagram above). In addition, there are issues of transportation and refining.
  • Because shale oil is much lighter and thus not refinery-ready, oil prices may even have to rise further: the seemingly large oil glut we have had over the last year or so is masking the fact that shale oil cannot be currently so easily refined and prepared for consumption.
  • We can see this also in the data. Despite the rise in shale oil production, total fossil fuel consumption has actually gone done since 2000. While nuclear energy is unchanged, this has coincided with a surge in renewables energy consumption.

Chart 3

  • Digging deeper within fossil fuels, petroleum consumption is lower than the peak, pre the financial crisis in 2008, and, interestingly, lower than the peak in the late 1970s oil crisis. Similarly, for coal, where the decline post the financial crisis of 2008 is even more pronounced.

Chart 4

  • The oil vs. natural gas consumption going in the opposite direction has a lot to do with their diverging costs: on an energy equivalent basis, natural gas is currently much cheaper than oil.

Chart 5

  • The surge in renewables consumption has all to do with the rise in wind and, to some extent, solar. Biomass, which generally is the largest renewable consumed, has also gone up at the expense of hydro (2nd largest).

Chart 6

  • Renewables consumption rise started in the early 2000s, at the same time when fossil fuels consumption started to decline; again, diverging costs of the two have a lot to do with this phenomenon: since the 2000s, the cost of solar energy has collapsed by about 25x, the cost of wind energy has halved, while the cost of oil has more than doubled.
  • So, all this talk about shale making US energy independent, the question is at what cost? Technology is indeed making shale oil extraction possible, but it’s not like the cost of oil is going down (in fact it has gone up) =>Peak oil=Peak ‘cheap’/easily extractable oil (see Diagram 1 above, the newest forms of energy have also the lowest EROIs).
  • Aren’t we better off in the long run focusing on renewables, where technology is actually making energy costs go down, instead of flogging a dead horse in the name of an old paradigm of fossil fuel?
  • Finally, even if we assume that the US is indeed becoming more energy efficient, energy consumption per capita is still the highest in the world. In fact, 2x higher than Japan’s, which comes in second place.

Chart 7

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