Forecast Frenzy

Jim Brown
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It appears to be a contest to see who can make the most bearish forecast on oil prices and project the lowest demand growth numbers for 2015. The energy bears are coming out of hibernation to predict $40 oil and rapidly slowing demand growth. Six months from now we can look back on these forecasts and laugh.

Three weeks ago analysts were warning that oil could drop to $60-$65 and that would be extremely negative for the oil sector. Companies could go bankrupt from the drop in cash flow. Two weeks ago analysts were starting to talk about $50 oil and the 35% of drilling companies that were going to default on their debt, file bankruptcy or be acquired. The magic $50 was discussed with a cringe because analysts wanted to go on record for lower prices but they were hesitant to actually claim $50 was possible.

Last week the cringe worthy number was $40 a barrel. Hitting $50 seemed like a done deal so in order to have your name repeated on CNBC or Fox Business analysts were forced to conjure up a scenario for $40 oil.

The facts started getting in the way to a point when it was learned that China had a record number of crude oil tankers headed their way as they stocked up on cheap oil. A record 83 tankers are enroute to China in December compared to an average of 67 in a normal December. That is 166 million barrels headed for China. VLCC tanker rates surged to $83,605 per day and the highest since January 2010.

West Africa booked 33 VLCC tankers (2.0 million barrels each) for the month of December and a 43% increase over December 2013. The IEA said additional stockpiling could consume 297 million additional barrels in the first half of 2015. That would lift global inventory levels to 2.87 billion barrels and right at the total global storage capacity.

Baker Hughes reported a sharp decline of -29 rigs drilling for oil and the decline is just getting started. Conoco said they were slashing capex by -20%. BP is cutting capex by -$2 billion. Chevron said 2015 spending plans were on hold. Apache cut its North American spending for 2015 by -25%. Halliburton is cutting 1,000 jobs to reduce exposure to a drilling slowdown. I could go on because of the tsunami of capex cuts hitting the wires every day.

The biggest challenge is not $57.50 oil. The challenge is the drop in oil prices in the shale fields. Bakken crude was quoted at $51 on Friday. Canadian Select was $42 and tar sands crude was in the mid $30s. Venezuelan heavy crude was $21 under Brent at $40. We import over a million barrels of their crude every day.

Stephen Schwartzman of the Blackstone Group is raising up to $4 billion for a new fund to invest in energy. He is positively giddy about the buying opportunity he is seeing now. He said in an interview, "I think this is going to be a wonderful, wonderful opportunity for us. It is going to be one of the best opportunities we have had in many, many years."

Thomas Lee of FundStrat Global Advisors pointed out that the Relative Strength Index (RSI) on Brent crude has fallen below 23 for only the fourth time in 26 years. On each of the prior three occurrences oil was higher 100% of the time 3, 6 and 12 months later with an average gain of +74%. Three times over 26 years is not a very big dataset but we should pay attention. My chart program does not go back 26 years on Brent but you have to admit the damage is obvious. We are also at the 2007 and 2009 support lows. 1

The International Energy Agency (IEA) cut its demand forecast for 2015 for the fourth time in five months. The agency now expects demand to rise +900,000 bpd in 2015 to 93.3 mbpd and -230,000 bpd below their prior forecast. The agency had a novel reason. They said the fall in prices would reduce government spending in places like Russia, Venezuela, Brazil and Nigeria. Those countries derive much of their revenue from oil prices and that revenue has fallen -44% in the last six months. This is really going to crimp their operations, which depend on export revenue. The IEA said demand in Russia alone would decline -195,000 bpd to 3.4 mbpd.

The IEA said new supplies outside OPEC should rise +1.3 mbpd in 2015 after a +1.9 mbpd rise in 2014. They only expect U.S. production to rise +685,000 bpd but that may be wildly optimistic. This production is from projects already underway that can't be cancelled. For instance there are several deepwater Gulf of Mexico projects that will begin production to add about 300,000 bpd. These multibillion dollar projects have been in the development stages for years.

The IEA expects the demand for OPEC crude to decline -300,000 bpd to 28.9 mbpd. The current OPEC production quota is 30.0 mbpd and they produced about 3.42 mbpd in November. That was down about 400,000 bpd from October.

OPEC is paying the price for 4 years of $100 oil. When prices were high producers spent their extra cash on new wells to increase production even more. They basically overdosed on the large profits and overspent on new equipment, new wells and new government spending on social programs. With that revenue cut in half they can't afford to cut production now because that will further reduce income. To put it bluntly they are in trouble.

Russia is in serious pain. They are commonly referred to as a first rate military with a third world economy. With 9 mbpd in production the revenue funds the military and allows Putin to project force around the world. With that revenue cut in half and the Ruble, or should we say rubble, crashing into oblivion and Russia in recession and sinking fast we could see another debt default on the horizon. So much for the New Russia that Putin was trying to build. A funny thing happens to dictators that run out of money. They tend to be removed from power. We are about to see that in Venezuela. President Maduro is circling the drain. Inflation is rampant. Revenue is nonexistent. He and Chavez before him have nationalized any business that made money and there is nothing left. The 44% drop in oil revenue is the final straw and the country could implode any day now.

