oil

Fundamental Shifts

Oil prices shrugged off OPEC's bullish announcement last week as the Organization of the Petroleum Exporting Countries (OPEC) agreed to extend its production cuts for nine months (through March 2018) at its semiannual meeting. The agreement was generally expected given prior meetings and comments from various countries involved. The cuts, representing about 2% of global supply, come mostly from Saudi Arabia and its Arab member nations, as well as a few nonmember nations, most notably Russia. The extension had been broadly communicated in recent days and oil was down after the news broke as some market participants likely expected a bigger cut or a longer extension into mid-2018. Much of the weakness in energy prices has been due to the surprising (to some) rebound in American production even in light of $45 $55 oil. This production growth is coming from both shale oil and increasingly offshore oil.

Improvements in offshore oil production technology are driving the cost of deepwater
oil production in a similar fashion to the way fracking and horizontal drilling drove down the cost of shale oil production. According to Wood Mackenzie Ltd, pumping crude from sea beds thousands of feet below water is turning cheaper because producers are implementing cost improvements and streamlining operations in core wells. That means oil at $50 a barrel could
sustain some of these projects by next year, down from an average breakeven price of about $62 in the first quarter of 2017 and $75 in 2014, the energy consultancy estimates.

The falling production costs make it more likely that investors will approve pumping crude from such large deepwater projects, the process for which is more complex and risky than drilling traditional fields on land. That may compete with OPEC’s oil to meet future supply gaps that the group sees forming as demand increases and output from existing wells naturally declines. Over the next three years, eight offshore projects may be approved with breakeven prices below $50, according to a Transocean Ltd. presentation at the Scotia Howard Weil Energy Conference in New Orleans in March. Eni SpA could reach a final investment decision on a $10 billion Nigeria deepwater project by October.

While costs for shale production, known as tight oil, are edging higher now, expenses associated with deepwater drilling are finally coming down. Rental rates for drilling rigs have been cut in half since 2014, and companies are redesigning projects to be more cost efficient instead of to maximize output.

According to Fitch Group’s BMI Research, deepwater exploration will see “renewed momentum” over the rest of 2017 as large integrated oil companies look to capitalize on lower service costs and strengthening fiscal positions. In the U.S. Gulf of Mexico, a more costefficient
design for deepwater projects has reduced the breakeven cost at many wells to below $40 a barrel.

(Additional investment specific comments follow for client subscribers)

Sources:

https://www.bloomberg.com/news/articles/20170530/
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Salmon Oil

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One salmon now costs more than one barrel (42 gal.) of crude oil.

The statistic seems mind-boggling on the surface, and is even more mind-boggling under the surface as we will see, but nevertheless, there it stood as fact on the virtual “pages” of www.bloomberg.com, along with several years of salmon and oil price data.

Both salmon and oil are used primarily for their energy content. Salmon is generally converted to human or animal (e.g. grizzly bear) energy while oil is typically used to power various machines. A typical 10lb salmon contains 10,000 calories. Our representative salmon could sustain average human activity for about 5 days. One barrel of oil contains 1,500,000 calories, or enough energy to sustain human activity for 2 years!

Something to chew on… 

Markets start off 2016 with a bang…and then a rebound

There was no shortage of market excitement in January. Unfortunately, that excitement initially took place in a big way to the downside in nearly every major asset class. Measured from the end of 2015 to the market lows around January 20th, nearly every asset class experienced significant declines with the notable exception of gold. 

The S&P 500 fell 11%, while international developed markets fell 12%. An emerging market index dropped 14%, high yield bonds fell 6%, and a gold mining stock index declined 10%. Large cap notables including Apple and Exxon fell similarly, 12% and 8% respectively. Then it was as if someone had flipped the light switch back on! From the monthly lows the S&P 500 rose 7%, international developed markets increased 8%, emerging market stocks climbed 10% and high yield went up 5%. Exxon finished the monthly almost back to where it started the year and Apple clawed back about half of its losses. The gold mining stock index climbed 15% from the lows while gold itself continued rising all month long finishing with a monthly gain around 5%.

This remarkable action punctuates a period of heightened uncertainty. Among other factors, central bank policy, international economic struggles, turbulence in the energy markets, and political uncertainty all played a role. Market volatility may continue for some time (or it may not, we aren’t making a prediction here), but it certainly serves to underscore one of the primary principles of investing. We don’t want to be forced or pushed to sell into steep market declines. Proper portfolio construction and risk assessment mean that we are prepared ahead of time in order to either do nothing and let the storm pass, or perhaps take advantage of market panic by buying assets cheaper than they would otherwise be. 

Statistically speaking

Bear markets are defined as declines of at least twenty percent from peak to trough. Likewise, bull markets are defined as price gains of at least twenty percent from trough to peak. Why twenty and not some other number? Our guess is the reason probably has more to do with the fact that most of us have ten fingers and ten toes than any other significant cause. For any long term investor both bull and bear markets are inevitable and a perfectly normal component of the market milieu. While many (particularly the media) focus on the scary and sensational news component of bear markets, and some even think it is possible to avoid them altogether, professional investors know that bear markets represent the periods of time when the likelihood and magnitude of future gains are highest. Therefore, they are to be studied with a mindset geared toward to buying assets rather than selling them.

Andrew Sheets and his team at Morgan Stanley crunched the numbers of forty bear markets in the last fifty years spanning multiple equity asset classes. They found that the average bear market has lasted roughly 190 to 270 business days, although the shortest and longest were substantially outside of this range. Bear market declines typically ended with roughly 30% declines measured from peak to trough. 

The current emerging market bear (as measured by the MSCI Emerging Markets Index) is currently 370 days old and at a total decline of roughly 35%. The S&P 500 has not technically entered into a bear market yet. Since May, its decline has registered roughly 15% over 160 days.

Andrew’s team also looked at the historical market behavior in the subsequent months following a decline meeting the official definition of a bear market. Looking at the history of the MSCI All Country World Index, measuring three months forward from the day marking at least a 20% decline showed an average additional loss of about 10%. Again, measured from the bear market demarcation date, “fast-forwarding” in time twelve months showed an average gain of 30%!

It is very important to point out that market history is exactly that, just the measurement of price movements in the past, and as such, it doesn’t provide a crystal ball forecast of the future. However, it has been said that while history may not repeat, it often rhymes. Understanding typical behavior in the relatively recent past can shed some light on probabilities, and typical ranges of outcomes, that can be quite useful.