Shorting Oil, Hedging Tesla

[jhm]

Did Aramco Just Open Pandora’s Box? | OilPrice.com

Saudi Aramco is showing a little leg. I am a bit surprised that the earnings are as high as $111B. A moderate P/E ratio would place the market cap near $1.1T. I think the true reserve size is pretty much irrelevant to market valuation. It says that production volumes are sustainable for 5 decades, while the sustainability of earnings is very much dependent on oil prices. Also after discounting earnings, the size of the oil reserves is not the binding constraint the present value of earnings. Actually oil demand growth is the much more likely the binding constraint on the value of Aramco.

Additionally, the following gives us some clues:

As indicated in 2017, in preparation of the IPO, the Kingdom changed the income taxes Aramco pays to the government from 85 percent to 50 percent. The latter sounds reasonably positive, but the fact that the royalties on Aramco are progressive, wasn’t common knowledge. Shareholders will have to understand that the company’s effective royalty rate is determined based on a baseline marginal rate of 20 percent applied to Brent prices up to $70 per barrel, which increases to 40 percent applied to Brent prices above $70 per barrel and 50 percent applied to Brent prices above $100 per barrel.

So it appears that the Kingdom has tried to make the profitability look much more favorable by decreasing taxes. In that light the $111B is largely a manufactured number to so that it looks twice as profitable as Apple. If the tax rate were to return to 85%, what would have been $111B would shrink to $33.3B. So shareholder's EPS is still pretty much at the whim of the Kingdom.

The graduated royalties also look calibrated to make recent earnings history look favorable. The royalty is lowest while Brent is below $70/b and highest above $100/b. What impact could this have on oil prices going forward? I think the motive here for the Kingdom to reap more of the windfall from high oil prices, but what it produces is a progressive disincentive for grow all out when oil prices are highest. ROE for the shareholder does not increase linearly with the price of oil, but is sub-linear. Now as an alternative royalty scheme, a flat rate could be set to some level that would equalize the production cost difference between Aramco and US shale producers. The would created a financial disincentive for Aramco to try to undercut shale on price but not inhibit production growth when the price of oil is sufficiently high for shale to grow all out. I think a flat royalty structure would better align shareholder interest with a competitive market and help to stabilize and make less political the price of oil. The stabilization is improved because when the price of oil goes to close to the level of the royalty drilling stops and when the price is really high drilling is at a max. In this way, simple market prices can regulate production levels and not need much political intervention. But be contrast the progressive royalties encourage production when the price is low and inhibit production when the prices are higher. The interest of shareholders actually are more shielded from market price sensitivity, and so that could subject it to more need for political intervention just to balance the market, placing the interest of shareholders at odds with the kingdom.

 

[TheTalkingMule]

If you were trying to sell a chunk of your company in a completely opaque marketplace, wouldn't you quadriple the on paper profits?

I'm surprised anyone even funded the sabic purchase.

 

[replicant]

Uh oh.

European Commission finds German automakers illegally colluded on emissions technology | DW | 05.04.2019

 

[jhm]

Uh oh.

European Commission finds German automakers illegally colluded on emissions technology | DW | 05.04.2019

Ugh, this is sickening. No better than the tobacco industry. No wonder it was absolutely necessary for Tesla to emerge to provide some real competition. If these "big boys" collude on illegal stuff like this, would it be a surprise if they are colluding to manipulate the media and market against Tesla? The irony here is that because they were colluding not to bring cleaner technologies to market they have made themselves less prepared to compete when cleaner technologies do come to market. They truly have themselves to blame for all the market share they will lose to Tesla and other serious EV makers.

 

[ggies07]

Uh oh.

European Commission finds German automakers illegally colluded on emissions technology | DW | 05.04.2019

das ist nicht gut.....

