Shorting Oil, Hedging Tesla

[SebastianR]

Interesting quote from Is The Private Equity Oil Rush Back On? | OilPrice.com:

One of the founders of Argus told Bloomberg that for those who have cash now is the perfect time to buy – assets and companies are relatively cheap and the industry will inevitably recover by 2020. In fact, Charles Cherington expects “a boom” in U.S. oil by 2020.

[...]

So, what’s next? It seems that a lot of smaller energy companies in the U.S. are now backed by private equity cash, and private equity investors are a pragmatic lot for the most part. Cherington, for example, expects prices to fall again this year. This will likely prompt a wave of consolidation deals that will bring down costs and improve returns. It will also bring in new PE players in, as companies for sale become even cheaper. In short, now is the time to buy.

It is always interesting to hear the other side: They think that prices will necessarily raise. I believe that's due to the fact that historically oil consumption has globally only ever grown (outside recessions). So one of the key reasons in believing that eventually prices for oil need to raise lies in the firm belief that economic growth is coupled to increased oil consumption. We know this is no longer true for developed countries. Now, how can we start to correct this misconception out there?

I feel if people would stop looking at oil as an economic necessity and regard it as a commodity just like any other commodity, too - we would all be in a better place as this would affect price, policies and investments into oil...

 

[adiggs]

This just showed up on oilprice as well:
Shell’s New Permian Play Profitable At $20 A Barrel | OilPrice.com

When you read an article where Shell tells the world they are profitable in the Permian Basin (I believe that's Texas) at $20/barrel, is your first thought:
a) Shell is going to make a ton of money, and they probably want to pump every barrel as soon as they can (and this won't have much effect on the price of oil).
b) With Goldman Sachs projecting a 1M bbl/day annual increase in US oil production (because of profit levels like this) are you thinking $40/bbl oil is coming soon? $30/bbl oil?

The way I see this, part of the current high price exists because a significant minority of the world oil suppliers are voluntarily choosing to not supply product. They are artificially constraining supply to keep the price up, with the corresponding penalty to them that they are giving away their market share.

The way this dynamic system evolves is easy to predict. If they are seeing prices come down despite their supply restrictions, they see more and more market share going to somebody else (such as this article suggests for Shell - any guess how the other US majors are positioned in the Permian?), their own self-interest will much sooner than later demand they return to full production.

I see this as weeks or months, not years, but that's me guessing. My guess is that OPEC is right on the edge of making this choice, as painful as they know it will be for them, the alternative is going to start looking MORE painful.


I wonder if Keystone XL will actually get built. And someday if it doesn't get built, will the pipeline company look back and thank the environmentalists that slowed them down and helped them avoid building a stranded asset?

 

[adiggs]

Holy macaroni:

Buying up land in the Permian at $33,000/acre to get the oil.

Billions Pour Into Permian Oilfield Amid Land Grab

That means buying 21,000 acres all at the same time in the deal talked about here ($700M).


O&G is big business, that's for sure

 

[adiggs]

Interesting quote from Is The Private Equity Oil Rush Back On? | OilPrice.com:



It is always interesting to hear the other side: They think that prices will necessarily raise. I believe that's due to the fact that historically oil consumption has globally only ever grown (outside recessions). So one of the key reasons in believing that eventually prices for oil need to raise lies in the firm belief that economic growth is coupled to increased oil consumption. We know this is no longer true for developed countries. Now, how can we start to correct this misconception out there?

I feel if people would stop looking at oil as an economic necessity and regard it as a commodity just like any other commodity, too - we would all be in a better place as this would affect price, policies and investments into oil...

Something about this reminds me of Axion Energy (except here, we're reading about it early in the curve, instead of looking back at the wealth already destroyed):
AXPW Split History

Yes, there are prices lower than $.01.

And yes, the private equity firms can burn up a lot of capital fast. Though really - I expect it'll all look pretty good for another 2-4 years. It's just that when you're investing capital in 10-30 year assets, they REALLY need to pay for more than just a few of them.

 

[jhm]

I've been playing with some data this weekend and thinking about peak demand.

Some thought that demand for gasoline had peaked in 2007. Products supplied, a measure of consumption from the EIA, was at 3393 mmb gasoline and 1532 mmb distillates. So this looks like a double peak for the two most important gas products. In fact, they comprise about 15% of global consumption.

