Andy Hall’s Astenbeck Capital annual letter for the year ended December 31, 2015. The “Oil G-d” is still bullish despite the near universal gloom surrounding the now (nearly worthless) commodity. It is hard to find many long term managers that are not extremely bullish on the asset class but Hall lays out his thesis below in a letter to investors obtained by ValueWalk. Another hedge fund which is going long on the sector is Elm Ridge Capital. The hedge fund recently sent a presentation to investors detailing the bullish case for oil, and we recently posted that commentary here. Besides, for Elm Wood and Astenbeck Capital it is hard to think of other names who are long. Anyway, without further to do readers can find the full letter below. The latest Astenbeck Capital news was first reported by Barani Krishnan of Reuters.
If 2015 ended badly, then the start of 2016 was even worse. Global markets were wracked by pessimism over the outlook for economic growth. The epicenter of this anxiety was China. Concern that the Fed’s move to raise rates looked premature added to the worries. The price of oil continued to plunge along with those of other risk assets. This only added to the negativity: oil’s collapse was being read as the harbinger of some greater economic malaise.
Astenbeck Capital: 25 percent rally in oil spot prices
Sentiment has since improved somewhat as central banks yet again announced further easing (BOJ) or its possibility (ECB). Some sanity also returned to oil markets when the head of Saudi Aramco suggested that prices had totally detached from reality. These comments along with rumors of possible cooperation between Russia and OPEC to curb production helped to trigger a 25 percent rally in spot prices. Even so they are still almost 10 percent lower since the start of the year.
It is the nature of markets to overshoot both on the way up and on the way down. Predictions of $200 oil in 2008 helped spur prices to unsustainable and self-defeating levels and contributed to the subsequent global economic collapse. Similarly predictions of $20 and even $10 oil have helped to exacerbate the impact of what in reality is a relatively modest oversupply. We estimate it to be about 1 percent of global oil consumption. This is at a time when spare production capacity has seldom been lower and geopolitical risks higher. Nonetheless, one emboldened pundit pronounced last week on CNBC that he would never again see $44 oil in his lifetime. As far as we know this expert is in rude health so his call is a brave one for the reasons we discuss below.
[drizzle]The oil industry had already shelved $400 billion of projects when oil was trading at $50-60. Oil prices below $40 will see further curtailment in investment. At $30 and lower huge swathes of the industry become totally uneconomic and face insolvency. Because of transportation and quality differentials, Brent and WTI trading at $30 means that prices for many grades of crude oil are actually in the $20 range or lower, putting them not much above, and in some cases below, their lifting costs. Prices for West Canadian Select – the principal Canadian export grade – hover in the mid-teens or about half the cash cost of production. Canadian bitumen is selling in the single digits. For a few days last month the posted price for some grades of crude oil in Wyoming were actually negative which meant producers had to pay users to take the stuff away.
Astenbeck Capital: E&P companies scaling back production
A recent analysis by Calgary-based analysts RSEG reckons that virtually no North American E&P company covers its borrowing base with WTI at $30 – that is to say these companies’ proved developed (PD) assets are worth less than their net debt. This makes it difficult if not impossible for these companies to raise new debt. Moreover, PD assets decline with production so to maintain debt coverage requires production to also be maintained. In order to do this at current strip prices and stay within cash flows requires new wells to have breakevens below $30 for the top tier operators. For the second tier operators the required breakeven is below $20. Actual well breakevens are at roughly double this level for even the very best operators. For third tier operators current netbacks are negative so it behooves them to actually let production decline regardless. This means then, at current strip prices, the entire E&P industry is, sooner or later, headed for insolvency as they burn through their cash reserves. Dozens of smaller operators had already filed for bankruptcy by the end of 2015 owing in aggregate $13 billion according to law firm Haynes and Boone. Even assuming a price recovery later this year, analysts predict that up to a third of U.S. E&P companies and half of U.S. shale drillers could disappear in 2016 because of insolvency. To increase their odds of survival, the stronger companies are again slashing their capital expenditure budgets. Last week, Hess, Continental Resources and Noble Energy announced cuts for 2016 ranging from 40 percent to 66 percent.
It’s not just the independent E&P companies and shale drillers that are hurting. Chevron just reported a quarterly loss of around $600 million, the first loss for the company in 13 years and much worse than had been predicted by the analyst community. In response, the company announced it was cutting its 2016 capex budget by 24 percent.
Across the globe, companies are now guiding production forecasts lower as they once more take the axe to capital expenditure. Canadian producer Husky Energy scaled back its production forecast for this year by about 5 percent. Two weeks ago China’s CNOOC set out plans to cut capex by more than 10 percent in 2016 and reduce oil production by around 5 percent. The annual production forecast by CNOOC’s listed entity is an early proxy for the investment and production plans of the other state-controlled Chinese oil producers. Chinese oil production last year was over 4 million bpd. Producers in the North Sea – which saw production grow in 2015 because of projects initiated when oil was $100 – are also retrenching. Rig utilization last month had fallen to 63 percent in the U.K. sector and 71 percent in the Norwegian sector, the lowest levels since at least 2000 according to RigLogix. Operating costs in the North Sea run as high as $45/bbl according to Macquarie Group Ltd. Rig Zone, RigLogix’s parent company, also reports a slowdown in offshore drilling in the Gulf of Mexico and Southeast Asia.
National oil companies too are reeling along with the governments that depend on the oil revenues they generate. The IMF parachuted into Azerbaijan last week to discuss the terms of a possible $4 billion bailout. Oil accounts for 95 percent of Azerbaijan’s exports. The country has been plunged into crisis as its oil revenues have collapsed and with it the government’s virtual sole source of income. Scattered protests have already occurred in response to rising prices and unemployment following the collapse of the manat – the local currency. Oil production in Azerbaijan looks set to contract by around 5 percent in 2016 as