Andrew J. Hall, the head of commodity hedge fund Astenbeck Capital, and sometimes referred to as the “Oil God” is still holding onto his view that the price of oil will rise substantially from current levels.

In Astenbeck’s second quarter letter to investors, a copy of which has been reviewed by ValueWalk, Hall writes that if you look past the media hype, oil market fundamentals are steadily improving, however, “the market is not concerned whether current prices are sustainable. The market is being driven by its own momentum and currently that is down.”

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But in the August 1st letter Hall doesn’t expect this trend to last much longer. He continues, “extreme positioning coupled with improving fundamentals should ultimately – and at potentially any time – result in a strong reversal. Thereafter, as the improving supply and demand picture becomes more apparent, prices will need to rise to higher levels on a more sustained basis if future supply is to be adequate to meet future demand.”

This isn’t the first time Hall has made such a forecast. Within Astenbeck’s first quarter letter to investors Hall claimed that the price of oil is heading to $80 a barrel during 2016 thanks to a smaller than expected oil “glut”, moderation of rhetoric from Saudi Arabia and “near total capitulation” by E&P companies – see: Andy Hall: Oil Prices Could Be Headed To $80 In Next 12 Months

As of yet, Hall’s $80/bbl target remains elusive, but the oil trader sees some positive developments playing out in the oil market.

Photo by lalabell68 (Pixabay)
Photo by lalabell68 (Pixabay)

Andy Hall letter: Key Takeaways

According to Andy Hall, the recent fall in oil prices can be attributed to nervous investors. Data suggesting that the rebalancing of the oil market has slowed down considerably has sent traders into a tailspin:

“While the initial downdraft was sparked by a strengthening dollar, the real culprit were data that suggested the rebalancing of the oil market had slowed down markedly. In particular, recent data show that total oil inventories continued to edge higher here in the U.S. This, and an uptick in U.S. drilling rig counts, brought back memories of last summer’s oil debacle. Longs liquidated, shorts piled in and prices have given back most of the gains made in Q2.”

The reason oil prices have come under renewed pressure is largely due to enormous changes in positioning triggered by some disappointing data points.”

However, if you look past the price action, oil market fundamentals are starting to come into line:

“Supply and demand have come into balance. Over the coming 12 months, on most reasonable assumptions, demand growth should continue to outstrip supply growth. This should with time lead to the elimination of surplus inventories and necessitate prices rising on a sustained basis that creates supply rather than destroys it.”

And the oil market is in a much better position than it was this time last year:

“Parallels to last year are overblown. Last year, from January through June, observed global commercial oil inventories grew by about 1.5 million bpd. This year they grew by less than 0.4 million bpd. That is half the average rate of growth seen in 2011-2014 of 0.80 million bpd and implies surplus inventories were reduced by about 80 million barrels, at least when seasonal considerations are taken into account.”

Claims that the oil industry can cope with prices sub $50/bbl are spurious according to Hall:

oil prices volume august-2016 chart via Capital-IQ
Chart via S&P Capital IQ

“Whereas previously companies had indicated they might increase activity if WTI prices stayed above $50, based on comments from companies like Anadarko, Hess and Baker Hughes, that bar has now been raised to $60. Only Pioneer Resources among the larger operators has indicated a willingness to add rigs at sub $50 prices and that’s because they have the best acreage in the best shale play, the Permian Midland basin. For more and more companies, debt is becoming a constraining factor. So it seems unlikely that the recent uptick seen in U.S. oil directed rig counts will be sustained.”

Lower production costs have come at the expense of oil service providers, but this favourable environment won’t last for long:

“Major oil service companies like Baker Hughes and Schlumberger have said they will seek to raise their prices at the first opportunity since at current levels they are losing money. This will inevitably result in higher costs for the E&P companies as activity picks up. There is also some evidence that the rapid efficiency gains seen in recent years in shale oil production are coming to an end as companies exhaust the best drilling locations”

What about that deluge of oil from Iran? Well, Iran has already ramped up supply but the market seems to have taken it in its stride:

“Last year the market was confronting the prospect of Iranian production and exports increasing sharply following the lifting of sanctions at the end of 2015. No one was really sure how quickly the Iranians would be able to ramp things up.

As it turned out, they made it happen very quickly – faster than virtually anyone expected. Supplies from Iran have surged in the first half of 2016. It’s still not totally clear how much of this additional oil has come from production as opposed to inventories and reduced refinery runs.

But regardless, the rate of increase of Iranian production will be much slower going forward.”

Finally, on those abnormally high gasoline figures Hall writes:

 “While U.S. gasoline inventories seem quite elevated in absolute terms, relative to demand they are much closer to normal levels, given the strong growth that has taken place in the past couple of years. Expressed in terms of days of cover of domestic finished gasoline supplied plus exports of gasoline, current inventories are about 1 day above normal levels for this time of year. That translates to about 10 million barrels, which does not seem overly burdensome.”

“Once inventories start to visibly fall in the U.S. it will provide a powerful boost to confidence.”

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