Now those who doubt the demand peak hypothesis are going to make much out of the fact that gasoline consumption has risen to 3414 mmb in 2016 after having fallen to a low of 3178 mmb in 2012. It sure looks like demand has come roaring back from that low. Consumption is up 7.4% in four years.

But let's not pop the Champaign corks just yet. The market price of gasoline had to fall 52.5% in four years to get that 7.4% boost in consumption. With such a deep discount, can we honestly believe that demand is at an all new peak?

Doesn't price matter too? Well, if you're interested in how much capital goes into growing oil supplies, you really do care about price and volume. In fact, you care about market revenue, the product of price and volume. So I computed this for each month using monthly US Gulf Coast prices and monthly gasoline supplied fro EIA.

In 2007, gasoline market revenue was $291B on 3389 mmb for an average market price of $86/b or $2.04/gal.

In 2016, gasoline market revenue was $192B on 3414 mmb at $56/b. This was nearly a decline of $100B revenue to sell an extra 25 mmb of gas.

So clearly we are not anywhere near a new peak for gasoline revenue. That peak actually happened coincidentally in 2012, when volume bottomed out.

In 2012, gasoline market revenue hit a peak of $375B on 3178 mmb at $118/b. Moreover, this peak lasted three years. 2011 and 2013 saw $369B and $365B on 3195mmb and 3225mmb at $116/b and $113/b, respectively. So over $1.1T in gasoline revenue and super high prices fueled production leading into a glut. In fact, signs of weakness were already present in the 2013 results. Revenue had fallen 2.7% and prices fallen 4.2% to push out an extra 1.6% in volume. So even in 2013, there was the hint that production was getting ahead of demand.

But the bottom fell out in the following years. From 2012 to 2016, revenue fell 49.0% and prices down 52.5% all to push an extra 7.4% of volume onto US consumers. Gasoline was on the clearance rack at TJ Maxx and still not moving much.

What are the prospects that US gasoline revenue will ever get back up to $375B from were it stands at $192B?

I also looked at distillates and prided them with NY Harbor heating oil prices. Distillates hit a volume peak in 2007 of 1532 mmb at $85/b for market value of $130B. Market value peaked in 2011 at $176B on 1423mmb at $124/b. Volume bottomed out the next year. As of 2016, distillates have yet to hit a me volume peak. Revenue stands at $77B on 1419mmb at $54/b. So it is questionable whether distillates will see a new volume peak, much less a new revenue peak.

Putting US gasoline and distillates together. I reckon that peak revenue happened in 2012, $549B on 4547mmb at $121/b. In 2016, revenue stands at $286B on 4833mmb at $55.50/b. Long term volume growth over the last 30 years is just 0.9% per year.

Clearly volume growth is not going to achieve a new revenue peak anytime soon. Essentially, prices need to get so high again that consumption growth declines again. Long term price appreciation is just 3.3% per year, and most of this is simple inflation. Trying to grow faster than that leads to turbulence. Ultimately, long term revenue growth is just 4.3%. At this nominal growth rate, it would take over 17 years to reach a new revenue peak, although that would hardly be a real peak in inflation adjusted dollars. But more importantly, EVs can make an awful lot of progress in that timeframe. I believe it is highly unlikely we will ever see a new revenue peak for gasoline and distillates, and if one occurred it would be short-lived.

So why does revenue matter? Market revenue drives the amount of capital that oil companies can attract. It represents the contribution of demand in maintaining and growing supply. The cost of production also matters to the bottom line, but cost is supply side constraint. The demand side constraint it revenue. Ultimately, peak oil happens when marginal costs grow faster than marginal revenue. Back in 2007 the worry was that these costs were growing to fast. Now the concern is that revenue is fallen too fast. And so we've flipped from a peak supply worry to the peak demand worry. In reality, both are happening and will contribute to the inevitable decline in investment leading to decline in production volumes. Peak revenue stands as a critical milepost along this path.

Motor fuel revenue also serves as an important market for EVs. It is an estimate of opportunity for auto batteries. We should love to see this get back to $400B or more because that too would attract incremental investment in batteries and EVs. Even so, EVs and grid batteries can continue to grow 50% per year with gasoline and distillate revenue under $300B. No doubt things would heat up if this jumped to $400B or more.

