By Rupert Hargreaves Andrew J. Hall, the the commodity hedge fund manager and oil trader whose pay package of about $100 million ensnared him in the fight over compensation at bailed-out banks in 2009, believes that oil prices are almost certain to head higher over the long-term.
In a letter to clients of Astenbeck Capital reviewed by ValueWalk, Andy Hall’s commodity-focused hedge fund, Hall writes that current oil prices “are unsustainably low on any reasonable assessment and global spare capacity is wafer thin.” However, Hall believes that “there is certainly still a chance of lower prices in the next month or so,” although “weighing that possibility against the virtual inevitability of higher prices down the road leads to a simple conclusion: now is not the time to exit the market.”
The hedge fund manager sometimes called “the oil G-d” is having a rough year, but is not backing down from his thesis. According to Christian Berthelsen of The Wall Street Journal, who first reviewed the letter, Hall’s fund lost 9.7% in November, bringing YTD losses to $26%. This would make 2015 the worst year for Hall since 2008 when the hedge fund was founded. Oil: Demand remains robust
Hall has been bullish on the price of oil for some time and lays out why his position hasn’t changed over the past few months within Astenbeck’s December letter to investors. Hall’s analysis shows that while it’s broadly believed that the oil market is oversupplied, the gap between supply and demand isn’t as wide as the media is reporting.
“The weak physical crude oil market can largely be attributed to lingering refinery turnarounds. Accounting and fiscal effects exacerbated the situation as refiners postponed purchases to minimize onshore stocks at year’s end. This, in turn provoked press reports of queues of oil tankers waiting to discharge, adding to the gloom and resurrecting fears of the industry running out of storage,” he wrote.
In fact, Hall’s research shows that the crude oil the market is much closer to being balanced and “for gasoline, the market is almost certainly in deficit given phenomenal demand growth in the U.S. and Asia.”
EIA data for September shows gasoline demand in the U.S. grew 4.5% compared to a year earlier. Vehicle Miles Traveled grew at a similar rate, while fleet efficiency fell for the first time in eight years as buyers switched to trucks and SUVs. In India, gasoline demand increased by over 14% percent in October with auto sales up by almost 22%. Apparent demand for gasoline in China grew by nearly 11% in October: SUV sales were up 60% year-on-year. Analysts from Credit Suisse estimate that burgeoning car sales in China will result in gasoline demand there growing by around 300,000 bpd during 2016.
On the storage front, Hall points out that there has been a significant decline in total oil inventories during the past few months. Combined data for commercial inventories in the U.S. and Japan, in leased storage in Rotterdam and Singapore plus oil in floating storage, showed a decline of over 1.5 million bpd in November – the first monthly decline this year. Commercial oil inventories in China fell by over 600,000 bpd in October and now stand at the same level as a year ago. All in all, based on oil inventory data, Hall concludes that:
“It seems extremely unlikely to us that the industry will run out of places to store oil even if inventories resume growth during the lower demand months in the first half of 2016.”
Capitulation Long-term thesis remains intact
“Despite all the short-term negativity, the longer term story regarding oil remains very much intact. Indeed the longer prices remain at current levels the more powerful the ultimate recovery will likely be. The oil industry simply cannot function with oil prices stuck at current levels. This was demonstrated with the publication of third quarter 2015 E&P company earnings which were a sea of red ink,” he added.
According to Andy Hall, the effect of the rout in oil prices should really start to show through on the supply side during 2016. For example, as they enter 2016, the U.S. E&P complex will lose much of the protection afforded to it in 2015 by hedges.
State oil companies Pemex and Petrobras are also feeling the pressure. Pemex is reportedly nine months in arrears in paying its service providers, and Petrobras, reeling under a mountain of debt, is trying to sell assets — a strategy workers are opposing. Striking workers cost the company as much as 200,000 bpd of lost production in November.
Meanwhile, in China, production is expected to decline significantly next year as investment in new offshore projects tails off and aging onshore fields are starved of capex. Even within OPEC, low prices are taking their toll. The Iraqi government has instructed oil companies there to curtail investment to reduce the drain on government revenues. The Saudi policy of trying to drive higher-cost shale producers out of business is taking longer than anyone expected to play out:
“Global oil supply has therefore continued to grow — albeit at a much lower rate. As the excess has lingered and low prices have prevailed for longer, producers outside the shale arena and whose investment lead times are longer are increasingly being impacted. Rystad Energy, in a recent report, estimated that because of reduced maintenance investment in mature offshore sources of production, decline rates there will double in the coming 12 months, from 750,000 bpd to 1.5 million bpd,” said Hall.
US E&P bankruptcy filings: Chart via S&P Capital IQ
Additionally:
“Platts reported that oil analysts, Tudor Pickering Holt (TPH), had identified some 150 oil and gas projects that have been delayed or cancelled globally in response to lower oil prices, “jeopardizing a combined 19 million boe/d of future production”. These deferred and cancelled projects hold some 125 billion boe of resources, 60 percent of which are liquids according to the analysis,” he wrote. Oil prices are likely to remain volatile for the time being
Andy Hall concludes his December letter to Astenbeck investors by stating that, “with short term and long term factors pulling in opposite directions, prices are likely to remain volatile for the time being.” Although demand is rising, inventories and production will take time to readjust. However, global spare production capacity is wafer-thin, and as the oil sector slashes jobs to cut costs, there is a question of how well the industry can respond to any upturn in demand. As a result, “the virtual inevitability of higher prices down the road leads to a simple conclusion: now is not the time to exit the market,” he said.
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