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Overpriced Oil – The Fundamental Facts

Commodities / Crude Oil Sep 04, 2014 - 06:22 PM GMT

By: Andrew_McKillop

Commodities

Andy Hall Takes a Bet
Sometimes dubbed the Billionaire Better who always gets things right, Andy Hall has come out swinging. Bloomberg, September 3, reports Hall as saying US shale oil (and even shale gas) “are a dud” and will play down and out much faster than most people think. Hall says there is no way that either US or world oil prices can erode down to around $75 a barrel. He says barrel prices will be closer to $150 within 5 years, by at latest 2019. Hall is buying long-dated oil futures contracts to as far out as 2019 on that basis


His nearly “long only” strategy is as simple as that. Early this year, Hall could buy futures contracts for December 2019 delivery of WTI oil at a barrel price of $76. By July this year, the same contract priced the future oil at $88 a barrel. Although there is no way Hall will be giving details on his trading strategy, and all his associates are committed to a “no comment” blackout, his preference is to hang in and get the Big Flip upwards in prices, that he says has to happen between now and at latest 2019.

Geopolitics versus Fundamentals
Hall spends a lot of each day phoning contacts and friends around the world with global oil knowledge, and Hall certainly does not ignore breaking political events in key producer countries and regions, like Libya and the Middle East, but for US domestic oil he has a fundamentals-heavy readout. Bloomberg reports that UK-born Hall is in no way impressed by the unprecedented rise in US oil production spurred by fracking. Blooomberg says he has “no charity for those touting the message that shale drilling will take over the world” and usher in a new era of cheaper oil.

In particular Bloomberg cites Hall's irritation with the former Lehman Bros chief oil analyst Edward L. Morse, now with Citigroup, who I had some contacts with myself in New York, 2007-08, during the frenetic run-up of prices and its probable linkage with Goldman Sachs – not fundamentals! Bloomberg cites Hall's dismissal of articles by Morse, this year, published by Citigroup forecasting $75 oil. These articles, Hall's associates say “really bug him”. Not citing Morse by name, Hall wrote in June that he can't understand what supports Morse's conviction that oil prices will erode 25%-30% in the relatively near term. Hall said that whatever this conviction was, “it is apparently not facts or analysis”.

When it concerns his own convictions, Hall often cites what he says gave him key insights for his oil trading. These are the books by Tom Bower, for example “The Squeeze: Oil, Money and Greed in the 21st Century” which quite significantly has its own Web page on a Royal Dutch Shell plc site (Shell denies both the ownership and posting!). Bower rips through the oil industry and its already-dead flirt with “Green Things” about a decade ago. Bower says that the majority of oil company chiefs are not only insufferably arrogant, but also incompetent. They can be relied on to get things wrong – and they got everything wrong about world, regional and national oil demand and supply, and more recently, the shale boom. Interesting to me, Tom Bower has no time at all for Peak Oil which for him mainly concerns technology issues,  but this is nothing to do with oil corporate arrogance and the basic instinct of fixing and rigging markets to get a high price, alongside the Goldman Sachs of this world.

However, the “Edward Morse hypothesis” has things going for it (see chart below)


Source: CXO Advisors, SNBCHF Switzerland

This chart show that US oil price seasonality is definitely alive and well but also changing over the decades, for several reasons. Overall but with spiky exceptions for some months of the year, US oil prices tended to be more seasonal in 1986-1998 than since that time. Also related to this previously slightly-higher seasonal price change for US oil, 1986 was th biggest-yet game changer for world oil. By purely political decision of Saudi Arabia and its Arab Gulf allies, to harm Revolutionary Iran and support their own Sunni regime defender – Saddam Hussein – oil prices were slayed. They fell 67% in less than 6 months and stayed “sweet and low” until at least 2002.

What Really Sets Oil Prices
The 1986 price crash had zero relation with any technology or resource issue, constraint or opportunity. Why prices recovered after about 2002 is the meat of Tom Bower's books – and he says it was heavily influenced by corporate arrogance and incompetence among the Big Oil fraternity. To be sure Bower also nails the market riggers and fixers (but never mentions Andy Hall!).

Not only Bower, but plenty of other energy analysts and commentators like myself can point to the strange “out to lunch” refusal to plan, predict and anticipate world oil demand recovery after the mid-1990s. There was the semi permanent under-estimation of China and India's growing oil demand – followed by over-estimating it – and we also had the bizarre Green Flirt of the “old majors” about 10 years ago. Drugged on a mix of global warming hype, and peak oil hype, they thought “oil was finished” and acted that way.

After that, they had the feel-good result of oil scarcity jacking up prices, but due to the fatal mix of arrogance and incompetence, the corporate chiefs of the “old majors”, once called The Seven Sisters, believed – like Andy Hall – that $150 oil was coming and would come. “It was inevitable”. Royal Dutch Shell, for example, badly needs overpriced oil to limit the serious damage to its corporate finances from its Go For Gas strategy, unveiled about 15 years ago and heavily influenced by the Green Energy/Climate Change/Peak Oil myths and theories. Shell simply believed that if oil can get to $150 a barrel, gas prices can soar to $25 per million BTU (about $145 per barrel equivalent) and everything would be fine for Shell – if not gas users! The US domestic shale gas boom was a “bad surprise”, and ironically is relates to Andy Hall's “captive client list” including massively debt-laden US gas producers, who bet on rising oil prices because that will be their salvation. US natural gas struggles to price itself at $22 for a barrel equivalent, today.

So Andy Hall is using a fundamentals-based rationale for his theory that oil has to go on rising. The highest-level world energy fundamentals are the basic costs of production and final market prices for each type of energy, and they are negative for overpriced oil. Edward L. Morse among others covers these issues which for example and one day, will make things come right, or less bad for Royal Dutch Shell and plenty of majors, and the NOCs, and the independent producers, who have made massive gas discoveries since 2009 and are sitting on vast reserves of coal.

Oil's share of world energy is dwindling on a constant basis and for over 30 years – could this be something to do with it being overpriced?

By Andrew McKillop

Contact: xtran9@gmail.com

Former chief policy analyst, Division A Policy, DG XVII Energy, European Commission. Andrew McKillop Biographic Highlights

Co-author 'The Doomsday Machine', Palgrave Macmillan USA, 2012

Andrew McKillop has more than 30 years experience in the energy, economic and finance domains. Trained at London UK’s University College, he has had specially long experience of energy policy, project administration and the development and financing of alternate energy. This included his role of in-house Expert on Policy and Programming at the DG XVII-Energy of the European Commission, Director of Information of the OAPEC technology transfer subsidiary, AREC and researcher for UN agencies including the ILO.

© 2014 Copyright Andrew McKillop - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisor.

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