BlackPacific Capital


They Say There Is A Lack In Demand

Posted on 1 February, 2016 at 19:48
Weekly Market Assessment
The Saga Continues: They Say There Is a Lack in Demand...
The cure for low oil prices is low oil prices! Over the course of my investing in oil and oil related stocks, many analyst, economist, investors and strategist have preached that there is "lack" in demand for crude oil. However, I have found many others that dispute this claim along with data that suggests something completely different. So, right out of the gate is a quote from the International Energy Agency (IEA), "World oil demand is growing at its fastest pace in five years, thanks to rebounding economic growth and low prices." Along with the IEA there are two other major organizations that the market looks to for forecasts and overall oil market outlook, the Energy Information Administration (EIA) and the almighty Organization of the Petroleum Exporting Countries, know as OPEC.  

So lets take a look at how accurate these three agencies demand forecasts have been over the years. "Since 2010 the EIA, IEA and OPEC have rarely been accurate in their short term forecasts of demand growth", a Wall Street Journal analysis found. In a December 2014 outlook, the EIA predicted oil demand would increase by 900,00 barrels a day in 2015. But in its latest revision, it said consumption increased by 1.4 million barrels a day this year (2015). Whoops!

To make matters even worse, on average, the three agencies in their December year ahead forecasts have missed their later assessment of actual consumption by 600,000 barrels a day since 2010, according to the Journals analyst. Can it get any better than that! Well, the EIA's demand forecast is the one used most by oil analyst on Wall Street as the basis for their own forecast. Wow, so the input data analyst use to make predictions and put out to the public is materially wrong!?

Now for the grand finale, which is my favorite and it comes directly from an employed Energy Information Administration (EIA) engineer. "If you're using the weekly production numbers to do trades on Wall Street, your dumb, said Gary Long, a petroleum engineer who compiles numbers for the EIA. This is not going to work out for you. Don't do that. We've actually had people call us and be very angry with us because they've lost a lot of money."  So the people who actually produce the most widely followed oil production data think that it is so unreliable that you are a fool to make any decision based off them. This has made me think that the whole world is in the dark as to the real time state of supply and demand in the oil markets. This is another reason why trading oil is and will always be the most difficult commodity to understand, let alone invest in.

"We pay a lot of money to these guys, I wish they'd get it right once in awhile," said Ian Taylor, Chief Executive of Vitol Group, the Worlds largest oil trader, at a conference this year. For these few reasons, looking to private firms helps paint a better picture of the oil market.           

Now putting those interesting facts and statements behind us, who do I look towards for some credible and reliable information about the oil market? Well, they have to be people or firms, that over the years been both long and short the market and have been extremely successful at it. A simple way to explain this is, they don't have an agenda to always be long or always be short the oil market. They have been able to see that the market is going to be undersupplied/oversupplied and have been right more often then wrong.  

First, I turn to the legend in the oil trading business, Andrew Hall, who oversees Astenbeck Capital's $4.3 billion in assets, of which all is in energy. He has been in the oil trading business for 30+ years. He has made his living by predicting oil markets and throughout this process has gotten ridiculously rich predicting where oil prices are going. Among oil traders, [Hall] is referred to as “God.” His most highly publicized accomplishment was predicting both the oil spike of 2008 and the subsequent crash. He personally made $100 million in each of 2007, 2008 and 2009 because of those calls. He had to take his 2009 profits in the form of an increased ownership stake in the firm he runs because President Obama wouldn’t allow his employer, Citigroup (which had accepted a huge taxpayer bailout), to cut him a check.

As of late 2014, Hall has exited all of his short oil positions and gone long. Some say he has three gears when picking a direction in the market; Long, longer and really long. I wonder what gear he is in now? He is betting that the oil market isn't as oversupplied as most analyst and agencies believe. He states, "Oil's collapse is sending demand in the U.S. and Asia on a tear' that will push prices up this year and into 2016. Demand in the U.S. is up over 600,000 barrels per day, or 3.4%. The latest four week average is 1 million barrels per day or 5.7 percent. Lower prices together with more people working translates into more demand for oil. Europe will see growth in demand for oil in 2015 for the first time in years. Demand growth in China during the the first half was higher year over year by almost 500,000 barrels per day or nearly 5%." 

