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Time to Call the Oil Bulls Back Home

Joe Mac's Macro Blog: July 3, 2017
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MRP’s Long Energy theme is predicated on the view that oil prices will soon rise to the $60 - $80 per barrel range. But, in the past four months, oil has headed in the other direction. After doubling from its February 2016 low, the price of US crude oil has slumped to the mid-$40s. Traders are convinced that the world will remain awash in oil, and its price can only go down. But MRP believes otherwise. In fact, we see an oil shortage looming ahead.

STRONGER U.S. DEMAND: It is projected that a record 37.5 million Americans will drive 50 miles or more from home during the Independence Day holiday weekend of June 30th to July 4th. This period also kicks off the second half of the calendar year. Drivers traveled 53 billion more miles in the latter half of 2016 than in the first half.  In each of the first four months of 2017, American drivers have easily surpassed miles driven over the same periods in 2015 and 2016. That trend is expected to continue for the rest of this year, especially with gas prices at their lowest in 12 years.

STRONGER GLOBAL DEMAND: In their June Short Term Energy Outlook, the US Energy Information Administration (EIA) upwardly revised its forecast for global consumption of petroleum & other liquids to 98.46 million barrels per day in 2017 (a YoY increase of 1.54 million b/d), and to 100.08 million b/d in 2018. According to the International Energy Agency (IEA), worldwide demand for oil is expected to grow strongly at least to 2022.

DECLINING SHALE PRODUCTION AHEAD: Shale now makes up 48% of all US crude production and, although shale firms are helping set records for output, most are losing money or just barely breaking even. Since 2011, the largest 30 independent U.S. shale producers spent an average of nearly $1.33 for every $1 they made drilling wells. In the past two years, those 30 have lost $130 billion, and more than 120 companies have gone bankrupt. Many of those that survived have hedging programs that have protected them from this year’s oil slump, but eventually the hedge maturities will expire. In the meantime, drilling and production costs are rising. Shale companies will either have to moderate production or risk drilling themselves out of business. Perhaps as a sign of things to come, the U.S. rig count fell last week for the first time in 24 weeks. 

DECLINING GLOBAL INVENTORIES: Despite all the headlines about U.S. fracking flooding the market with crude, BP’s Statistical Review of World Energy showed earlier this month that 2016 saw Global oil production rise by only 0.5%, the lowest percentage increase since 2009. Meanwhile, The 21 country petrol syndicate formed by OPEC and other oil-producing nations last November has thus far achieved more than 104% compliance on desired output reductions from OPEC members in each of the last 3 months. Non-OPEC members as a whole have lagged behind, but did post a respectable 86% compliance measure in May. The syndicate has agreed to extend the 1.8 million b/d cuts through at least next March. As the stockpiles continue to shrink, the oil market will rebalance itself. If shale production sharply drops as we expect, there could be a temporary supply deficit.

Year over year change in U.S. crude days of supply, the ratio of current stock level divided by product supplied, has shown an inverse relationship to crude prices. When a 9 week lag period is applied to days of supply, the correlation is amplified. Currently, just as days of supply has been decreasing, the price per barrel of crude has rebounded 7% over the last week. It is MRP’s view that prices will continue to rise well above the recent lows throughout the rest of the year.

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Joe McAlinden jpegJoseph McAlinden, CFA, is the founder of McAlinden Research Partners and its parent company, Catalpa Capital Advisors. He has over 50 years of investment experience. Previously, he was at Morgan Stanley Investment Management for over 12 years, first as chief investment officer and then as chief global strategist. During his 10 year tenure as CIO, Joe was responsible for directing MSIM’s daily investment activities and oversaw more than $400 billion in assets. As chief global strategist, he developed and articulated the firm’s investment policy and outlook. Joe frequently appears in the financial media including Bloomberg Television. Follow JoeMac on Twitter

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