Here’s Why Crude Oil Stocks Haven’t Bottomed Yet

By Justin Spittler

Oil companies are hemorrhaging money. The oil market is in its worst downturn in decades. The price of oil has plummeted 72% since June 2014. Oil is trading below $30 a barrel for the first time since 2003.
If you’ve been reading the Dispatch, you know the world has too much oil. In recent years, technologies like “fracking” have unlocked billions of barrels of oil that were once impossible to extract from shale regions.
Global oil production has climbed 20% since 2000. Last year, global output hit an all time high. Yesterday, The Wall Street Journal reported the global oil market is oversupplied by 1.5 million barrels a day.
Because oil is leaving the ground faster than it’s being consumed, oil storage tanks are overflowing. 

Companies are now storing oil on tankers floating at sea, according to Bloomberg Business.

Low oil prices have slammed oil stocks..…
Since June 2014, Exxon Mobil (XOM), the world’s largest oil company, has dropped 27%. Chevron (CVX), the second biggest oil company, has plunged 38%. European oil giants Royal Dutch Shell (RDS-A), BP (BP), and Total S.A. (TOT) have plummeted 46%, on average, over the last 18 months. Together, these giant companies are known as the oil “supermajors.”

BP had a $3.3 billion net loss last quarter..…
And it lost $6.5 billion for the year, its worst annual loss in at least 30 years. Exxon sales fell 28% last quarter. Its profits plunged 58% to $2.78 billion, the company’s lowest quarterly profit since 2002. Chevron also booked its worst quarterly profit since 2002. Shell expects to report a 42% decline in profits for their fourth quarter.

Oil and gas companies slashed spending by 22% last year..…
Analysts expect another 12% cut this year to $522 billion, according to Reuters. The industry hasn’t spent that little since 2009…when the U.S. economy was going through its worst downturn in almost a century. More spending cuts are coming this year. Chevron plans to cut spending by 24% this year. The company laid off 10% of its employees in October. Exxon plans to cut spending by 25% in 2016. And BP plans to eliminate 9% of its jobs over the next two years.

The supermajors have not cut dividends yet..…
Regular readers know these oil giants pay some of the steadiest income streams on the planet. Shell hasn’t cut its dividend since World War II. Exxon and Chevron have both increased their annual dividends for at least the past 25 years, which earns them a spot in the “Dividend Aristocrats” club. Investors view these dividends as sacred. Some have even passed along their original shares to children and grandchildren, like grandma’s ring or the family farm. These giant oil companies have been paying regular dividends for decades, even through the 2001 dot com crash and 2008 financial crisis. Cutting their dividends would be a last resort.

The world’s oil giants may have to do the “unthinkable” if oil prices stay low..…
Financial Times reported in December,

…(J)ust weeks ago, BP and France’s Total each pledged to balance their books at $60 a barrel oil, saying they aimed to cover their dividends from “organic” cash flow by 2017.

…(E)ven at $60, the three biggest European majors will need to take further cost-cutting action to cover investor payouts…Total’s $6.8bn dividend would exceed its projected organic free cash flow by $800m two years from now. For BP, the cash shortfall is put at $500m…

These oil companies cut costs to be profitable at $60 oil. But with oil now at $30, they need to make even more drastic cuts.
BP is running out of places to cut spending according to Bloomberg Business.

While Chief Executive Officer Bob Dudley has trimmed billions of dollars of spending, cut thousands of jobs and deferred projects in response to the plunge in crude prices, BP’s cash flow still doesn’t cover investments and dividends…

BP has already cut “a lot” from capital expenditure, Chief Financial Officer Brian Gilvary said Tuesday at a press briefing in London. When asked how much room it has to reduce spending further before cutting into the bone, Gilvary said “we are around that zone.”

Standard & Poor’s (S&P) downgraded Chevron and Shell this week..…
Ratings agencies downgrade a company’s credit rating when they think the company’s financial health is getting worse. Like a person having a bad credit score, a downgrade can make it harder and more expensive for a company to borrow money. S&P cut Shell’s credit rating to the lowest level since 1990. S&P also put the debt of BP, Total, and Exxon on watch for downgrades.

S&P doesn’t think oil companies have cut spending enough. Bloomberg Business reported:

S&P’s moves come after the ratings company lowered its 2016 oil-price assumption Jan. 12, reducing Brent crude by $15 a barrel to $40. The 52 percent average price decline in 2015 won’t be matched by most companies’ cost and spending reductions, S&P said.

As regular readers know, the oil market is cyclical. It goes through big booms and busts. Eventually we’ll get an amazing opportunity to buy world-class oil companies at absurdly cheap prices. But with dividend cuts looming, the bottom likely isn’t in yet. We recommend avoiding oil stocks for now.

Louis James, editor of International Speculator, sees an opportunity to profit from cheap oil..…
Louis is our resource guru. He specializes in finding small miners with huge upside. Louis is an expert in the cyclical nature of commodities. He knows how to make money during booms and busts. And now, Louis sees opportunity in airlines. Jet fuel, which is made from oil, is a major operating expense for airlines. So, airline stocks often move up when oil drops. Last year, jet fuel prices fell by more than one-third. Major airlines are now raking in cash. The U.S. airline industry made $22 billion in profits during the first nine months of 2015, according to the Department of Transportation. That’s more than any entire year in its history.

In December, Louis recommended his favorite airline stock in International Speculator.....
The company has doubled its profits during the third quarter of 2015. On Monday, Louis said the company doubled its profits again last quarter.

The company just announced more-than-solid financial results for last quarter, doubling its quarterly profit. The company says it’s on track to hit the high end of its operational goals for the fiscal year. All great, but even better is that the stock rebounded from its recent slide on the news. That’s “proof of concept” that this stock can buck the market by delivering to the bottom line when other businesses are hurting, which was one of the main reasons we bought this stock.