Hall's research shows that the crude oil market is much closer to being balanced and "for gasoline, the market is almost certainly in deficit given the phenomenal demand growth in the U.S. and Asia. September's data shows gasoline demand in the U.S. grew 4.5% compared to a year earlier. Vehicle Miles Traveled (VMT) grew at a similar rate, while fleet efficiency fell for the first time in eight years as buyers switched to trucks and SUV's. In India (which Hall believes will surpass the growth of China) gasoline demand increased 14% in October with auto sales up by almost 22%. Apparent demand for gasoline in China grew by nearly 11% in October: SUV sales were up 60% year over year." 
When a colleague asked Hall about his current losing long position in oil, Hall goes onto say, "He hasn't betrayed any doubts about his analysis or his strategy, he's taking this the way he's taken every other dislocation in the oil markets, he absolutely thinks he's right!" Then he leaves us with some simple advice, "The virtual inevitability of higher prices down the road leads to a simple conclusion: now is not the time to exit the market."

One of Andrew Hall's right hand man is Steven Kopits of Prienga (short for Princeton Energy Advisors), who also believes, as shown from the charts above, that the market isn't as oversupplied as most think and believes that demand remains robust as shown by the Vehicles Miles Traveled (VMT) and the previous chart of the demand and supply difference.  He suggests through his research that 2016 will be much like 1986. "In that year OECD (Organization for Economic Co-Operation and Development, basically major developed counties that are outside of OPEC) demand soared by 5% in the second quarter alone- equal to a gain of more than 4 million barrels per day in global demand today. Demand is up sharply in India, Europe and even China. At some point, traders will take note that a huge supply deficit is forming in international markets."

Kopits goes onto to say that a supply shock could come as soon as the second half of 2016. The reason is simple he says, "Demand will rise due to the lower prices and supply of conventional oil production will fall by as much as 2.4 million barrels a day." So, are these two guys, who have over 30 years experience in predicting the oil markets direction crazy? I find it hard to believe that, it takes time to turn such a large ship, but once it's turned and heading in the right direction, there might not be a way of stopping it!   

Another man I follow is Dave Demshur, who is the CEO of Corelabatories. He comments on China's ever increasing appetite for crude oil. "China's July imports of 7.2 million barrels per day which was up 29% year over year and 11% year to date. So if we compare the amount of crude oil being used in China in 2015, it is up 12% compared to 9% in 2014, to only 4% the year before. So when we look at China, we have an economy that went from bicycles to automobiles. So we might be seeing some weakness in China but certainly on the demand side for crude oil and gasoline products, its never been higher!"

To follow up on China's demand, a Jefferies (a global investment banking firm) analyst goes onto show how the market is misunderstanding China's oil demand. "Chinese oil demand is quite robust, up 9.2 percent year over year as of August. In this case, lower oil prices have spurred demand; annual demand growth from January to August of this year (2015) totaled 5.7 percent; well above its rate of 1.6 percent in 2014. We believe the market is missing China's strengthening oil demand, just as it missed weakening demand three years ago...China is pulling a head fake, which we believe could whiplash prices."  

To help reaffirm this demand from China has continued, in a January 2016 Bloomberg article, with help from Energy Aspects and FGE, found that China may buy 8% more oil from overseas in 2016, taking average purchases to 7.2 million barrels per day.  In a preliminary Reuters calculation based on government figures showed record oil consumption of 10.32 million barrels per day in 2015, up 2.6 percent from 2014, defying slowing growth in the worlds second largest economy. So, for those who believe that there is a lack in demand in China, because of its recent stock market concerns may need to rethink their case on China's constant need for oil at these extremely low prices.   