 

[jhm]

I think you are far over complicating it.

Demand is far more robust than you give credit for, but supply has changed.
New supply in the mid of the cost curve has appeared, now the price of oil drops,
old supply at the high cost is no longer economic.

Demand has stayed relatively steady, the dynamics of supply has changed, the price therefore also changes.

Right, you are suggesting that price and volume movements are primarily supply driven. I would agree with that. And that is precisely why consumption (volume) should not be taken as an indicator of demand. Consumption is increasing primarily because suppliers are putting more on the market and the price falls to clearing price.

Empirically, I observe that volume has increased as prices decreased each of the last four years. So increasing supply appears to be the driving force. Other analyses such as the one Art Berman cites directly model the supply curve, actually volume by breakeven prices, show that more oil is available at lower prices. So that is fairly direct evidence of increasing supply.

 

[renim]

>Jhm

Demand as a dollar amount is a different concept to demand as a quantity amount. Oil has significant swings in dollar value, but a lot of constancy in quantity.
$35 barrel is a normal price for normal demand for normal supply. Current price is still excessively high. Current sale price of Western Canada Select is about $35/barrel. That price allows for profit for lean players.
Many countries are significantly increasing their oil import dependence, China is the gorilla in this regard, but so too are most countries whose economies are growing relative to the declining 'developed' world.

We have entering a post North America stage in world oil, just as North America exited the world gas markets. Chinese consumers will be far more sensitive to the price of global oil than American consumers, even if there is so many more of them.

So the dynamic becomes, more demand for oil quantity, but less demand for oil value. An interesting proposition.

 

[renim]

....We have entering a post North America stage in world oil, just as North America exited the world gas markets. Chinese consumers will be far more sensitive to the price of global oil than American consumers, even if there is so many more of them.....

This is the counter-intuitive effect of Keystone XL being built.
As American consumer become immune to world oil price, the world oil price burden shifts to China etc.
As China becomes the driver of world oil price, the world oil price drops, due to Chinese sensitivity and pro-activeness.
As the world oil price drops, the global funding of oil is diminished, and the supply is reduced.

It may seem strange, but its really obvious to anyone outside of USA. Americans bidding up the price of oil has subsidized global oil production for past 50+ years.
Just ask the European off shore oil worker how redundancy feels.
There is even a name for the doctrine of American bidding up the price of oil, so to increase supply, can you name it?

 

[jhm]

Surge in oil hedging could worsen U.S. supply glut, Wood Mac says

I disagree with WoodMac. Hedging is good. It will drive down the futures curve which is how a free market signals that it has sufficient supply. Speculative production without hedging is much more reckless for the whole market.

 

[jhm]

So the dynamic becomes, more demand for oil quantity, but less demand

This does not make any economic sense, unless you are saying only that people prefer lots of cheap oil to spending lots on a little oil. The economic idea of demand is the willingness to buy a certain quantity at a certain price. When you separate quantity from price it is no longer demand in a proper economic sense.

 

[Bangor Bob]

So how do we feel about this, and how it's potentially locking-in several years of increased US gasoline demand vs. a more rational vehicle mix.

 

[renim]

So how do we feel about this, and how it's potentially locking-in several years of increased US gasoline demand vs. a more rational vehicle mix.

meaningless without context of efficiency, its not that bad

todays SUVs challenge yesteryears sedan for fuel efficiency
Compare Side-by-Side
2016 Ram 1500 HFE EcoDiesel fuel-economy review: 24-mpg full-size pickup truck

if Americans where choosing a product mix similar to Japan, America would be an oil exporter...

 

[renim]

This does not make any economic sense, unless you are saying only that people prefer lots of cheap oil to spending lots on a little oil. The economic idea of demand is the willingness to buy a certain quantity at a certain price. When you separate quantity from price it is no longer demand in a proper economic sense.

put the PQ charts away and repeat after me

maximum profit is not demonstrated until there is curtailment
maximum profit is not demonstrated until there is curtailment
maximum profit is not demonstrated until there is curtailment

chant it everytime you see a gasoline station.

then, only then, come back with the PQ charts.

 

[neroden]

So what happens as gasoline demand fall over time? The days supply for gasoline should tend to grow longer. It looks like jet fuel could become the marginal product.

