Most of the oil and gas market has exhibited a two-day price rally from the previous month’s carnage in what can be considered a “dead cat bounce”. This is probably in recognition that Talisman’s acquisition implies that the rest of the oil that is stuck in the ground also has similar value despite the commodity price being lower than the cost to get it above the ground.
Some companies have reduced their capital budgets already – Canadian Oil Sands, Penn West, etc., have already announced capital expenditure reductions and dividend cuts.
The question here is how low crude oil will go before it truly bottoms. In 2009, it bottomed out at US$35/barrel, while today it is at around US$55/barrel. My gut instinct here says that we are very, very, very close to the bottom, but if you recall during the era of Bear Stearns’ near-bankruptcy (technically taken over by JP Morgan), it could take a few more months for this to play out to its ultimate bottom.
One thing I do know, however, is that the demand for liquid crude is not going away – airplanes are flying, people are driving their vehicles, and trucks are delivering cargo. The need for energy in the form of transport fuels is not going away anytime soon. A commodity can trade under the marginal cost of extraction for quite some time (this was the case for Silver post-80’s collapse) but continued demand will inevitably result in price rises unless if the extractors are operating as charitable organizations – most of them are currently at US$55/barrel!
I must admit I am more than a bit surprised that oil is trading in the 50’s, but what I’m most surprised with is the volocity of this rout. By all reliable data, the supply demand imbalance is around 1.5 million boepd with demand in the 90 million boepd range. And this is characterized as a glut by the media? In response to the price, The basic laws of supply demand economics are working perfectly: capital budgets are being reduced, dividends slashed, assets sold, acquisitions taking place. One thing about oil companies is that they understand for the most part how to react to these cycles. That’s why the best cure for a low price is, as the saying goes, a low price. And of course, the low price of oil has the same effect of really a nice tax break for consumers in the US and other driving economies…who now find themselves with more disposable income! The uptick in demand will follow.
It seems to me a perfect storm as soon as OPEC made their decision: negative spin media frenzy, margin calls, tax loss selling and year end window dressing by funds. All in a matter of days. Dizzying!
Foolish to call a bottom but I tend to agree that it feels like we are close. I have been picking away at my favorites: DTX , RMP and WCP. My feeling remains that those with the best balance sheets will recover the fastest once we get through this.
Nerve of steel indeed!
Hi Sacha. Read your year end portfolio performance post. Trying to understand why you vaporized your oil and gas holdings, especially since you characterized them as small. What was it that tipped the scales to make you undo those positions?
I continue to be amazed at the relentless drop in the prompt month oil price but in a weird way I’m glad it’s happening with such speed…and that’s because it will cause someone to blink sooner than later. I expect even the Saudis are surprised at where oil prices have fallen to. The shale oil players are getting crushed like tin cans. Rig counts are falling. Capex budgets slashed and so on. It will be very interesting to see size of the supply destruction as we enter Q2 this year. It will also be interesting to see where demand numbers come in given the positive effects for the consumer.
I’m going to wait it out. Nerves of steel.
Cheers! Neil J
I’m not sure when the maximum pain point will be realized, but it sure doesn’t feel like it yet. This is reminding me of the state of the financial companies in the mid-2008 stages – we probably have to see some genuine washouts before we’re going to see some sort of moderation.
I guess my problem with catching the falling knife is that I was far, far, far too early.