 

[jhm]

The World’s Cheapest Natural Gas | OilPrice.com

Waha hub natural gas price drops to -$6/mmBtu. That's a negative price, folks. The problem of course is insufficient gas infrastructure to move the associated gas from oil field to market. Notice that if the price were as low as -$20/mmBtu, this could force shut ins of oil wells with $30/b operating margins. Shut ins happen with the net operating margin is negative. So a cost of $20 to off load a mmBtu of gas must be enough to wipe out marginal profitability on barrel of oil.

If I understand the math here, a gas price of -$6/mmBtu removes $9/b from operating margin. So the net operating margin would be like $21/b. So if Brent cratered from $70/b to below $50/b while gas stays at -$6, this would also lead to shut ins. This is looking pretty fragile to me. You can see why oil producers are so concerned about gas infrastructure.

Perhaps this is why so much investment is flowing into natural gas. But even with infrastructure in place, gas is trading cheap, currently Henry Hub is $2.65/mmBtu. So the economics of US shale and oil in other place where their is significant associated gas depends on offloading gas at a loss.

Let imagine a scenario. What happens when oil demand peaks? Oil prices fall to a level that reduces global production. A fall greater than $20/b could knock out production in places where infrastructure is insufficient for associated gas. The risk of shut ins would hopefully discourage drilling even before such price collapse occur. So the broader issue here is that the aggregate volume of associated gas could fall as uncertainty in the oil market takes root. So there could be a scenario where peak oil demand leads to higher natural gas prices. This intensifies just how disruptive batteries are to the oil&gas industry. Batteries push oil demand to peak. This triggers higher gas prices, which in turn intensifies demand for wind, solar and grid batteries. So cheap batteries also kill the price that power grids pay for gas. Thus, high gas prices do not last, but fall leading to further shut ins of oil with significant exposure to associated gas liabilities. So I think the implication here is that gas production falls at least as fast as oil production falls post oil demand peak.

I'm not sure how much I believe this scenario at this point. But it does raise the question, how much longer can natural gas demand grow past the oil demand peak? Some would imagine that natural gas demand will keep growing independently of oil for quite a long time. However, what is currently driving the growth of gas consumption is cheap associated gas. But the supply of cheap associated gas is put at risk by declining oil demand, while demand for gas is also eroded by cheap batteries. I guess means that if you really want to disrupt gas, you should focus on bring EVs to the mass market. Driving down battery prices is key to defeating both oil and gas.

 

[jhm]

Banking on Climate Change – Fossil Fuel Finance Report Card 2019

Here's what we're up against. 33 major banks alone are pumping some $1.9 trillion into fossil fuels over the last 3 years. There is no way we can cut carbon emissions in half by 2030 so long as we keep investing $2T in fossil fuels for every $1T invested in renewables.

Imagine how the needle would move if we invested $700B per year in renewable while cutting back fossils to just $350B per year.

You can cut emissions in half without cutting fossil investments in half well in advance.

 

[neroden]

We have to bankrupt these financiers of death.

The fact is that they're financing money-losing projects, so they are going bankrupt anyway, but it's time to throw them an anvil.

It's really strange that they keep throwing money down unprofitable holes in the ground.

 

[jhm]

Aramco’s True Breakeven Price | OilPrice.com

Robert Rapier estimates Aramco's break even price at $40/b. I think this may be indexed to Brent, but I am not quite sure of his methodology. He does see in this a powerful reason why Brent should not see prices below $45/b for long. In such down markets, the Saudis have to pull back production quite a bit just to remain profitable.

I would note that this break even seems to include royalties and taxes paid to the government. It is right to do so, but I suspect early estimates ignored this.

 

[jhm]

We have to bankrupt these financiers of death.

The fact is that they're financing money-losing projects, so they are going bankrupt anyway, but it's time to throw them an anvil.

It's really strange that they keep throwing money down unprofitable holes in the ground.

Let me say that I am an employee of one of these banks and that views expressed in social media are my own and do not reflect that of my employer.

Having said that, I certainly do not want to see these 33 major banks take on losses from the overinvestment in fossil projects. It is not within my role to have any direct influence on this. I think the basic problem is that banks need steady deal flow to keep refreshing their assets. So most of this $630B per year is likely just replacing older assets. The oil&gas industry has the scale that these banks need.

