It seems as if Andy Hall of Astenbeck Capital Management, who was once known as the ‘Oil God’ thanks to his skill at predicting the direction of oil markets, has finally changed his view on oil prices. Since the beginning of 2015, when oil prices first started to slide, Hall’s belief that the decline is only temporary has been unwavering, and as other oil bulls have thrown in the towel, Hall has continued to try to justify his bullish stance.
However, it now looks as if Hall has become the latest oil bull to capitulate. In a July 3rd letter to investors of Hall’s oil-focused hedge fund, Astenbeck Capital, a copy of which has been reviewed by ValueWalk, the fund manager strikes a downbeat note and seems to finally admit that OPEC is no longer in control of the market and shale’s dominance now means $50 oil is the new normal.
Astenbeck Capital Management Oil Update
Hall starts his letter by acknowledging that oil fundamentals have only deteriorated over the past six months as “demand growth seems to be somewhat less than anticipated while supply keeps surprising to the upside.” Meanwhile, “the expected acceleration in inventory drawdowns has not materialized – at least as evidenced by available high-frequency data.”
There are two main driving forces behind these fundamental changes, one long-term, the other short-term.
The long-term factor is “it is becoming increasingly evident that, under most reasonable scenarios, U.S. shale oil will be the marginal source of supply, at least until 2020” Hall writes. The most significant contributor to this is that the “cost of this oil is significantly lower than was believed to be the case even a few months ago,” and as a result “the long-term price anchor for oil has moved lower.” According to Hall’s letter, the price anchor has now fallen to $50 a barrel, down from $60 at the start of the year. Specifically, Hall writes:
“Technological advances have continued to drive down well breakevens as well as expand the shale oil resource base in the U.S. In a recent report, PIRA estimated that there are now 80 billion barrels, or half of the recoverable U.S. shale oil resource base, that is economic at $50 Brent (say $48 WTI) or less. This represents some 215,000 well locations. Each of these on average can produce around 300 bpd in its first year on stream. The current horizontal oil rig count is 650 and has been growing at a rate that would bring the count to close to 800 by the end of the year. 800 rigs can drill about 15,000 wells per annum which means potentially 4.5 million bpd of gross new production.
A recent Goldman Sachs analysis posits continued productivity growth for years ahead. This will be driven by higher rates of recovery of initial oil in place through the application of artificial intelligence and big data analytics. Goldman argues that this could eventually reduce breakevens to $45 and below. The best operators in the Permian like EOG already have well breakevens at, or even below, $40 WTI. As the rest of the pack catches up with the leaders, average breakevens are likely to fall further if Goldman is correct.”
The second, short-term factor is an apparent deterioration in the supply and demand balances for 2017. While many analysts were expecting OPEC’s actions to curb supply to reduce the inventory overhang, the expected supply deficit has not materialized. Hall writes that based demand in 2017 should be growing by around 1.7 million bpd, if not more. Actual growth, however, “seems to be closer to 1.4 to 1.5 million bpd for reasons that are not yet clear.” As demand comes in lower than expected, supply is building faster than expected with growth in non-OPEC supply revised progressively higher by 0.3 million bpd and OPEC additional supply increasing by 0.2 million bpd.
“Together,” Hall reports “these changes amount to a 0.9 million bpd deterioration in the supply and demand balance for 2017 and an initially expected supply shortfall for the year of 1.4 million bpd now looks like it will be closer to 0.5 million bpd.” These figures are before shale contributions. “At the rate at which oil drilling rigs have been added in the U.S., non-OPEC production has been on a path to grow by as much as 2 million bpd in 2018.”
Astenbeck Capital Management on shale and oil supply
Shale is blamed for much of the oil markets oversupply but it’s not just U.S. onshore producers that are weighing down the market according to the oil trader. Astenbeck Capital Management highlights in this letter that because costs have fallen across the industry, the cost curve for oil has become much flatter and there is “now an abundance of potential supply at around $50 Brent.” Therefore “Prices will tend to oscillate around this long-term price anchor in response to changing inventory levels as the market tries to determine the right price to satisfy the call on shale.”
Thanks to all of the above-mentioned factors, Astenbeck Capital Management, now giving up on his long-term bullish oil for oil prices. Instead, it seems as if the trader is going back to his roots, adopting a short-term strategy to profit from volatility.
“These developments call for a more opportunistic approach to the oil market than hitherto. Whereas it once seemed positions could be held with an eye to a longer-term secular appreciation, that is no longer the case. Indeed, the evidence is now in plain sight. Over the past year, the front month WTI futures contract has moved by double digits in percentage terms 10 times within a $40 - $55 band. This volatility has been accentuated by large financial flows into and out of the market by non-traditional investors and algorithmic trading systems. Attempting to capture just a percentage of those moves makes more sense than trying to ride what has turned out to be a non-existent trend, especially when contango inflicts a negative roll return on investors. The extreme volatility within a rangebound environment also argues for a more tactical and conservative approach to portfolio management.”
The letter was first reported by Simone Foxman of Bloomberg News.