This may happen faster than I thought, based on the data you are looking at. I figured it would take quite a while before jet fuel became the marginal product. I also figured it would require major refinery closures. But it may be very soon.

There is one aspect which is not obvious from the EIA data: refineries face a choice whether to produce jet fuel or diesel. It mostly comes from the same "cut" in the fractionation column -- 11-18 carbons. Another source says 12-20 for diesel, 6-16 for jet fuel. But anyway, major overlap in the cut.

As EVs rise, I think demand for diesel will fall even faster than for gasoline.

The initial response will be to convert the diesel to jet fuel. Jet fuel is a slightly lower-carbon-number cut than diesel, but those lower-carbon numbers come from the gasoline cut.

So as gasoline and diesel decline, the production capacity goes straight to jet fuel.

So it could be that propane or some other oil product could become the second marginal product after jet fuel. If natgas production falls with oil production, that would also raise the price for propane. So imagine the oil industry if jet fuel and propane were its two most crucial products, not gasoline or diesel.

For the last several months, that's exactly what I've been trying to imagine the transition to. But naphtha, currently made into gasoline, can be made into propane instead. It is possible that *asphalt* will become the second marginal product, which would be weird!

 

[neroden]

In 2007, gasoline market revenue was $291B on 3389 mmb for an average market price of $86/b or $2.04/gal.

In 2016, gasoline market revenue was $192B on 3414 mmb at $56/b. This was nearly a decline of $100B revenue to sell an extra 25 mmb of gas.

So clearly we are not anywhere near a new peak for gasoline revenue. That peak actually happened coincidentally in 2012, when volume bottomed out.

In 2012, gasoline market revenue hit a peak of $375B on 3178 mmb at $118/b. Moreover, this peak lasted three years. 2011 and 2013 saw $369B and $365B on 3195mmb and 3225mmb at $116/b and $113/b, respectively. So over $1.1T in gasoline revenue and super high prices fueled production leading into a glut. In fact, signs of weakness were already present in the 2013 results. Revenue had fallen 2.7% and prices fallen 4.2% to push out an extra 1.6% in volume. So even in 2013, there was the hint that production was getting ahead of demand.

But the bottom fell out in the following years. From 2012 to 2016, revenue fell 49.0% and prices down 52.5% all to push an extra 7.4% of volume onto US consumers. Gasoline was on the clearance rack at TJ Maxx and still not moving much.

Oooh, thanks for this. This squeezes margins in four places:
-- "upstream" drilling and production
-- refineries
-- transportation
-- retailers
The retailers already have no margin and are operating as loss leaders, so they close when volume drops enough to make it a poor loss leader. I still can't figure out when that happens exactly.
The old pipelines have low operating costs, but new ones have debt to pay back and will probably go bust. Railroads and tanker trucks can always carry something else.

Refineries are where it gets interesting. They're already complaining about low crack spreads, and as you documented, those are way higher on gasoline than on anything else. I think the next step *has* to be a shakeout in the refinery markets, with a bunch of refineries closing to increase the crack spreads. The result? Gas prices go up with constant oil prices, or alternatively oil prices go down with constant gas prices. Not quite sure when this will happen, because it depends on how much debt the refineries are carrying.

 

[jhm]

put the PQ charts away and repeat after me

maximum profit is not demonstrated until there is curtailment
maximum profit is not demonstrated until there is curtailment
maximum profit is not demonstrated until there is curtailment

chant it everytime you see a gasoline station.

then, only then, come back with the PQ charts.

I really do not follow what you are saying here. Are you invoking monopoly pricing? If so, you ought to know that monopoly pricing is all about the market demand curve and that the optimal price depends on demand elasticity.

 

[jhm]

This may happen faster than I thought, based on the data you are looking at. I figured it would take quite a while before jet fuel became the marginal product. I also figured it would require major refinery closures. But it may be very soon.

There is one aspect which is not obvious from the EIA data: refineries face a choice whether to produce jet fuel or diesel. It mostly comes from the same "cut" in the fractionation column -- 11-18 carbons. Another source says 12-20 for diesel, 6-16 for jet fuel. But anyway, major overlap in the cut.


The initial response will be to convert the diesel to jet fuel. Jet fuel is a slightly lower-carbon-number cut than diesel, but those lower-carbon numbers come from the gasoline cut.