Rather than thinking about how to decrease this reinvestment level, it may be more productive to focus on how to drive up investment in renewables from $350B per year to $700B. In fact the investment level in renewables has not grown much over the past 10 years. The unit cost of renewable has come down significantly, so GW of renewables have grown steadily, even as investment levels have plateaued. So we need some sort of driver to get renewable investment levels to grow again. Solid and growing deal flow on the renewable side will more easily shift capital away from the fossil side.

Somehow we need to get banks to lend $2 to renewables for every $1 they lend to fossils. That really must happen to cut emissions in half by 2030. So how do we motivate banks to make this shift?

 

[winfield100]

@jhm
Somehow we need to get banks to lend $2 to renewables for every $1 they lend to fossils. That really must happen to cut emissions in half by 2030. So how do we motivate banks to make this shift?

well, green new deal partially
i got an 11.655kW PV array, that helped employ ?a bunch of folks?, installers, sellers, manufacturers, loan folks
i got an ~$33,000 15year, note, costing about the same as my average electric bill
people get jobs, banks get loans, velocity of money increases a teeny tiny bit
do this another 1,000,000 times and you got an almost 12 gigawatt VPP that will make >14 terawatt hours/year, scales easily, etc

 

[neroden]

Somehow we need to get banks to lend $2 to renewables for every $1 they lend to fossils. That really must happen to cut emissions in half by 2030. So how do we motivate banks to make this shift?

Perhaps get them to understand that fossil fuel deals have massive credit risk? Because they do have massive credit risk. Banks which are lending to fossil fuel projects are gonna take huge losses. The ones which lent to coal companies already have.

However, if the banks are just acting as intermediaries -- like they did when they took garbage-backed securities and touted them as "AAA" -- then they already know that the fossil fuel loans are going to default. They're just lying to their customers. So we have to get the investors to recognize that they're being handed garbage. There are more and more investors refusing to put their money in bad loans to fossil fuel companies.

Those seem to be the pressure points. Weirdly, both bank and private money continues to be dumped down holes in the ground. How to get more people with money and more bank lending officers to recognize that they're taking on humungous credit risk which threatens huge losses? I don't know -- we didn't convince the banks in the mortgage crisis to stop making garbage loans until *after* they started declaring bankruptcy so probably the only option is to wait for the oil company insolvencies. The coal company bankruptcies have already happened and that still doesn't seem to have woken up most of the bankers.

I mean, there's plenty of opportunity to lend against new solar panel construction or new wind farm construction, which has essentially zero credit risk.

 

[Oil4AsphaultOnly]

It seems Amazon's trying to help big oil stay solvent longer: Amazon Is Aggressively Pursuing Big Oil as It Stalls Out on Clean Energy

This is rather disappointing, and just makes me dislike Bezos if he's doing this in a drive towards profits.

 

[TheTalkingMule]

US commercial crude inventories up another 7M barrels to 457M last week, so obviously WTI should jump a bit. After all it's a "gasoline story" this week, obviously. Huh?

I can't even read the Bloomberg and analyst interpretations of these weekly readings anymore. The narrative is so warped I can't believe anyone is editing the language.

We may well be in a perma-glut that runs right through peak demand in 2023. Brent stands at $71.36 as of noon today.

 

[jhm]

OPEC's April issue of the Monthly Oil Market Report is out. I'd like to highlight a changes from the prior months report as this suggest how OPEC's perception of the market is changing.

Oil demand forecast for 2019 is now 99.91 mb/d down 0.05 mb/d from forecast as of March. OPEC is now forecasting a y/y growth in demand of 1.21 mb/d in 2019. This is down from the four prior years of growth, 2.01 mb/d in 2015, 1.46 in 2016, 1.66 in 2017, and 1.41 in 2018.