The stock surged 4% with the quarterly news…and Louis thinks the stock will continue higher. You can learn more about Louis’ favorite airline by signing up for a risk-free trial to International Speculator.

Chart of the Day

BP just had its worst year in at least three decades. Today’s chart shows BP’s profits since 1985. Since then, the oil giant has made money in 27 years and lost money in 3. Last year, BP lost a record amount of money. It lost more than it did in 2010 when one of the company's oil rigs exploded in the Gulf of Mexico. BP has cut billions of dollars in spending. It’s laid off thousands of workers. Yet, it’s still bleeding cash. The company may soon have to do the unthinkable and cut its dividend.

The article Here’s Why Oil Stocks Haven’t Bottomed Yet was originally published at caseyresearch.com.

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How Saudi Arabia and OPEC are Manipulating Oil Prices

About eighteen months ago the international price of WTI Crude Oil, at the close of June 2014, was $105.93 per barrel. Flash forward to today; the price of WTI Crude Oil was just holding above $38.00 per barrel, a drastic fall of more than 65% since June 2014. I will point out several reasons behind this sharp, sudden, and what now seems to be prolonged slump.

The Big Push

Despite a combination of factors triggering the fall in prices, the biggest push came from the U.S. Shale producers. From 2010 to 2014, oil production in the U.S. increased from 5,482,000 bpd to 8,663,000 (a 58% increase), making the U.S. the third largest oil-producing country in the world. The next big push came from Iraq whose production increased from 2,358,000 bpd in 2010 to 3,111,000 bpd in 2014 (a 32% increase), mostly resulting from the revival of its post war oil industry.

The country-wide financial crunch, and the need for the government to increasingly export more to pay foreign companies for their production contracts and continue the fight against militants in the country took production levels to the full of its current capacity. In addition; global demand remained flat, growing at just 1.1% and even declining for some regions during 2014. Demand for oil in the U.S. grew just 0.6% against production growth of 16% during 2014.

Europe registered extremely slow growth in demand, and Asia was plagued by a slowdown in China which registered the lowest growth in its demand for oil in the last five years. Consequently, a global surplus was created courtesy of excess supply and lack of demand, with the U.S. and Iraq contributing to it the most.

The Response

In response to the falling prices, OPEC members met in the November of 2014, in Vienna, to discuss the strategy forward. Advocated by Saudi Arabia, the most influential member of the cartel, along with support from other GCC countries in the OPEC, the cartel reluctantly agreed to maintain its current production levels. This sent WTI Crude Oil and Brent Oil prices below $70, much to the annoyance of Russia (non-OPEC), Nigeria and Venezuela, who desperately needed oil close to $90 to meet their then economic goals.

For Saudi Arabia, the strategy was to leverage their low cost of production advantage in the market and send prices falling beyond such levels so that high cost competitors (U.S. Shale producers are the highest cost producers in the market) are driven out and the market defines a higher equilibrium price from the resulting correction. The GCC region, with a combined $2.5 trillion in exchange reserves, braced itself for lower prices, even to the levels of $20per barrel.

The Knockout Punch

By the end of September 2014, according to data from Baker Hughes, U.S. Shale rigs registered their highest number in as many years at 1,931. However, they also registered their very first decline to 1,917 at the end of November 2014, following OPEC’s first meeting after price falls and its decision to maintain production levels. By June 2015, in time for the next OPEC meeting, U.S. Shale rigs had already declined to just 875 by the end of May; a 54% decline.

The Saudi Arabia strategy was spot on; a classic real-life example of predatory price tactics being used by a market leader, showing its dominant power in the form of deep foreign-exchange pockets and the low costs of production. Furthermore, on the week ending on the date of the most recent OPEC meeting held on December 4th, 2015, the U.S. rig count was down even more to only 737; a 62% decline. Despite increased pressure from the likes of Venezuela, the GCC lobby was able to ensure that production levels were maintained for the foreseeable future.

Now What?

Moving forward; the U.S. production will decline by 600,000 bpd, according to a forecast by the International Energy Agency. Furthermore, news from Iraq is that its production will also decline in 2016 as the battle with militants gets more expensive and foreign companies like British Petroleum have already cut operational budgets for next year, hinting production slowdowns. A few companies in the Kurdish region have even shut down all production, owing to outstanding dues on their contracts with the government.

Hence, for the coming year, global oil supply is very much likely to be curtailed. However, Iran’s recent disclosure of ambitions to double its output once sanctions are lifted next year, and call for $30 billion in investment in its oil and gas industry, is very much likely to spoil any case for a significant price rebound.

The same also led Saudi Arabia and its GCC partners to turn down any requests from other less-economically strong members of OPEC to cut production, in their December 2015, meeting. Under the current scenarios members like Venezuela, Algeria and Nigeria, given their dependence on oil revenues to run their economies, cannot afford to cut their own production but, as members of the cartel, can plea to cut its production share to make room for price improvements, which they can benefit from i.e. forego its market share.

It’s Not Over Until I’ve Won

With news coming from Iran, and the successful delivery of a knockout punch to a six-year shale boom in the U.S., Saudi Arabia feared it would lose share to Iran if it cut its own production. Oil prices will be influenced increasingly by the political scuffles between Saudi Arabia and its allies and Iran. The deadlock and increased uncertainty over Saudi Arabia and Iran’s ties have sent prices plunging further. The Global Hedge Fund industry is increasing its short position for the short-term, which stood at 154 million barrels on November 17th, 2015, when prices hit $40 per barrel; all of this indicating a prolonged bear market for oil.

One important factor that needs to be discussed is the $1+ trillions of junk bonds holding up the shale and other marginal producers. As you know, that has been teetering and looked like a crash not long ago. The pressure is still there. As the shale becomes more impaired, the probability of a high yield market crash looks very high. If that market crashes, what happens to oil?  Wouldn’t there be feedback effects between the oil and the crashing junk market, with a final sudden shutdown of marginal production? Could this be the catalyst for a quick reversal of oil price?

