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I’m an East Bronx boy, more accustomed to matzoh farfel trees than oil rigs in my back yard. Projecting supply and demand for oil long term or even short term is a sometime thing, covering variables of Mideast geopolitics and anarchy in Nigeria.
In Iraq, where ExxonMobil and others are exploring, there is the potential of 6 million barrels of production some day, but 3 million is the going rate until terrorist acts simmer down.
My pragmatic reference point on oil prices is the charts on WTI oil futures going out 5 years. Anyone long or short oil futures is an active player with a point of view based on supply and demand projections and the reserve margin. Futures factor in the state of worldwide GDP growth, upcoming alternative energy sources like wind and solar as well as geopolitical risks to production in Iraq, Iran, Libya, even Russia.
Add in all the financial players putting on or taking off macro hedges like long gold and oil and short the dollar, or now possibly visa versa. All this financial mumbo jumbo dwarfs legitimate hedging by airlines and oil operators with leveraged capitalizations who choose to lock in futures production realizations.
My charts surprised me. With WTI crude oil trading above par, futures going out a couple of years fall off into the low nineties, even out to December 2018. Clearly, the players don’t see $150 oil in their sights. Rather, a benign outlook for supply and demand shapes up, near equilibrium, maybe even a surplus.
This was not the sense of the situation couple of years ago. Academics as well as speculators saw oil supply peaking in the reservoirs of the Saudis and Russians, in the North Sea fields and certainly in the United States. China, actually the fifth largest oil producer, still imports half its oil and gas needs, which can account for as much as 50 percent of worldwide incremental demand, annually.
If my charts are anywhere near the truth, they adumbrate either lackluster demand or much new supply either from oil or alternative energy. Taking the downside, the world could be in a long-term malaise or at best minimal GDP momentum for years and years.
There is a bright side to interpreting becalmed oil futures. Supply and demand stays in long-term equilibrium. We don’t see $4 plus gas at the pumps and consumer disposable income is enhanced by lower energy outlays. This touches off more personal consumption, helps keep down inflation and Detroit prospers – selling more-high margin SUVs and light trucks. This is happening right now and I’m long mucho General Motors despite euro land’s economic stagnation.
I was saying all this to Danny Yergin whose new book, The Quest, is just out. Yergin’s life work is studying energy markets and its players. I told Danny that nobody in the history of the world has ever predicted oil prices accurately for more than six months at a time, including all the big operators, Exxon et al. Danny just smiled.
Big oil operators gave up long ago on forecasting oil prices, short or long term. They just concentrate on defining elephantine fields and dedicating tens of billions to their development, which can take 10 years or so, always longer than projected.
I put Yergin’s tome, some 700 pages, up there with other fat works that I periodically refer to, inclusive of Milton Friedman’s A Monetary History Of The United States 1867-1960 and Sidney Homer’s History Of Interest Rates.
I knew Sidney in the sixties when he was a partner at Solomon Bothers. Solly’s traders ignored his interest rates forecast, but if you wanted to know about inflation and interest rates biblical times in Egypt when the drought destroyed wheat crops everywhere, Sidney was your man.
Reading Yergin’s work, I was struck with how little I’ve retained about cycles in oil prices as well as the motive forces for deals starting with Exxon’s acquisition of Mobil in 1999. The Persian Gulf still supplies 40 percent of the oil sold into world markets. Operators like Exxon needed to diversify the geo-strategic balance of their oil reservoirs as well as add to their financial heft for drilling and exploration of new fields.
Oil use in the developed world is 14 barrels per person per year but 3 barrels in the developing world. Oil production is 5 times greater today than in 1957, Yergin tells us. I remember when gasoline was 21 cents a gallon, maybe less in the Great Depression. We lived on a hill that overlooked the Hudson River. My father would coast down from the top to save gas. I doubt if anyone does that anymore even with gas at four bucks.