Non-OPEC supply (+NGLs and NCF) forecast for 2019 is 69.61 mb/d, adjusted up 0.11 mb/d from last months forecast. Actuals for 2018 were 67.35 mb/d, also adjusted up 0.17 mb/d. So OPEC is feeling more pressure from non-OPEC producers. The forecast growth at 2.26 mb/d. This is tapering off just a bit from 2018 when non-OPEC production grew 2.95 mb/d.

So it is clear that non-OPEC supply is growing substantially faster than world demand for oil. This can only mean that net demand for OPEC crude is falling. It's projected to fall 1.05 mb/d in 2019. It also fell 1.54 mb/d in 2018. The adjustments in historical data and forecasts are telling OPEC demand was adjusted down 0.19 mb/d for 2018 and down again 0.16 mb/d in 2019. So their analysts are coming to terms with how they have misestimated the recent past. The loss of OPEC demand is substantially worse than they thought it was just a month ago.

My hunch is that as the reality of demand loss settles in OPEC is going to need to it's strategy. Demand growth is in decline, 2019 being the worst in 5 years, while non-OPEC producers are growing supply crazy fast. Higher oil prices are only going to continue both of these trends. OPEC also estimated that the market was oversupplied to the tune of 0.51 mb/d in 2018 and still 0.44 in Q1 2019.

Either prices come down or the oil market may slide into a glut.

 

[jhm]

US commercial crude inventories up another 7M barrels to 457M last week, so obviously WTI should jump a bit. After all it's a "gasoline story" this week, obviously. Huh?

I can't even read the Bloomberg and analyst interpretations of these weekly readings anymore. The narrative is so warped I can't believe anyone is editing the language.

We may well be in a perma-glut that runs right through peak demand in 2023. Brent stands at $71.36 as of noon today.

I wrote my last post before seeing this. OPEC has gotten pretty good a managing OECD inventory levels. Over the last year inventory went from 4421 mmb to 4420 mmb, and yet there was a 0.51 mb/d or 186 mmb surplus for the year. So OECD inventories are not really tracking the build up of surplus. When a large price manipulator is also manipulating visible inventory levels, I don't think we can trust those reported inventory levels very far.

So I suspect a glut is forming.

EV sales should hit about 3 million this year, enough to displace 0.10 to 0.15 mb/d in fuel demand in 2019. Now compare that to forecasted demand growth of 1.21mb/d or a market oversupply of about 0.50 mb/d. Imaging putting the glut off for a few years as EVs scale up to erode demand 0.20 mb/d in a year, 0.30 the next year and 0.45 the year after. How would it take to work off a glut with EVs taking 1mb/d demand away in three year. Not that from 2014 to 2017, demand grew 5 mb/d, really fast because of low prices. It will be interesting to see how this next glut plays out.



On a separate note. I learned that petrochem demand is about 13% or 13 mb/d and BP expects it to grow to 20 mb/d by 2040. So that is not more than a 2.0% annual growth rate. Thus, petrochem is contributing about 0.26 mb/d to annual demand growth. This is the demand growth that is supposed to push the demand peak away for another 20 years! What a joke! About 6.5 million EVs per year would offset this specific demand for crude. These guys are seriously underestimating just how quickly EV adoption is occurring.

 

[neroden]

So, is 2023 still a good bet for peak oil demand? Or 2025? I figure it's somewhere in there.

We may see some headwinds at that point, since oil is going to get very cheap. It'll be permanently unprofitable to drill new wells, so producers will slash prices until they hit the "lifting" costs of production from existing wills. (Sunk costs will be dropped during the bankruptcies which will take place.) Since these are under $20/bbl for conventional oil, this actually gets oil back into price-competitiveness with EVs... as long as oil demand doesn't grow, since it's still not viable to drill new wells.

 

[jhm]

So, is 2023 still a good bet for peak oil demand? Or 2025? I figure it's somewhere in there.