The strategic interests, primarily of the U.S. and Saudi Arabia; the Saudis have strategically decided to go all in to maintain their market share by maximizing oil production, even though the effect on prices is to drive them down even further. In the near term, they have substantial reserves to cover any budget shortfalls due to low prices. More importantly, in the intermediate term, they want to force marginal producers out of business and damage Iran’s hopes of reaping a windfall due to the lifting of sanctions. This is something they have in common with the strategic interests of the U.S. which also include damaging the capabilities of Russia and ISIS. It’s certainly complicated sorting out the projected knock-on effects, but no doubt they are there and very important.    

I’ll Show You How Great I Am

Moreover, despite a more than 50% decline in its oil revenues, the International Monetary Fund has maintained Saudi Arabia’s economy to grow at 3.5% for 2015, buoyed by increasing government spending and oil production. According to data by Deutsche Bank and IMF; in order to balance its fiscal books, Saudi Arabia needs an oil price of$105. But the petroleum sector only accounts for 45% of its GDP, and as of June 2015, according to the Saudi Arabian Monetary Agency, the country had combined foreign reserves of $650 billion. The only challenge for Saudi Arabia is to introduce slight taxes to balance its fiscal books. As for the balance of payments deficit; the country has asserted its will to depend on its reserves for the foreseeable future.

Conclusion

The above are some of the advantages which only Saudi Arabia and a couple of other GCC members in the OPEC enjoy, which will help them sustain their strategy even beyond 2016 if required. But I believe it won’t take that long. International pressure from other OPEC members, and even the global oil corporations’ lobby will push leaders on both sides to negotiate a deal to streamline prices.

With the U.S. players more or less out by the end of 2016, the OPEC will be in more control of price fluctuations and, therefore, in light of any deal between Iran and Saudi Arabia (both OPEC members) and even Russia (non-OPEC), will alter global supply for prices to rebound, thus controlling prices again.

What we see now in oil price manipulation is just the mid-way point. Lots of opportunity in oil and oil related companies will slowly start to present themselves over the next year which I will share my trades and long term investment pays with subscribers of my newsletter at The Gold & Oil Guy.com

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Chris Vermeulen

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Riding the Energy Wave to the Future

By John Mauldin 

“Formula for success: rise early, work hard, strike oil.” –  J. Paul Getty

This week’s yuan devaluation was big news, but it’s really part of a much bigger saga. Events around the globe are combining to create huge economic change over the next few years. We are watching giant, multidimensional chess games played by some master players. Energy is the chessboard that connects all the players. What happens when the board changes shape in the middle of the game? If you don’t know the new energy landscape, you’ll have a hard time playing to a draw, much less winning.

Today I’ll tell you about some big shifts in the energy industry. These shifts are about as positive as can be, unless you need high oil prices to run your country. In the long run, these changes are bullish for the whole world, which I think this will surprise many of you. And though we’ve been used to thinking about energy and technology as two different facets of modern life, today they are inextricably linked.
When energy changes, everything else changes, too.

16 Candles

Thoughts from the Frontline is now entering its 16^th year of continuous weekly publication. I constantly meet readers who have been with me since the beginning – and even some who read an earlier print version of my letters. I put TFTF on the Internet in August 2000 as a free letter, starting with just a few thousand names, and was amazed at how rapidly it grew. It took just a few years for me to realize that this new thing called the Internet was the real deal, and I discontinued my print version. We now push the letter out to almost one million readers each week, and the letter is posted on dozens of websites.

I began to archive the letter in January 2001; and every issue – the good, the bad, and the sometimes very ugly – is still there in the archives, just as I wrote it. I will admit there are a few paragraphs, and maybe even a whole letter or two, that I would like to go back and expunge from the record. But I think it’s better just to let it all be what it is.

Investing in energy without the risk....Here's what our trading partner John Carter is doing.

I thank you for allowing me to come into your homes and offices each week. I consider it a privilege and honor to be able to offer you my research and thoughts. This letter has been free from the beginning, and my full intent is that it will always remain that way. Longtime readers know the topics can vary widely over the course of the year. I write about what I find interesting that week. I find that writing helps me focus my own thinking.

If you are reading this for the first time, you can go to www.mauldineconomics.com, subscribe by giving us your email address, and join my one million closest friends who get my letter each week. And if you’re a regular reader, why not give me a 16^th birthday present and suggest to your friends that they subscribe too! I also want to thank the staff and my partners, who make it possible for me to spend the bulk of my time thinking and writing. And traveling, of course. And now let’s think about energy.

The Cover Pic Indicator

Contrarian and value investors like to buy assets that are in distress, or at least “out of favor.” You don’t hear much about those assets at the time. That’s part of being distressed – everyone ignores you. So, following that logic, the last thing you want to buy is a stock or industry that appears on the cover page of popular financial publications. Commodity and energy bulls should take note of last weekend’s Barron’s cover.

“COMMODITIES: TIME TO BUY,” Barron’s practically screamed at its readers. In case you can’t read the fine print on the cover, it says, The harsh selloff in energy, gold, and other commodities is starting to look like capitulation. Opportunities in Exxon, Chevron, BHP, Goldcorp. Plus six funds and six ETFs to help build a position in this oversold sector.

I presume the photo is supposed to show the sun rising on an oil rig, not setting. The article quotes some very smart people who are bullish on commodities right now. Some energy stocks look like real bargains. Barron’s is simply repeating the market’s conventional wisdom: After a brutal decline, oil prices are stabilizing and should head higher as the global economy recovers.

That’s a perfectly defensible position – but I think it’s wrong.