So as gasoline and diesel decline, the production capacity goes straight to jet fuel.


For the last several months, that's exactly what I've been trying to imagine the transition to. But naphtha, currently made into gasoline, can be made into propane instead. It is possible that *asphalt* will become the second marginal product, which would be weird!

Thanks, this is helpful info. I was not aware that their was as much tradeoff potential between diesel and jet fuel. Jet does fetch a lower price at market, so this may be another reason to keep inventory lower than diesel for the time being. Of course, thinking ahead to a time where demand for diesel has fallen off, jet tend to have the higher price.

Also in the meantime, US refiners are looking to increase exports of finished refining products. So I would not expect refineries to be idling much.

It is interesting that as we think about prices reflecting demand, we not that there are three sources of demand: domestic consumption, exports, and trade in inventory. Opening up more exports, leaves domestic consumers paying closer to export prices. So this trend may also have an impact on domestic demand.

 

[renim]

I really do not follow what you are saying here. Are you invoking monopoly pricing? If so, you ought to know that monopoly pricing is all about the market demand curve and that the optimal price depends on demand elasticity.

every time an american puts 10 gallons of gas in their tank, someone in China / India / Greece is staying home or riding a bike because the price of oil is just too expensive.

its like going to a house auction, the dominant bidders gets the house.

If America ceases to be part of that auction, then the dominant price bidder becomes China, a school teacher in China earns about $500 a month (depending on province) that middle class simply will not pay USA prices for oil.

maximum profit is not demonstrated until there is curtailment, somewhere around the the world, curtailment is happening, as it has for the past 50years.
Americans bidding up the price of oil has subsidized global oil production for past 50+ years.
Americans bidding up the price of oil has curtailed consumption by poorer nations for the past 50+ years

 

[GoTslaGo]

I'm not the one you asked, but SPYX, EFAX and EEMX are exactly the ETFs that allow me to have a global lazy portfolio ex Fossil Fuels... Thanks again to @rallykeeper for alerting me to them!

Thanks for pointing these out. Ran a comparison between SPYX and SPY and made me realize how much of SPY is fossil fuels. SPYX at the time was positive, SPY was negative. Also the price differential. Finally it helps that I follow this thread and have an Energy Fund that's in the dumps, so I know how much fossil fuels are pulling things down.

 

[SebastianR]

every time an american puts 10 gallons of gas in their tank, someone in China / India / Greece is staying home or riding a bike because the price of oil is just too expensive.

its like going to a house auction, the dominant bidders gets the house.

If America ceases to be part of that auction, then the dominant price bidder becomes China, a school teacher in China earns about $500 a month (depending on province) that middle class simply will not pay USA prices for oil.

maximum profit is not demonstrated until there is curtailment, somewhere around the the world, curtailment is happening, as it has for the past 50years.
Americans bidding up the price of oil has subsidized global oil production for past 50+ years.
Americans bidding up the price of oil has curtailed consumption by poorer nations for the past 50+ years

I get what you say. However, I'm not fully convinced I agree with you. Firstly, what you say is (to some extent) true for any commodity that can be traded globally. It is true for many food related items including sugar, coffee etc. In many of these markets you have local subsidies / local versions of the market but ultimately, grain prices in the poorest regions of this world increase if world market prices increase. So in some ways, I don't think what you describe is unique.

But oil used to be unique: if you wanted (individual) transport, if you wanted local economic activity, you literally couldn't do without. You can substitute coffee for tea, but you couldn't really do that with oil. For decades economic growth was growth in oil consumption. That's less true now: oil is about to experience that the "school teacher in China" has an alternative to using a fuel burning car. China is full of electric scooters, electric bikes and increasingly also electric cars. And it is not just China. It is all over Asia. I was in Myanmar the other day and found that every second bike was electric and there were many bikes. It really really really surprised me.

And that's the difference between the past 50 years and now. Yes, in the past, oil prices may have impacted on poorer nations oil consumption. But now poorer nations increasingly have alternatives. And just like many of them leapfrogged land-line telephony and adopted cellphones immediately, I see them jump to renewable alternatives quickly. It also makes sense: You can impose an oil embargo. But you can't impose a "sun light" or "wind" embargo - so why would you want to subject yourself to energy dependency if you had to build new energy infrastructure?