I didn’t know that West Siberia production reached 8 million barrels per day, rivaling Saudi output. Then, it collapsed, down to 5 million barrels during the nineties when Russia dwelt in near anarchy. New production is back to 10 million barrels and Russia is the largest producer and second largest exporter of oil.
Startup production at Kashagan’s elephantine field in Kazakhstan took a decade longer than projected but this year could add 1.5 million barrels a day to world supply.
As late as 2001, management at Royal Dutch Shell believed the clearing price of new oil would be $14 a barrel so they stood clear of all the mega deal activity then. In 2008 Venezuela was selling gasoline internally at 8 cents a gallon. Oil accounts for 25 percent of GDP in Russia and 50 percent of government revenues so oil prices are a pivotal variable in Russia’s future.
Late nineties, oil sold as low as $10 a barrel before OPEC cut back production, but then, prices snapped back as economic recovery came to the Far East and quotas took hold at OPEC. I don’t remember $10 oil so I’m a good indicator of how fuzzy institutional memory waxes in the energy sector.
Even major operators and OPEC were slow to comprehend how oil demand would mushroom in the developing part of the world, namely China, starting in 2004, where demand growth zoomed from 6 percent to 16 percent. Yergin calls it “the demand shock.”
Nigeria, really a conglomeration of tribes rather than a unified country, is a major supplier of oil to the U.S., as is Venezuela. Shut in capacity in Nigeria mounted to a million barrels in 2007 because of internal violence. Let’s be aware that the U.S. will remain an oil imports dependency for many years to come.
By 2004 trading in oil futures on the NYMEX ticked at 30 times its 1984 level. Speculators bought the “peak oil” production theme by 2007 and called for a supercycle in most commodities. There were many burnt fingers after oil peaked at $147 a barrel and then sputtered down to $40. Spare capacity had widened earlier than expected in 2008 but prices didn’t peak until July. The country was on the eve of a deep recession and near implosion in the financial sector.
Yergin rightly calls attention to the surge in oil prices between June ’07 and June ’08. Oil prices doubled, an increase of $66 which in absolute terms was one helluva oil shock. I’d already forgotten this cyclical magnitude. Institutional memory, where art thee? Oil bottomed in 2009 at $32 a barrel with gasoline at $1.50 a gallon. Does anyone remember all this? Not me.
Lest you think China is going to bail out all the demand side bulls, consider this: China is already self-sufficient in overall energy needs. Estimates of undiscovered oil in the South China Sea range between 150 billion to 200 billion barrels, still unproven, but promising.
The heart of Yergin’s thesis is that the proponents of peak oil supply, many housed in Texas, are dead wrong. Their doomsday date keeps getting pushed out, now set for 2020. Yergin sees the course of oil supply plateauing only by 2050, but not before. There’s plenty of time to develop alternative energy sources and boost gas mileage to 50 miles per gallon, even buy an electric car.
My oil charts, currently confirm oil’s plentitude, at least for this decade. One less macro variable for me to worry about. Exxon keeps ratcheting its dividend by a couple of pennies and buys back some stock, annually. I’d rather see them push their dividend into the 4 percent range, but it won’t happen. This is an unflappable, conservative management going back 50 years.
I’m sticking with equal weighted Exxon as the stock last year was a good ball carrier. By comparison Schlumberger was doggy. Maybe, we’ll see its reversal soon. The market is pricing in $90 oil in terms of major integrated oil producers' valuation. This leaves some room for an upside surprise.
Martin T. Sosnoff is chairman and founder of Atalanta Sosnoff Capital, LLC, a private investment management company with $8 billion in assets under management. Sosnoff has published two books about his experiences on Wall Street, Humble on Wall Street and Silent Investor, Silent Loser. He was a columnist for many years at Forbes Magazine and for three years at The New York Post. Sosnoff owns personally and / or Atalanta Sosnoff Capital owns for clients the following investments cited in this commentary: ExxonMobil, Schlumberger and General Motors.
Martin Sosnoff
mts@atalantasosnoff.com
January 12, 2012