It’s wrong because it misses a major shift in the way we produce energy. Many people think OPEC’s high oil and gas prices led to the US shale energy boom. That’s not right. The shale boom was born in a time of lower energy prices, and it was the result of new technologies that make recovering large quantities of oil and gas less expensive than ever.

I used to get the occasional letter from James Howard Kunstler, who would tell me that whatever letter I had just written was completely bass-ackwards, and how his books explained that we were going to run out of energy and then collapse. His books (Wikipedia lists about a dozen) and dozens of others warned us of Peak Oil. (For the record, James, a certain longtime editor on my staff made sure I got all your letters, reports, and more, as he is firmly in your camp! I kept smiling and saying that he was (and is) wrong; but Charley is a phenomenal editor, and you put up with a few quirks for brilliant editing that makes you look better. Besides, if the world does come to an end, I can wend my way to his survivalist farm and beg for a job and food, although I’m not exactly sure I’m ready to milk goats. Just for old time’s sake.)

I have written for years that Peak Oil is nonsense. Longtime readers know that I’m a believer in ever-accelerating technological transformation, but I have to admit I did not see the exponential transformation of the drilling business as it is currently unfolding. The changes are truly breathtaking and have gone largely unnoticed.

By now, you probably know about fracking, the technology where drillers pump liquids into a well to “fracture” the ground and release oil and gas deposits. It’s controversial in certain quarters, especially among those who hate anything carbon-related.

Fracking technology is moving forward like all other technologies: very fast. Newer techniques promise to reduce the side effects, at even lower operating costs. Furthermore, fracking is only the beginning of this revolution. The Manhattan Institute recently published an excellent (bordering on brilliant) report by Mark P. Mills, Shale 2.0: Technology and the Coming Big Data Revolution in America’s Shale Oil Fields. I highly recommend it.

Mills outlines the way the new technologies are turning this industry on its head. Shale production or “unconventional” production is really a completely new industry.

Here is a short quote: The price and availability of oil (and natural gas) are determined by three interlocking variables: politics, money, and technology. Hydrocarbons have existed in enormous quantities for millennia across the planet. Governments control land access and business freedoms. Access to capital and the nature of fiscal policy are also critical determinants of commerce, especially for capital-intensive industries. But were it not for technology, oil and natural gas would not flow, and the associated growth that these resources fuel would not materialize.

While the conventional and so-called unconventional (i.e., shale) oil industries display clear similarities in basic mechanics and operations – drills, pipes, and pumps – most of the conventional equipment, methods, and materials were not designed or optimized for the new techniques and challenges needed in shale production. By innovatively applying old and new technologies, shale operators propelled a stunningly fast gain in the productivity of shale rigs (Figure 4), with costs per rig stable or declining.

[Look at the above chart for a few moments; it’s truly staggering. In just seven years, the amount of oil per well in some shale plays has risen by a factor of 10! That is almost all due to new technologies that are increasingly coming online.]

Shale companies now produce more oil with two rigs than they did just a few years ago with three rigs, sometimes even spending less overall. At $55 per barrel, at least one of the big players in the Texas Eagle Ford shale reports a 70 percent financial rate of return. If world prices rise slightly, to $65 per barrel, some of the more efficient shale oil operators today would enjoy a higher rate of return than when oil stood at $95 per barrel in 2012.

Read that last paragraph again. Some shale operators can make good money at $55 a barrel. At $65, they can make higher returns than they did three years ago with oil at $95. I have friends here in Dallas who are raising money for wells that can do better than break even at $40 per barrel, although they think $60 is where the new normal will settle out. Texans are nothing if not optimistic.

To continue reading this article from Thoughts from the Frontline – a free weekly publication by John Mauldin, renowned financial expert, best selling author, and Chairman of Mauldin Economics – please click here.

The article Thoughts from the Frontline: Riding the Energy Wave to the Future was originally published at mauldineconomics.com.

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The New Normal for Crude Oil?

By Marin Katusa, Chief Energy Investment Strategist

You may have come across the word “contango” in an oil related news report or article recently and wondered, “What’s contango?”

It isn’t the Chinese version of the tango.

Contango is a condition in a commodity market where the futures price for the commodity is higher than the current spot price. Essentially, the future price of oil is higher than what oil is worth today.

The above forward curve on oil is what contango looks like. There’s more value placed on a barrel of oil tomorrow and in the future than over a barrel today because of the increased value of storage.

I personally believe our resource portfolios are in portfolio contango—but that’s an entirely separate discussion that I’ll get to later. In today’s missive, I want to focus entirely on oil contango.

Crude oil under $50 per barrel may seem to put most of the producers out of business, but many oil and gas exploring and producing (E&P) companies are sheltered from falling prices in the form of hedges.

Often, companies will lock in a price for their future production in form of a futures commodity contract. This provides the company with price stability, as it’s sure to realize the price it locked in at some future date when it must deliver its oil.

But the market will always figure out a way to make money—and here’s one opportunity: the current oil contango leads to plenty of demand for storage of that extra oil production.

With US shale being one of the main culprits of excess crude oil production, storage of crude in US markets have risen above seasonally adjusted highs in the last year. This abundance of stored crude has pushed the current spot price of crude oil toward five year lows, as current demand is just not there to take on more crude production.

When in contango, a guaranteed result is an increase in demand for cheap storage of the commodity, in order to clip the profit between the higher commodity price in the future versus what’s being paid for the commodity at present. This is precisely what’ playing out in oil today.

Contago, Five Years Later

Looking back at the similarities of the 2009 dramatic free fall in oil prices to $35 per barrel, after a five year hiatus, crude has returned to a similar price point, and the futures market has returned to contango (green shows oil in contango).

Floating Storage Is Back in Vogue

Oil traders are now taking advantage of the contango curve through floating storage in the form of waterborne oil tankers.

