Macro Micro: The Oil Conundrum

It has brewing for little while now however it appears we are finally at the inflection point that has formed three times over the past two and half odd years. The supply-demand set up in oil.

Below is the smoothed-out chart of WTI – the chart shows the tail end of the 2015 oil crash that saw WTI go from US$130 a barrel to US$44 over a 6-month period. If you want to see the micro carnage this caused have a look at Santos and Origin’s price chart over the same period – it still hurts me…

WTI Oil – continuous chart
WTI – continuous chart
Source: CME Group

Here is the conundrum that is oil – the Supply side, since the 2015 price crash, has tried on several occasions to reduce, freeze, cut or slash supply to shift the demand supply equation to a more ‘stabile’ the price.

‘Price stability’ has certainly tested the resolve of the OPEC cartel – or more realistically Saudi Arabia telling the group what will happen which has led to minion nations breaking ranks or breaking economically – Look at Nigeria and Venezuela. Other issues inside OPEC has been Iraq and Iran – geopolitics between the Saudis and Iranians has derailed several Vienna conventions and ‘agreed’ upon freezes to collapse (most notable was the mid-2016 breakdown) over the past 2.5 years and with OPEC looking to extend the current freeze to 2019 at the upcoming Vienna meeting – looking for further tensions between the 14-member bloc – the fall outs will see strong spikes inside WTI.

The other part of the Supply side story is non-OPEC nations such as the US, Canada, Norway and Kazakhstan – over the same period these nations routinely picked up the slack and soaked up the higher price.

According to Goldman Sachs and others at around US$53 to US$57 a barrel non-OPEC nations kick in as internal rates of return turn positive (highlighted by the green band on the WTI chart) –  this explains why measures from the EIA and Baker-Hughes show large increases in rig counts and stockpiling on pricing in this band since 2015 pricing period. The releases from the EIA over the weekend saw 1.85-million-barrels added to stocks (estimates where for a 2.2-million-barrel drawdown) and Baker-Hughes has seen a 14-rig increase over the past 2 weeks to 738. It would appear that the band will hold firm once more.

Looking bottom up then –  the question is: does the energy sector stack up for investments? There is always opportunity here no doubt – the last three months alone should indicate this, however over the preceding three months a similar reversal may be on the cards.

Which allows a narrowing down and concentration on certain criteria for energy exposures.

Firms with; controlled balance sheets, high concentrations of tier-1 assets, are highly advanced in its operations (in production phase rather than contraction phase) and have diverse access to markets should give the best platform for a macro investment around the oil price. It should be clear that the underlying asset price (oil) is the main driver – removing structural risk of the firm should provide stability.

Oil has moved into a new world order – so for those looking to move into this space look to control variables that are visible to minimise external risks – there is enough risk from the price alone without added structural concerns as well.


Evan Lucas is an expert guest contributor to Fairmont Equities.

Evan is founder of The Lucas Review. Prior to that he was Market Strategist at IG. He is well known as an expert commentator in finance media such as Sky News Business, ABC1, the Australian Financial Review, CNBC, and Reuters.

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