Oil insiders bet big on a price rise By Tim Treadgold January 21, 2009
PORTFOLIO POINT: Commodities traders, confident the current price will not last, are filling supertankers with crude and “parking” them. Buy oil cheap today. Sell it high tomorrow. It sounds simple, and while it obviously is not, the lure of low-priced oil explains one of the investment world’s most remarkable current events: hedge funds, investment banks and oil companies renting supertankers, filling them to the brim with oil, and “parking” them in the Gulf of Mexico.
Last week, according to reports from New York, the investment bank Morgan Stanley joined a Citibank commodities trading division and Royal Dutch Shell in this high-risk game. It acquired two million barrels of oil, put it in a surplus tanker and moored it in the Gulf.
In theory, this is how the game is played. At $US40 a barrel, oil is believed to be close to its cyclical bottom. Tankers are available at cheap rates courtesy of slumping world trade.
In reality, “tanker parking” is straightforward speculation based on the hope that the oil price will recover strongly over the next few years. It could make a fortune, depending on timing, but it could equally be just another misplaced strategy which will cost investment banks (and their clients) very dearly.
However, the fact that some of the smartest people in the oil and banking world (and yes, dear reader, there are some who survived last year’s crash) are placing big bets on the oil price rebounding back to about $US70 a barrel is a pointer to possible opportunities for less gung-ho investors.
The share prices of all of Australia’s oil producers have fallen sharply as the oil price has plunged by more than $US100 a barrel, from last year’s peak of $US145 to its current level below $US40.
The fall knocked Woodside Petroleum down by 62%, from a high of $70.51 on May 22 last year to $26.81 on November 21. Since hitting that low, Woodside has been in recovery mode, rising to about $37.70 (up 4% yesterday alone) – despite the oil price continuing to fall.
The rise in Woodside shares – and similar recoveries by Santos, Origin, AWE, and other local oil leaders, even as the price of oil seems poised to fall further – is a sign that some local investors are taking early positions ahead of an eventual oil price recovery.
The big unknown, and the big gamble with oil, is how long the recovery will take. Everyone in the oil business believes it will happen but they have different opinions as to when.
For most investors the preferred entry point to the oil business is via stocks that exhibit higher “utility” qualities than those of a pure oil company. Origin Energy and AGL are on any starter list, followed by the big oil companies in Woodside, Santos and Oil Search.
Caution is also high on the agenda of executives running oil companies. Eric Streitberg, chairman of freshly floated Buru Energy and one of Australia’s most successful oil industry executives, has adopted a cautionary approach less than six months after listing his latest company.
Buru’s flagship projects, the Blina and Sundown oil fields in the far north of WA, are being restricted to output of 100 barrels a day despite being capable of producing twice that after a major workover last year. When oil prices improve, production can be easily increased.
Streitberg, the one-time chief executive of Discovery Petroleum and Arc Energy, says it is impossible to ignore the 70% fall in the oil price since the middle of last year. “Oil is setting itself for a big [price] spike some time in the future,” he says. “The fact that we have oil tankers in the Gulf sailing around in circles gives you a pretty good feel as to where people think prices are going.
“I’ve always been a Peak Oil person, not in the sense that we’ll suddenly get to a point of peak production, more in the sense that we have not been replacing oil reserves for the past 10 years. That’s the big driver.”
But, if the long-term outlook (and perhaps even the medium-term outlook) is for a return to high oil prices what happened last year. Why did oil crash?
The answer is a combination of historic trends, and the short-term effect of the high prices experienced in 2007 and early 2008 encouraging excess production, especially from older and less efficient oilfields.
In other words, high prices did their job in the years of the “China boom” leading to an oil glut just in time to catch the global financial crisis triggered by the collapse of the US banking system (and wider economy).
“Oil at $US145 a barrel was a disaster,” a senior oil industry executive told Eureka Report this week. Unable to be identified because of stockmarket reporting requirements, the executive said strong economic growth underpinned the oil price: “but clearly there was some speculative business going on, there had to have been traders involved”.
Without pinning down precisely what pushed oil to its mid-2008 breaking point there is a belief in parts of the oil industry that price manipulation, and outright gambling, played a part. “At the time there was lot of denial about it (price manipulation) but its odds-on now, 90% of the people who know the business, understand that there was some stuff going on in some of the trading houses that was about trying to make a little bit of cream on top of the business. What we don’t know is whether it was coordinated, or whether it was illegal.”
The oil price currently appears to be seeking a mid-point between the extreme high of last year’s $US145 a barrel, and the current price of about $US40. Although some brokers such as Merrill Lynch expect prices to remain low, the majority of analysts now expect higher prices in the second half of this year. The bulk of analyst fall within the range.
As a chief executive at one of our biggest oil companies explains, oil prices have to deal with the surge in production that followed last year's price spike, sagging global demand and what's known in the industry as “last barrel economics”.
As the chief executive (who spoke off-the-record) explains: “All 86 million barrels (the daily rate of world oil production) were not worth $US145 a barrel at the peak. It was people chasing the last barrel. On the opposite side, as the price comes down, there is so much oil floating around on the ocean, that you’re getting tremendous downward pressure on crude.
“So, if you’ve got problem crude to get rid of you’re not getting anywhere near the WTI (West Texas Intermediate) price. The accelerator effect means that when you have over-supply the last barrel is worth a lot less than the underlying market.”
For investors, the oil (and wider energy business) is loaded with opportunity and danger. The danger is that the oil surplus will take much longer to be absorbed than optimists expect. This means the oil price will stay low for longer as it did from the mid-1980s, arguably sowing the seeds of the boom years between 2003 and 2008 because of the dampening effect low prices had on exploration and project development in the 1990s.
If that happens then oil investors will be twiddling their thumbs waiting for recovery, while investors in energy sources that compete with oil, including the much-promoted coal-seam methane producers (and coal-to-liquids hopefuls) will be scorched. (To read more on the gas sector, see Madeleine Heffernan’s feature today, Linc's troubled times)
“In our industry we have this overhang of really quick oil that came on that has to be squeezed out, and we have to get through the oil people are storing.”
Exposure to oil is an essential part of a balanced portfolio. But, don’t expect too much to happen too quickly. There’s a glut of supply to consume, and global demand has stalled and serious price action is probably not on the cards until after June.
BPT Price at posting:
77.0¢ Sentiment: Buy Disclosure: Held
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