The IEA upgrades their demand forecast every month. It is a moving target. Long term I don't give it much credibility. For instance U.S. citizens each consume an average of 23 barrels of oil per year. The average Indian consumes 3 barrels per year and the average Chinese citizen consumes only 1 barrel. China's economy is now bigger than that of the U.S. and still on track to grow by 7% in 2015. They are the largest car manufacturer with more than 20 million cars a year and growing. They have 1.3 billion people and 1.0 billion are trying to move from an agrarian economy into the 21st century. Their oil demand is going to explode over the next several years. They currently import about 8.0 mbpd and they produce about 4.5 mbpd. If Chinese consumption rose only 1 barrel per person in 2015 they would need twice the 12.5 mbpd they consume now. That is not going to happen in 2015 but it is going to happen over the next several years. China is an emerging economy turning into a developed economy and their oil consumption could double by 2020. India is just like China only growing at a slightly slower pace.

Unfortunately the world's excess production is not going to double in the same period. We are going to be looking back at this oil crash several years from now in amazement and wishing we had mortgaged the home, farm and kids to buy energy stocks.

A trader made a $2 million bet on oil on Thursday that could return $10.9 million. The trader bought 14,500 of the March 53/62 call spreads on the XOP for $1.50 each. That cost $2.2 million. The SPDR Oil & Gas Exploration ETF (XOP) has to close over $54.50 by March expiration to be profitable and over $62 to earn the maximum $10.9 million profit. The XOP closed at $44 on Friday so it has to rise +23% just to break even. The high on November 21st was $63. This trader is betting a lot of money the hysteria will fade and crude prices will rally over the next three months.

Deutsche Bank warned that oil prices below $60 could force restructuring in more than one-third of producers. The banking sector is also declining on worries over exposure to energy loans. Five years ago U.S. E&P companies had $300 billion in debt. Today that number is well over $1 trillion. Analysts claim there is $200-$500 billion in high yield debt that is likely to be distressed with oil prices under $65. Some were recommending shorting the XLF with a March timeframe because we should have a clearer picture of the debt problems by March. I think it would be a lot longer than that. Companies selling debt typically go out 5-10 years so the debt increase over the last 5 years probably won't come due until later in the decade.

I am bullish on energy this weekend. I can see crude touching $50 but the $53.50 level represents a 50% retracement from the highs. This is going to attract a lot of technical buyers. We may jump around a lot in the low $50s but I can't see us moving under the $50 level for more than a few days.

The demand growth story is still intact despite the lowered estimates. Demand is still growing despite the scary headlines. Read them carefully. They say demand "growth" is slowing. That means instead of demand rising by 1.2 mbpd as it has for the last several years it may only rise by 600,000 bpd in 2015. The stockpiling by oil importing countries is going to suck up excess inventories and put us back to neutral with supplies. Production 3-6 months from now is going to slow. Institutional investors understand buying at the bottom in anticipation of higher prices six months later.

If you are an investor you are probably familiar with the Warren Buffet quote, "buy when others are fearful and sell when others are greedy." There is another one that says "buy when there is blood in the streets." That refers to wars, civil unrest, etc but the concept is the same. There is blood in the energy sector and investors are definitely fearful. Energy stocks are on sale. Get some before the sale ends.

Oil Inventories

Crude oil inventories rose +1.5 million barrels to 380.8 million. This was slightly more than expected but it had no impact on the market. Cushing inventories rose to 24.9 million barrels and a multi-month high. U.S. production rose to 9.118 mbpd and the highest level since 1983. Imports rose +365,000 bpd.

The big news was the surge in gasoline with a gain of +8.2 million barrels to 216.8 million and also a multi-month high. Apparently refiners are expecting the low prices to stimulate demand and they are planning ahead. Imports declined by -263,000 bpd or the inventory gains would have been even higher.

Refinery utilization rose to a multi-year high at 95.4%. This is well over the normal level for this time of year. The last time we saw utilization this high was in 1998. I am wondering if refiners are not trying to process all their high dollar oil in inventory and turn it into gasoline while they can still get a decent price. With gasoline prices declining for 78 consecutive days and oil prices collapsing the refiners don't want to be stuck holding $90 oil and selling it as gasoline for $1.40 (futures price). That would create a major loss for the refiners.

If they flush that high dollar oil in inventory they can replace it with $56 oil today and once the rebound begins they will be selling the refined products for a lot more. This is just a guess on my part. What would you do? They also want to reduce the amount of oil in inventory to avoid paying taxes on it at year end.

Diesel inventories rose +5.6 million barrels to 121.8 million. Obviously diesel was benefitting from the same surge in refining as gasoline. Imports also rose +53,000 bpd.

Gasoline demand declined significantly from 9.43 mbpd to 8.55 mbpd. This report was for the week ending December 5th so the high the prior week was the lead up to Thanksgiving and Black Friday. The week covered in this report was the week after Thanksgiving and nobody was traveling to or from Grandma's house for turkey dinner. I expect the demand numbers to level out at about 9.0 mbpd or slightly higher for the next three weeks as holiday shopping begins to take on a new urgency.

In the graphic below green represents a recent high and yellow a recent low.

Propane inventories declined slightly by +.26 million barrels to 79.16 million. Demand rose slightly from 1.24 mbpd to 1.30 mbpd.

Natural gas inventories declined -51 Bcf to 3,359 bcf. Inventories are now -9.5% below the five year average at 3,710 Bcf and -5.2% below year ago levels at 3,545 Bcf.

The blue line in the chart below shows the current inventory relative to the five year average.


The market had its worst week since May 2012 with the Dow declining -677 points. This was related to the drop in oil prices, weak economic data out of China, fear of the FOMC statement this coming Wednesday, worry over a possible government shutdown over funding and concerns about the Japanese election on Sunday.

This week the FOMC statement on Wednesday is the biggest hurdle. Crude prices are down to $56.50 on Sunday night and nearing a catastrophic level. The decline should end soon despite all the energy bears coming out of the forest. Astute investors are already taking positions in the best stocks in the sector.

Jim Brown

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