This is what a big oil tanker looks like:

I’m personally reminded of contango whenever I look out my living room window:

Here’s a photo taken out my living room window—and this is non-busy part of the harbor. At times when I do my runs along the seawall, there have been up to 30 large oil tankers just sitting in the harbor. (On a side note, Olivier and I went for a run in July along the Vancouver seawall, and we counted 26 oil tankers.) All that pricey Vancouver waterfront will have an incredible view of even more oil tankers in the years to come when the pipelines are eventually built. I can only imagine what the major import harbors of China and the US look like… never mind the number of oil tankers sitting in the export nations’ harbors and the Strait of Hormuz. Multiply the above by at least 50 red circles.

As the spread between future delivery of oil and the spot price widened, traders looking to profit from the spread would purchase crude at spot prices and store it on oil tanker ships out at sea. The difference between the spread and the cost to store the crude per barrel is referred to as the arbitrage profit taken by traders. Scale is a very important factor in crude storage at sea: therefore, traders used very large crude carriers (VLCC) and Suezmax ships that hold between 1-2 million barrels of crude oil.

In the late summer of 2014, rates charged for crude tankers began to climb to yearly highs because of the lower price that spurred hoarding of crude oil. This encouraged VLCCs to lock in one year time charter rates close to and above their breakeven costs to operate the ship.

Time charter rates share similarities to the oil futures market, as ships are able to lock in a daily rate for the use of their ships over a fairly long period of time. VLCC spot rates have reached around $51,000 per day; however, these rates tend to be booked for a shorter period of around three months. These higher spot rates tend to reflect the higher cost paid to crew a VLCC currently against locking in crew and operating costs over a longer-term charter that could last a year. Crude oil is often stored on floating VLCCs for periods of six months to a year depending, on the contango spread.

Floating Storage: Economics

Many VLCCs are locking in yearlong time charter rates at or above $30,000-$33,000 per day, as that tends to be the breakeven rate to operate the vessel. If we assume that a VLCCs charge their breakeven charter rate and we include insurance, fuel, and financing costs that would be paid by the charterer, storage on most VLCCs in the 1-2 million barrel ranges are barely economic at best.

However, they’ll soon become profitable across the board once the oil futures and spot price spread widens above $6-$7 per barrel.

The red star depicts the current spread between the six-month futures contract from the futures price in February 2015. Currently companies are losing just under $0.20 per barrel storing crude for delivery in six months. However, once that $6-$7 hurdle spread is achieved, most VLCCs carrying 2 million barrels of crude will be economic to take advantage of the arbitrage in the contango futures curve.

The VLCC and ULCC Market

VLCC= Very Large Crude Carrier
ULCC=Ultra-Large Crude Carrier

VLCCs store 1.25-2 million barrels of oil for each cargo. Globally, there are 634 VLCCs with around 1.2 billion barrels of storage capacity, or over one-third of the US’s total oil production. The VLCC market is fairly fractioned, and the largest fleet of VLCCs by a publicly traded company belongs to Frontline Ltd. with 25 VLCCs. The largest private company VLCC fleet belongs to Tankers International with 37 VLCCs. In early December, Frontline and Tankers International created a joint venture to control around 10% of the VLCC market. Other smaller VLCC fleets belong to DHT with 16 VLCCS, and Navios Maritime with 8 VLCCs.

The lowest time charter breakeven costs of $24,000 per day are associated with the largest VLCC fleet from Frontline Ltd. and Tankers International. This is followed by the smaller fleets that have time charter breakeven costs of around $29,000 per day. Of course, on average the breakeven costs associated with most VLCCs is around $30,000 per day, and current time charter rates are around $33,000.

Investing in companies with VLCC fleets as the contango trade develops can generate great potential for further profits for investors. The focus of these investments would be between the publicly traded companies DHT Holdings, Frontline Ltd., and Navios Maritime.

But one must consider that investing in these companies can be very volatile because of the forward curve’s ability to quickly change. It isn’t for the faint of heart.

However, if current oil prices stay low, there will be an increase in tanker storage and thus a sustained increase in the spot price of VLCCs. However, eventually low prices cure low prices, and the market goes from contango to backwardation. It always does and always will.

Shipping companies have been burdened by unprofitable spot and charter pricing since the financial crisis, and these rates have only recently started to increase.

Warning!

As I sit here on a Saturday morning writing this missive, I want to remind all investors now betting on this play that they’re actually speculating, not investing.

There’s a lot of risk for one to think playing the tankers is a sure bet. I have a pretty large network of professional traders and resource investors, and I do not want to see the retail crowd get caught on the wrong side of the contango situation.

In the past, spot rates for the VLCCs usually decline into February and have dropped to as low as under $20,000 per day. It is entirely possible that if the day rates of VLCCs go back to 2012-2013 levels, operators will lose money.

Conclusion: this speculation on tankers is entirely dependent on the spot price and the forward curve.
The risk of this short term trade is that these companies are heavily levered, and some are just hanging on by a thread. Although this seasonal boost to spot rates has been a positive for VLCCs and other crude carriers, the levered nature of these companies could spell financial disaster or bankruptcy if spot rates return to 2012-2013 levels.

What should be stressed are the similarities to the short-lived gas rally in the winter of 2013-‘14, and the effect these prices have had on North American natural gas companies. A specific event similar to the polar vortex has occurred in the oil market, which has spurred a seasonal increase in the spot price tankers charge to move and store oil.

However, much like the North American natural gas market, the VLCC market is oversupplied; a temporary increase in spot prices that have led to increased transport and storage of oil will not be enough to lift these carriers from choppy waters ahead. Future VLCC supplies are expected to rise, with 20 net VLCCs being built and delivered in 2015 and 33 in 2016. This is much more than the 17 net VLCCs added in 2013 and 9 in 2014.

