Phil Flynn is writer of The Energy Report, a daily market commentary discussing oil, the Middle East, American government, economics, and their effects on the world's energies markets, as well as other commodity markets. Contact Mr. Flynn at (888) 264-5665
Oil prices turned lower as long-time oil bull, formally known as the “oil god”, threw in the towel on his largest Astenbeck Capital Management LLC commodity fund. Not only did he close the fund, he shook his bullish followers with a blasphemous statement that oil may be stuck around $50 a barrel or lower, I guess, forever. In one of the most challenging years in oil trading history for ultra bulls or ultra bears, Mr. Hall’s fund was down reportedly around 30% and he decided it was time to throw in the towel as he bemoaned that the crude oil had materially worsened. This caused other oil bulls to be shaken and start to sell. It raised fears that the unwinding of this fund might cause more selling even if it’s unclear as to when he started to wind the positions down. Yet is this former oil deity, who has been brought back down to mere mortal status, getting out when it is really time to get in?
There are many styles of trading. Some are short-term and some are a long term. Some of the biggest profits I have ever seen in trading came only after the trade took some extreme heat. Obviously that style is not for most but if you believe that at some point the fundamentals will eventually win out and you have deep enough pockets, you can sometimes ride out market moves and get to the point where the fundamentals will eventually come into play and prices will be forced to certain levels as the supply and demand fundamentals play out and finally become clear. Of course sometimes you are wrong and you must admit it and get out and take your lumps. But in the vicious world of trading, with flash crashes and news flow, you are sometimes wrong about being wrong. You are just so beat up psychologically, feeling that you question yourself and let the market convince you that you were wrong. That’s why so many people, after a losing trade, sell at the bottom just as the market starts to turn around.
So the reports that Mr. Hall decided to close his fund last month was before the news flow started to justify his bullish outlook he had in the beginning of the year. Hall predicted that the oil market would fall into a deficit, reducing global supply. That is now starting to happen. He predicted that low prices would heat up demand. That is starting to happen. He predicted that shale oil would start to falter. That too is starting to happen.
Let’s start with shale oil concerns. I have brought up concerns about shale oil production and its current production cycle. I have spoken about uncompleted wells and financial issues as well as steep production decline rates that seem to be accelerating. Shale drilling stocks have been getting hammered. Firms like Pioneer and Pacific Drilling are said to be mulling the idea of bankruptcy against warnings by Halliburton about a slowdown in shale. Now a report by Bloomberg News is warning the, “the wild shale race may be harming the U.S. oil trove.”
Bloomberg reports that the, “frantic shale race may be causing some long-term damage to assets in the Permian and other major U.S. oil fields.” As production from wells rapidly decline, drillers are rushing to add new ones at a faster pace to keep increasing output. The problem is that drilling multiple wells closer together is contributing to the drop in established ones, and sometimes causing harm that can’t be fixed. Output from legacy wells, a term that in the fast-pace shale world includes those that are just a month old, is dropping by 350,000 barrels a day every month and has fallen steeply since 2012, according to data from the U.S. Energy Information Administration.
Unlike offshore wells in the Gulf of Mexico which can produce for decades, shale wells can peak within months and sometimes cease after two years. Eager explorers may undercut the life of wells by over-drilling, said Russell Clark, investment manager at Horseman Capital Management Ltd. So-called frack hits occur when drilling in one well interferes with another, causing a pressure transfer that can disrupt or stop production. “New well production is increasingly cannibalizing legacy production,” Clark wrote in a report. “The decline rate looks to be accelerating.” A must reads in Bloomberg.
Oil bears have been selling on so-called weak demand but that is rapidly changing. U.S. gasoline demand is at record highs and demand in Europe and China is surging. Reuters News is reporting that China is on pace to overtake the United States as the world’s biggest oil importer this year, cementing its status as Asia’s most pivotal oil market actor that will increasingly dominate the region’s fuel trade. For the first time, China imported more crude oil in the first half of the year than the U.S., government statistics showed. China averaged 8.55 million barrels per day (bpd) versus 8.12 million bpd in the U.S., a trend that is expected to last.
China refinery demand is a key driver and they are exporting oil products making China a major refining hub. That has grabbed the attention of Saudi Arabia that is cutting a deal with China. Fox Business Network reports that state-owned oil giant Saudi Arabian Oil Co. is in talks to invest billions of dollars in a Chinese state-owned oil refinery, according to people familiar with the matter. The deal, which could be valued at up to $2 billion, would give Saudi Aramco a more-than 30% stake in a 260,000-barrels-a-day plant owned by PetroChina Co. in China’s Yunnan province, the people said. PetroChina is a unit of state-owned China National Petroleum Corp. Saudi Arabia could supply some of the refinery’s crude needs. Aramco might also buy some of PetroChina’s retail assets, it was reported. If the talks succeed, they would finally bring to fruition plans that Aramco and PetroChina have been discussing for several years.
So, while oil struggles at 50 the fundamentals are in play to still see higher prices long-term. Don’t let one fallen idol shake you out of your position. Obviously, you must trade with your own risk capital and within your means but the fundamentals of falling supply and rising demand always has led to higher prices. Shale oil may bounce back but it won’t be until prices are high enough to get confidence back in the sector. And that’s assuming they have not ruined all the wells.
Questions? Ask Phil Flynn today at 312-264-4364
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