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Före detta hedgefondförvaltare, partner och VD på Futuris som utsågs till Årtiondets hedgefond i Europa för perioden 2000-2009
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Oil opportunities and the slippery slope of contango extraordinaire

Retarded Redux

Once, a friend from business school wrote in his capacity as a business journalist "It's fascinating how retarded Syding is. He still hasn't realized that...". That was 20 years ago.

Well, here I go again, I just realized* there is this thing called contango..., and consequently I've had to update my view on oil.

*not really, see more below


 

Oil update - to keep or not to keep

This is a quick update on my thoughts on (brent) oil

It's not a recommendation to buy or sell anything (see disclaimer page), it's simply my thoughts on the issue of low oil prices potentially going (much) lower before exploding higher, and what that means for investments in oil futures and oil stocks.


 

Oil and Asperger's

Back in August last year I wrote this article on brent oil and Asperger's - about how I had profited from having both.

Today I'm long oil again, both a brent certificate/ETF (a Swedish instrument: Olja S)and two oil exploration companies (DNO and ShaMaran).

The case for oil is pretty easy and straight forward: the world is growing and we have reached peak cheap oil production. It will only become more and more difficult and expensive to find and extract oil, while the easily accessible oil reserves become depleted and go off-line one after the other. 

The case against oil relies mainly on solar energy and more effective use of energy, including storage (batteries). Well, that and the coming super recession.

I'm pretty sure renewables won't be able to fill the oil supply/demand gap within the next five to ten years - at least not unless oil prices sky rocket again, thus making non-subsidized alternatives attractive enough. I also think a recession has been more than priced in. I consequently think oil prices will be much higher than today 18 months from now, and yet much higher 18 months after that.

10$ oil

In the short term however, there are a few snags, including 10$ oil:

  1. Easy money has fueled malinvestments in north American shale oil/gas production capacity. Nobody wants to be the first to fold, but some need to fold though in order to rebalance the oil market and support higher prices. The latter is taking longer than expected. Crashing oil junk bonds is, however, a good sign things are moving in the right direction.
  2. Crashing oil prices have forced Opec to pump even more oil than usual on order to keep their countries afloat. Russia, Saudiarabia, Kuwait, UAE and Iran simply refuse to agree on the needed production cuts. Instead they seem hell bent to keep at this chicken race at least long enough to crush the north American shale industry.
  3. Oversupply. The combined production of a pumped up Opec, Iran coming online and massive investments in shale production capacity have created a shortage of storage capacity. Once the industry runs out of storage (including in tankers and refined products) excess oil can and will be sold at just about any price.
    1. Yes, 10$ per barrel is conceivable (for a very short time) - if that is what's needed to make anybody find use or (build) temporary storage for it, not to mention paying the cost to move the product.

Contango extraordinaire in the face of a storage crisis

The reason I am considering taking my oil profits to the sideline for a while is solely based on the risk of a storage crisis which could spark a panic sell off that in a single month can create a truly massive contango, wiping out 20%, 30%, 50% of the value of an oil ETF or certificate.

I have based my investments on Opec doing what they can to crush the shale industry.

I have been ready to sit through a bottom in oil prices caused by both a supply war and a simultaneous recession.

I have been quite calm, faced with a contango of  1-2% per month for the rest of the year, and a total of 20% until the end of 2017. No problemo.

oil futures

What I hadn't really considered, until I listened to the MacroVoices podcast the other day, was the risk of literally overflowing oil storage facilities (check out some of the statistics here), and thus nobody willing to take delivery of oil at just about any price, while next month's futures still trade at more or less reasonable prices. Even if current contango is limited to 1% per month, temporary spikes can kick that up to tens of per cent per month.

oil storage
picture from Art Berman via MacroVoices

I previously thought it would be quite easy to find alternative uses, or to build temporary storage facilities if you stood to make a dollar or two per barrel per month in arbitrage, but it seems it just isn't that easy.

Hence, if a long oil ETF trade as of today is to become profitable, the current oversupply of 2 million barrels per day pretty soon has to come down to zero. It only takes a few per cent production cuts by, Russia, Saudiarabia, Kuwait and UAE to accomplish that. However, they just won't, if Iran is increasing its supply at the same time, and definitely not if it means the US shale industry will survive.

If the cuts or shut-downs, shut-ins, don't come soon enough, any product relying on rolling oil futures contracts over from month to month, could be more or less wiped out, and not recover sufficiently in the ensuing rally, due to too low a starting point.

Veering

So, it's a chicken race, and I'm not entirely sure I want to be part of it anymore. The risk of suddenly losing even 'just' 10% in a single month's contango simply is too much of a gamble for me.

I will keep my oil stocks, but I just might sell my oil certificates as early as this Monday.

If I were you, I would think long and hard about what kind of oil exposure I had and why.

With that I leave you, and encourage you to spread this article far and wide, to help others in their quest for making a quick buck in oil.

P.S. If you haven't subscribed to my newsletter or read my eBook already, don't hesitate to sign up. It's free, spam free, easy to unsubscribe, and I hear it's pretty entertaining as well as useful (sometimes)

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