Another looming and very possible threat to these companies is the same debt threat that affected energy debt markets as global oil prices plummeted. If VLCC and other crude carriers experience a fall in spot prices, these companies’ junk debt could be downgraded to some of the lowest debt grades that border a default rating. This will increase financing costs and in turn increase the operating breakeven costs to operate these crude carrying vessels. The supply factor, high debt, and potentially short-lived seasonally high spot market could all affect the long-term appreciation of these VLCC stock prices. Investing in these companies is very risky over the long run, but a possible trade exists if storage and transport of oil continues to increase for these crude carriers.

Portfolio Contango—An Opportunity Not Seen in Decades

If you talk to resource industry titans—the ones who’ve made hundreds of millions of dollars and been in the sector for 40 years—they’re now saying that they’ve never seen the resource share prices this bad. Brokerage firms focused on the resource sector have not just laid off most of their staffs, but many have shut their doors.

The young talent is the first group to be laid off, and there’s a serious crisis developing in the sector, as many of the smart young guns have left the sector to claim their fortunes in other sectors.
There’s blood in the streets in the resource sector.

Now if you believe that, as I do, to be successful in the resource sector one must be a contrarian to be rich, now is the time to act.

I have invested more money in the junior resource sector in the last six months than I have in the last five years. I believe we’re in contango for resource stocks, meaning that the future price of the best juniors will be worth much more than they are currently.

I have my rules in speculating, and you’ll learn from my experience—and more important, my network of the smartest and most successful resource mentors whom I have shadowed for many years.

So how can we profit from the blood in these markets? Easy.

Take on my “Katusa Challenge.” You’ll get access to every Casey Energy Report newsletter I’ve written in the last decade, and my current recommendations with specific price and timing guidance. There’s no risk to you: if you don’t like the Casey Energy Report or don’t make any money over your first three months, just cancel within that time for a full, prompt refund, no questions asked. Even if you miss the three month cutoff, cancel anytime for a prorated refund on the unused part of your subscription.

As a subscriber, you’ll receive instant access to our current issue, which details how to protect yourself from falling oil prices, plus our current top recommendations in the oil patch. Do your portfolio a favor and have me on your side to increase your chances of success. I can’t make the trade for you, but I can help you help yourself.

I’m making big bets—are you ready to step up and join me?

The article The New Normal for Oil? was originally published at caseyresearch.com

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Make No Mistake, the Oil Slump Is Going to Hurt the US Too

By Marin Katusa, Chief Energy Investment Strategist

If you only paid attention to the mainstream media, you’d be forgiven for thinking that the US is going to get away from the collapse in oil prices scott free. According to popular belief, America is even going to be a net winner from cheaper oil prices, because they will act like a tax cut for US consumers. Or so we are told. In reality, though, many of the jobs the U.S. energy boom has created in the last few years are now at risk, and their loss could drag the economy into a recession.

The view that cheaper oil automatically boosts U.S. GDP is overly simplistic. It assumes that US consumers will spend the money they save at the pump on U.S. made goods rather than imports. And it assumes consumers won’t save some of this windfall rather than spending it. Those are shaky enough. But the story that cheap fuel for our cars is good for us is also based on an even more dangerous assumption: that the price of oil won’t fall far enough to wipe out the US shale sector, or at least seriously impact the volume of US oil production.

The nightmare for the US oil industry is that the only way that the market mechanism can eliminate the global oil glut—without a formal agreement between OPEC, Russia, and other producers to cut production—is if the price of oil falls below the “cash cost” of production, i.e., it reaches the price at which oil companies lose money on every single barrel they produce.

If oil doesn’t sink below the cash cost of production, then we’ll have more of what we’re seeing now. US shale producers, like oil companies the world over, are only going to continue to add to the global oil glut—now running at 2-4 million barrels per day—by keeping their existing wells going full tilt.

True, oil would have to fall even further if it’s going to rebalance the oil market by bankrupting the world’s most marginal producers. But that’s what’s bound to happen if the oversupply continues. And because North American shale producers have relatively high cash costs (in the $30 range), the Saudis could very well succeed in making a big portion of US and Canadian oil production disappear, if they are determined to.

In this scenario, the US is clearly headed for a recession, because the US owes nearly all the jobs that have been created in the last few years to the shale boom. All those related jobs in equipment, manufacturing, and transportation are also at stake. It’s no accident that all new jobs created since June 2009 have been in the five shale states, with Texas home to 40% of them.

Even if oil were to recover to $70, $1 trillion of global oil sector capital expenditure—in fields representing up to 7.5 million bbl/d of production—would be at risk, according to Goldman Sachs. And that doesn’t even include the US shale sector! Unless the price of oil miraculously recovers, tens of billions of dollars worth of oil and gas related capital expenditure in the U.S. is going to dry up next year. While US oil and gas capex only represents about 1% of GDP, it still amounts to 10% of total US capex.

We’re not lost quite yet. Producers can hang on for a while, since there has been a lot of forward hedging at higher prices. But eventually hedges run out—and if the price of oil stays down sufficiently long, then the US is facing a massive amount of capital destruction in the energy industry.

There will be spillover into the financial arena, as well. Energy junk bonds may only account for 15% of the US junk bond market, or $200 billion, but the banks are also exposed to $300 billion in leveraged loans to the energy sector. Some of these lenders are local and regional banks, like Oklahoma based BOK Financial, which has to be nervously eyeing the 19% of its portfolio that’s made up of energy loans.

If oil prices stay at $55 a barrel, a third of companies rated B or CCC may be unable to meet their obligations, according to Deutsche Bank. But that looks like a conservative estimate, considering that many North American shale oil fields don’t make money below $55. And fully 50% are uneconomic at $50.

So if oil falls to $40 a barrel, a cascading 2008-style financial collapse, at least in the junk bond market, is in the cards. No wonder the "too big to fail banks" slipped a measure into the recently passed budget bill that put the US taxpayer back on the hook to insure any ill advised derivatives trades!