We may see some headwinds at that point, since oil is going to get very cheap. It'll be permanently unprofitable to drill new wells, so producers will slash prices until they hit the "lifting" costs of production from existing wills. (Sunk costs will be dropped during the bankruptcies which will take place.) Since these are under $20/bbl for conventional oil, this actually gets oil back into price-competitiveness with EVs... as long as oil demand doesn't grow, since it's still not viable to drill new wells.

It's a good question. In contemplating oil glut scenarios, the specific timing and severity of the glut could move the demand peak around by a couple of years. Let's say a balanced market leads to a 2024 peak. A market with particularly tight supply maybe moves the peak up to 2023 or 2022. A market that is particularly oversupplied and crashes near 2024 could push the peak out to 2025, 2026 or beyond.

What I would prefer is to see oil investment levels pull back. A massive glut would not be good for fighting climate change. Perhaps a little glut this year or next could put the fear of the market into oil investors leading to a retreat of capital. I still think that the market is too naïvely conditioned to expect that OPEC will defend oil prices against natural market forces. This childlike faith in OPEC I think is key to the overinvestment we see. My preference would be for OPEC to simply drill at will and let competitive market prices prevail. This is what US shale does already. It is grabbing 2.5 mb/d market share from OPEC last year and this year and not really paying any price for that aggression. If OPEC were to stop accommodating this, I doubt it would change the longer-term price of oil that much. Rather this would make all oil investors a little more circumspect. This would curtail some excess investment and balance the market. The thing is as the market approaches disruption (EVs), price discovery will be very hard. OPEC interventions further impede normal market price discovery. This leads to a lot of bad investment, especially at a moment of critical transition for the oil market. Erring on the side of allowing the market to do price discovery, I think, would be prudent for all parties involved. It would actually make the timing of peak oil demand more predictable. To the extent that OPEC is able to suspend prices above competitive equilibrium, that premium is a distort signal of genuine market demand. I higher price creates the illusion that economic demand is stronger than it actually is. This sort of distortion is what energizes boom/bust cycles. A boom/bust cycle is in fact a kind of failure of price discovery.

We'll see if major participants get a clue.

 

[canoemore]

Forgive me if this thought has already been thoroughly discussed, but it seems like a period of very cheap oil will have consequences for the political stability of petro-states that may drive a feedback loop that pushes prices back up after not too long. I don't have a sophisticated understanding of this, but it's my impression that oil revenues in many of these states support the generous social services that could be cynically described as paying your people not to riot. We've seen a number of examples in the past 10 years of what happens to production in petro-states that experience severe unrest, from Venezuela, to Lybia and Syria. Civil conflict shutters production, and in ensuing power struggles oil infrastructure assets are a prize to be fought over. Those assets may be damaged during the conflict, and may even be intentionally destroyed as a last resort by whoever is about to lose. If things play out like that, the loss isn't temporary either, because who's going to invest in rebuilding that infrastructure in the chaos and instability that follows conflict? Especially when the near- to medium-term demand outlook already makes such investments shaky.

In that scenario, prices could shoot back up again, or at least become extremely volatile. It seems to me like that such uncertainty could accelerate demand for more reliable energy sources.

It seems like Saudi Arabia needs prices in excess of $80 a barrel to balance their budget (IMF: Saudi Arabia Needs $80-85 Oil Price To Balance 2019 Budget | OilPrice.com). I wonder how much that budget can be cut or how long they can absorb low prices before reductions in social services begin to cause unrest with some probability of spiraling out of control. Similar speculation seems warranted for states like Russia.

Anyhow, just a thought that crossed my mind. I imagine most of you have long since mulled it over.

Lybia: As conflict flares once more, what's at stake for Libya's oil? - Reuters
Syria, look at the drop-off in production in 2011: Syria Crude Oil Production | 2019 | Data | Chart | Calendar | Forecast

 

[adiggs]

Thank you for that Syria Crude Oil Production link (trading economics.com). I haven't seen that one before. Change the view to a 10y window and it's dramatic - Syria production today looks like a rounding error from what it's been in the past.

Even better - that site can be used to get similar production information for many other countries. Very good stuff.