Today’s Blog – Wednesday 20th January 2016

Please pass this blog onto others who might like to read it

Introduction

In a discussion earlier this week the following very interesting question was raised: why has there been no successful “Big Short” made on oil over the last ~12+ months”?

There has recently been released a movie version of Ted Lewis’s acclaimed “The Big Short” – basically the story of those prescient types who called the US housing market as being over-priced – and collectively made many billions from shorting that market in various ways.

The fall in oil prices since late November has arguably been of a greater order of magnitude than the fall in US house prices during the GFC.  Oil markets are deep and liquid.  Oil price can be played in ways outside commodity markets – companies, debt, derivatives, etc.  The mechanisms were available to potential big shorters.

However, we cannot think of any John Paulson equivalents who bet on oil prices falling and made billions.

Naturally we may just have missed the news.  Or was the oil price fall inherently a less likely outcome than the fall in US house prices and no-one really bet their shirt on this happening?

Our view in a nutshell is that ultimately US house prices are set in a market, imperfect as it might be – and subject to political drivers such as Government ownership of Fannie Mae, etc.

The main reason that oil prices fell – very unexpectedly it appears not only to me, but to hedge fund types who might have made billions by betting on such an outcome – was something that did not happen.  The dog that did not bark was OPEC (or more accurately, Saudi Arabia) deciding not to rein in production by a measly 1.5 mm bopd in November 2014.  And the data in the form of the lack of big shorts would seem to indicate that that event was not predicted by just about anyone.

Commodity prices

Brent crude was fairly flat overnight, closing at US$28.87.  WTI fell ~3% to US28.47, as the US market got a chance after a public holiday to ponder more on Iranian oil coming to market.

An IEA report released yesterday also seemed to spook the market, with the following blunt quote, which although colourful, is not saying anything new:

“Can it go any lower?  Unless something changes, the oil market could drown in over-supply. So the answer to our question is an emphatic yes. It could go lower.”

In our view this is hyperbolic.  The extent of over-supply at present is less than 1.5% of demand.  The IEA forecasts that demand growth will eat all of this up in 2016.  There is no traditional “spare capacity” left in OPEC.  Spare capacity is now held in tanks rather than behind pipe.  Events could interrupt supply.  Only Libya has shut-in production.  Etc.

Houston based energy advisers, Tudor Pickering Holt’s (TPH) daily note had rather better news for the industry – albeit in the medium term.  This was TPH’s most recent analysis that the Super-Majors required US$70/bbl oil just to pay current dividends and meet their reduced capex programs – if they wanted to live with-in free-cash flow.

This suggests the long term balance of the market requires at least this figure – and arguably a higher one to incent the new higher cost production that would be required to meet growing demand.

The Henry Hub natural gas price was flat overnight, closing at US$2.09.

LNG and international gas

The Wall Street Journal recently quoted an internal memo from Petronas’ CFO on capex cutbacks the company would be implementing  – more than US$11B per annum over the next four years.

In this context, we think Petronas will struggle to take FID on its Pacific Northwest LNG project in Western Canada any time soon, notwithstanding its publicly stated aim to do so in 2016.

Company news – Santos (STO)

Today’s Business Spectator noted that Scepter Partners (a private entity backed by Brunei and other sovereign funds) was rumoured to be considering making another approach to STO.

Scepter’s previous approach to STO involved a price of A$6.88 a share (current price: A$2.62).  The Business Spectator reported that “Santos is believed to be unwilling to engage at a price less than A$6.88″.

This statement seems bizarre to us.  The previous proposal was made in a different oil price and share price environment – and also before significant per share equity dilution at STO following its recent rights issue.

As a small (and getting smaller) STO shareholder – my view of “give me A$4 and I will rush you off your feet” would no doubt be shared by many.

Quote of the day

From Michael Lewis – analysis on what was needed to make a highly successful big short:

“To succeed in a spectacular fashion you had to be spectacularly unusual.”

Where were the nerds reviewing the oil market in 2014?   (Dare I say – some of them were in oil patch!)

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