We know what happened the last time a bubble in financial assets popped in the US. There was a banking crisis, a serious recession, and a big spike in unemployment. It’s hard to see why it should be different this time. It’s a crying shame. The US has come so close to becoming energy independent. But it’s going to have to get its head around the idea that it could become a big oil importer again. In the end, the US energy boom may add up to nothing more than an illusion dependent upon the artificially cheap debt environment created by the Federal Reserve’s easy money policy.

However, there are a handful of domestic producers with high operating margins that are positioned to profit right through this slump in oil prices. To find out their names, sign up for Marin Katusa’s just launched advisory, The Colder War Letter.

You’ll also receive monthly updates on the latest geopolitical moves in this struggle to control the world’s oil pricing and the energy sector at large and what it means for your personal wealth. Plus, you’ll get a free hardback copy of Marin’s New York Times bestselling book, The Colder War, just for signing up today. Click here for all the details.

The article Make No Mistake, the Oil Slump Is Going to Hurt the US Too was originally published at casey research

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A Scary Story for Emerging Markets

By John Mauldin

The consequences of the coming bull market in the U.S. dollar, which I’ve been predicting for a number of years, go far beyond suppression of commodity prices (which in general is a good thing for consumers – but could at some point threaten the US shale-oil boom). The all too predictable effects of a rising dollar on emerging markets that have been propped up by hot inflows and the dollar carry trade will spread far beyond the emerging markets themselves. This is another key aspect of the not so coincidental consequences that we will be exploring in our series on what I feel is a sea change in the global economic environment.

I’ve been wrapped up constantly in conferences and symposia the last four days and knew I would want to concentrate on the people and topics I would be exposed to, so I asked my able associate Worth Wray to write this week’s letter on a topic he is very passionate about: the potential train wreck in emerging markets. I’ll have a few comments at the end, but let’s jump right into Worth’s essay.

A Scary Story for Emerging Markets
By Worth Wray

“The experience of the [1990s] attests that international investors have considerable resources at their command in the search for high returns. While they are willing to commit capital to any national market in large volume, they are also capable of withdrawing that capital quickly.”
– Carmen & Vincent Reinhart

“Capital flows can turn on a dime, and when they do, they can bring the entire financial infrastructure [of a recipient country] crashing down.”
– Barry Eichengreen

“The spreading financial crisis and devaluation in July 1997 confirmed that even economies with high rates of growth and consistent and open economic policies could be jolted by the sudden withdrawal of foreign investment. Capital inflows could … be too much of a good thing.”
– Miles Kahler

In the autumn of 2009, Kyle Bass told me a scary story that I did not understand until the first “taper tantrum” in May 2013.

He said that – in additon to a likely string of sovereign defaults in Europe and an outright currency collapse in Japan – the global debt drama would end with an epic US dollar rally, a dramatic reversal in capital flows, and an absolute bloodbath for emerging markets.

Extending that outlook, my friends Mark Hart and Raoul Pal warned that China – seen then by many as the world’s rising power and the most resilient economy in the wake of the global crisis – would face an outright economic collapse, an epic currency crisis, or both.

All that seemed almost counterintuitive five years ago when the United States appeared to be the biggest basket case among the major economies and emerging markets seemed far more resilient than their “submerging” advanced-economy peers. But Kyle Bass, Mark Hart, and Raoul Pal are not your typical “macro tourists” who pile into common knowledge trades and react with the herd. They are exceptionally talented macroeconomic thinkers with an eye for developing trends and the second and third order consequences of major policy shifts. On top of their wildly successful bets against the US subprime debacle and the European sovereign debt crisis, it’s now clear that they saw an even bigger macro trend that the whole world (and most of the macro community) missed until very recently: policy divergence.

Their shared macro vision looks not only likely, not only probable, but IMMINENT today as the widening gap in economic activity among the United States, Europe, and Japan is beginning to force a dangerous divergence in monetary policy.

In a CNBC interview earlier this week from his Barefoot Economic Summit (“Fed Tapers to Zero Next Week”), Kyle Bass explained that this divergence is set to accelerate in the next couple of weeks, as the Fed will likely taper its QE3 purchases to zero. Two days later, Kyle notes, the odds are high that the Bank of Japan will make a Halloween Day announcement that it is expanding its own asset purchases. Such moves only increase the pressure on Mario Draghi and the ECB to pursue “overt QE” of their own.

Such a tectonic shift, if it continues, is capable of fueling a 1990s-style US dollar rally with very scary results for emerging markets and dangerous implications for our highly levered, highly integrated global financial system.

As Raoul Pal points out in his latest issue of The Global Macro Investor, “The [US] dollar has now broken out of the massive inverse head-and-shoulders low created over the last ten years, and is about to test the trendline of the world’s biggest wedge pattern.”

One “Flight to Safety” Away from an Earth-Shaking Rally?
(US Dollar Index, 1967 – 2014)



For readers who are unfamiliar with techical analysis, breaking out from a wedge pattern often signals a complete reversal in the trend encompassed within the wedge. As you can see in the chart above, the US Dollar Index has been stuck in a falling wedge pattern for nearly 30 years, with all of its fluctuations contained between a sharply falling upward resistance line and a much flatter lower resistance line.

Any break-out beyond the upward resistance shown above is an incredibly bullish sign for the US dollar and an incredibly bearish sign for carry trades around the world that have been funded in US dollars. It’s a clear sign that we may be on the verge of the next wave of the global financial crisis, where financial repression finally backfires and forces all the QE-induced easy money sloshing around the world to come rushing back into safe havens.

Let me explain…..

The EM Borrowing Bonanza
As John Mauldin described in his recent letter “Sea Change,” the state of the global economy has radically evolved in the wake of the Great Recession.