David Pursell, who is a well respected energy analyst and managing director at Tudor Pickering Holt & Co. (Energy only firm with $1.5 billion in assets) has been calling for $85 oil by the middle of this year. He goes onto to say that, "Oil markets get tight really fast. India is going gangbusters, China is OK. In the U.S. think about 3% growth on 20 million barrels a day. That's a lot of growth." I think that India has been forgotten about and could be one of the catalysts on the demand side that many aren't counting on. According to the International Monetary Fund (IMF), "For the very first time, India's economic growth rate (of around 7.3% for the year ending in November) is set to overtake China. It also note that, with sustained growth in internal combustion engine vehicles, the consumption of both gasoline and diesel (which constitutes almost 73% of the total sales of petroleum products in India) has witnessed a sharp increase in this decade, with gasoline sales increased by 14.77% (highest growth in a decade) in 2015."

Even the IEA (International Energy Agency) has come out and recognized that India has seen oil demand hit a 10 year high. With demand being up over 800,000 barrels per day from just a year ago. So, one can seen that with a decline in production through the decline curve and lack in investment with a continued thirst for oil, from the worlds largest economies could balance the oil market alot faster than most think. If there is a disruption in the supply of oil in anyway, there is little spare capacity to help fill the gap.

Another great investor, know more for seeing the housing bubble expand and benefiting from its collapse is Kyle Bass. His firm Hayman Capital Management oversees $2.8 billion in assets, has acknowledged the opportunity in oil. "I think there is a massive opportunity in energy. The global margin of safety in energy is the lowest ever, he continued to explicate. Global oil demand stands at its highest level ever, at 96 million barrels a day.
Lets get a view of the oil market from a man with boots on the ground in 85 countries, that is the CEO of Schlumberger, Paal Kibsgaard. This is what he said on their most recent conference call, "We still believe that the underlying balance of supply and demand continues to tighten, driven by solid growth in demand and by weakening supply, as the dramatic cuts in exploration and production are starting to take effect."
Ill leave my last quotes on demand from what I guess are two "reliable sources." The first comes from the EIA. "It's an art more than a science in many ways -that's economics, said Matt Perry, Senior Oil Market Analyst at the IEA, a Paris based group that monitors energy trends for industrialized nations. You have to make a lot of assumptions that could of course be wrong, be added, hopefully the errors sort of cancel each other out."  The last one comes from the Worlds largest oil trading firm mentioned earlier, Vitol, where CEO Ian Taylor says, "I think there's not been enough attention to be honest on what really happened in demand last year (2015)."  Ill let you figure out which one I consider a more reliable source.  

Who are we left to believe? Ill have to side with people who have their money on the line along with their clients money. Have we overshot to the downside, where the market is being pushed to new lows which further fuels the chant that the oil market is oversupplied? Time will tell, however those who say that there is a lack in demand may soon find themselves confused by the oil market's next move!           
Making the Watchlist: Below are the stocks that I will be looking at over the coming months.  I will provide the the current stock price and why I am watching them. I will comment on them as I continue to keep an eye on them.  You will be able to see and follow their growth and/or decline. Chart links may be attached.
BlackPacific Capital has created three funds. The first is the Total Return Fund and the other is the Growth Fund. Both of these funds will be compared against the S&P 500. Both will hold a total of no more than five companies each. The Total Return Fund is a low turnover fund where every holding must have a dividend and be undervalued to its peers. The growth fund is made up of momentum high growth stocks where the turnover rate is much higher. Below are their Weekly and Year to Date returns. For more information and to see the holdings in each fund click here

New holdings and liquidated positions: Sold out of my Under Armour (UA) position in the Growth Fund alot sooner than I would have expected. I exited the position at $84.85 after entering the position at $67.50. I had a 25.70% gain, and now looking to add Amazon (AMZN) into the Growth Fund after a huge selloff after their recent earnings release.          
 S&P 500 Return 
Year to Date: -4.81%

Year to Date: -8.73% 

Week: -6.23%
Year to Date: 7.40% 

Energy Fund Week: -6.73%
Year to Date: -6.73%

Categories: Weekly Market Assessment