Wrong Number, Right Idea
While there are actually other stories unfolding in the world of energy, you would never know that from my email inbox. Most of the correspondence I have received in the past week is still focused on oil prices, particularly following the big late-week rally in crude futures.
As I advised in this column last week (Panic Creates Opportunity) the fearful trading had created an opening last seen in 2008. While we don’t yet know whether we’ve seen the absolute bottom of this cycle, my strong belief is that crude oil below $40/bbl is a price point that simply can’t be maintained for long in today’s world.
Almost on cue, the price of WTI responded. After dropping below $40/bbl for the first time in over six years (more on that below), WTI closed on Aug. 24 at $38.24/bbl. But by the end of the week the price surged. On Thursday, WTI and Brent prices both jumped over 10%, the largest one-day percentage gains since March 2009 for WTI and since December 2008 for Brent.
Friday saw a lot of oil bears covering short positions as WTI tacked on another 6.3% to close the week at $45.22. The 16% gain on Thursday and Friday was one of the largest two-day gains in the past 25 years. Beleaguered oil stocks notched double-digit gains across the board.
Of course this doesn’t mean we have hit bottom. The operative word here continues to be volatility, as Tuesday’s plunge in oil prices reminds us. The path forward is likely to continue to be rocky. But dips like we saw last week should be viewed as opportunities for long-term investors.
Now, let’s address one of my January predictions. Most of these won’t be proven right or wrong until the year ends. For example, “The average Henry Hub spot price for natural gas will be below $3.50/MMBtu in 2015.” While that prediction is certainly on track to be correct, we will need to be at or near the end of the year to be certain.
There were two, however, that could be proven right or wrong during the course of the year. One of those predictions was “The closing price of West Texas Intermediate (WTI) crude will not fall below $40/bbl in 2015.” As we know, WTI did close below $40/bbl last week, making this the first of my 2015 predictions to end up wrong.
I began to get emails almost immediately after it happened. They came mostly from the crowd predicting $20 oil, claiming vindication for their view of much lower oil prices. One went so far as to chastise me for “having the audacity to make predictions in this uncertain climate.” This from a person who has been predicting much lower prices.
So let’s address first things first. Yes, that prediction was wrong. When we tally up the score at the end of the year, that one goes into the “Wrong” bucket. But that doesn’t mean this was a prediction without value.
I make predictions to set up a narrative that describes what I see in the market. As I always indicate when going out on a limb, the context of the predictions is important. In this case, the context was “$40 is so ridiculously cheap for crude that I don’t think we will get there.”
I considered this my riskiest prediction when I made it, because WTI was already in the $40s and dropping at a rate that would have taken it below $40 by the end of January unless it changed course. So it was a prediction that had the potential to be wrong shortly after I made it.
Instead, the prediction survived until nearly September. On Jan. 28 WTI closed at $44.08, but then ran back up to $53.56 over the following three weeks. Then WTI retraced to $44.02 by March 19 on concerns of growing crude oil inventories before running back up and bouncing around $60/bbl for most of May and June. So for most of the year, the price proved to be pretty resistant to $40 — even though each time the price reached the low $40s, there were predictions that oil would continue to fall, possibly to as little as $10/bbl.
While the prediction is now wrong, the future will dictate whether the context was wrong as well. If oil falls to well below $40 and remains there for an extended period, then my narrative will turn out to have been wrong. I still don’t see that happening. So even if the bottom proves to have been $38, I still view this as an unsustainably low price for oil. At present, U.S. oil production is falling, and global demand is increasing by about 150,000 bpd per month. On the other hand, crude oil inventories are still high. The next major price move by oil will probably be dictated by how quickly falling production and rising demand can put a dent in crude oil inventories.
By the way, I said above that two of my 2015 predictions could be proven right or wrong before year end. The prediction on a $40 floor for WTI could be (and was) proven wrong. The other — “BP (NYSE: BP) will be bought out or merged in 2015” — only had the potential to be proven correct before year end.
Again, that prediction is about narrative. It was a long shot for several reasons, and while the $40 prediction was the riskiest, as I noted when I made it, the BP prediction was the most aggressive. A lot of things have to fall into place for that to happen, but the narrative behind this prediction was that even after the unsettled legal liabilities were considered, BP was grossly undervalued relative to the other oil supermajors. And year-to-date, even though it has been a bad market all around the energy sector, BP has outperformed its supermajor rivals. Year-to-date, the share price of BP has performed 6 percentage points better than ExxonMobil (NYSE: XOM), nearly nine percentage points better than Shell (NYSE: RDS-A), and more than 15 percentage points better than Chevron (NYSE: CVX). So this could ultimately turn out like the $40 prediction — wrong, but with a useful (and actionable) narrative.