Against the backdrop of extremely accommodative central bank policy in the United States, the United Kingdom, and Japan and the ECB’s “whatever it takes” commitment to keep short-term interest rates low across the Eurozone, global debt-to-GDP has continued its upward explosion in the years since 2008… even as slowing growth and persistent disinflation (both logical side-effects of rising debt) detract from the ability of major economies to service those debts in the future.

Global Debt-to-GDP Is Exploding Once Again
(% of global GDP, excluding financials)

*Data based on OECD, IMF, and national accounts data.
Source: Buttiglione, Lane, Reichlin, & Reinhart. “Deleveraging, What Deleveraging?” 16th Geneva Report on the Global Economy, September 29, 2014.

As John Mauldin and Jonathan Tepper explained in their last book, Code Red, monetary policies have fueled overinvestment and capital misallocation in developed-world financial assets….

Developed World Financial Assets Still Growing
(Composition of financial assets, developed markets, US$ billion)

Data from the McKinsey Global Institute
Source: Buttiglione, Lane, Reichlin, & Reinhart. “Deleveraging, What Deleveraging?” 16^th Geneva Report on the Global Economy, September 29, 2014.

… but the real explosion in debt and financial assets has played out across the emerging markets, where the unwarranted flow of easy money has fueled a borrowing bonanza on top of a massive USD-funded carry trade.

Emerging-Market Financial Assets Have Nearly DOUBLED Since 2008
(Composition of financial assets, emerging markets, US$ billion)


Data from the McKinsey Global Institute
Source: Buttiglione, Lane, Reichlin, & Reinhart. “Deleveraging, What Deleveraging?” 16^th Geneva Report on the Global Economy, September 29, 2014.

These QE-induced capital flows have kept EM sovereign borrowing costs low….



… and enabled years of elevated emerging-market sovereign debt issuance….



… even as many those markets displayed profound signs of structural weakness.

To continue reading this article from Thoughts from the Frontline – a free weekly publication by John Mauldin, renowned financial expert, best-selling author, and Chairman of Mauldin Economics – please click here.

Important Disclosures

The article Thoughts from the Frontline: A Scary Story for Emerging Markets was originally published at mauldin economics

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EIA: Mexico's Energy Ministry Projects Rapid Near Term Growth of Natural Gas Imports from U.S.

 A combination of higher natural gas demand from Mexico's industrial and electric power sectors and increased U.S. natural gas production has resulted in a doubling of U.S. pipeline exports of natural gas to Mexico between 2009 and 2013. Mexico's national energy ministry, SENER, projects that U.S. pipeline exports to Mexico will reach 3.8 billion cubic feet per day (Bcf/d) in 2018. This would be more than double U.S. pipeline exports to Mexico in 2013, which averaged 1.8 Bcf/d. This projected growth is driven mainly by higher demand from Mexico's electric power sector in both the north and interior of the country.



Nearly three quarters of the projected growth in Mexico's natural gas consumption between 2012 and 2027 is projected to occur in the electric power sector (see graph). This growth is largely driven by private and independently operated power plants, whose natural gas consumption is expected to rise at a 7.9% average annual rate, from 1.6 Bcf/d in 2012 to 4.9 Bcf/d in 2027. By contrast, natural gas consumption from plants operated by national energy company CFE grows at just 0.4% per year, from 1.1 Bcf/d in 2012 to 1.2 Bcf/d in 2027. The growth comes largely from new combined cycle plants, which benefit from greater operational efficiencies and lower emission levels compared to other generation sources. Growth sharply accelerates over the near term but continues through 2027, when power sector consumption reaches 58% of total gas consumption, compared to 47% in 2012.

Mexico's projected growth in natural gas consumption occurs in each of its five market regions: Northeast, Northwest, Interior-West, Interior, and South-Southeast. According to SENER, demand growth is particularly strong in the northern and interior regions of the country.



All natural gas pipeline imports from the United States into Mexico enter the country's Northeast and Northwest regions. Some of these imports enter the country as logistical imports on pipelines owned by private entities, as well as by Pemex's natural gas subsidiary PGPB. The term logistical imports refers to imports that arrive in areas with no other form of access to natural gas. The largest growth in projected pipeline imports takes place from nonlogistical imports on PGPB owned pipelines in the Northeast. An increasing portion of this gas flows through the Northeast south to the interior regions, but much of it also serves increased consumption from the Northeast's industrial and electric generation facilities. Higher natural gas pipeline imports from the United States into the Northeast region meet both higher demand from consumers there and the increased pipeline flows from the Northeast to regions further south.

About three quarters of Mexico's natural gas production comes from associated gas that is produced at Pemex's offshore oil platforms in the South-Southeast region. Natural gas production in the South-Southeast is expected to grow by only 0.4% per year through 2019. Pemex consumes increasing amounts of this production in the near term for its exploration, production, and refining activities. With stagnant growth in the production of associated gas in the South-Southeast and limited capacity for future growth in LNG imports, pipeline imports from the United States become the primary means for Mexico to satisfy national demand growth.

SENER has previously made projections that assumed more robust investment in the development of new gas fields, and a more aggressive and diverse range of well productivity rates. SENER's high natural gas production growth projections included the undertaking of an initiative to enhance recovery rates in the South-Southeast of both gas and oil extracted from offshore fields in the Yucatan Peninsula, as well as development in the Northeast of the Sabinas Basin's La Casita shale gas play and Mexico's portion of the Eagle Ford shale play.

However, there are significant factors that could inhibit the development of shale gas and other basins in Mexico, including the geologic complexity and discontinuity of its shale gas areas, the availability of required technology and water resources, security concerns, and a focus on development of crude oil resources. Even if additional development did occur, Mexico's northern regions would likely still see high growth in pipeline imports from the United States, particularly in areas that lack pipeline connectivity to other parts of the country.

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