Oil's Nightmare Dominates Davos?
The first mantra of the oil crisis was “lower for longer.” Then “lower for even longer.” Now in Davos, oil executives are starting to talk -- or rather, whisper -- about a new nightmare scenario: “A lot lower for a lot longer.”
Oil executives, policy makers and banks said in the first days of the World Economic Forum that a recovery will remain elusive in 2016 as major producers keep pumping and China’s fuel appetite slackens. And they fret that prices could take another hit as Iranian crude freed from sanctions flows back on to world markets.
“It is the third year in a row we have more supply than demand,” Fatih Birol, executive director of the International Energy Agency, told Francine Lacqua in a Bloomberg Television interview. “Prices will be still under pressure. I don’t see any reason why we have a surprise increase in the price in 2016.”
Things won’t get better until energy markets have weathered the “supply shock,” said Tony Hayward, chairman of Glencore Plc, one of the world’s largest trading houses. Quite simply, there’s “too much oil,” he said.
Iran’s ReturnI beg to differ with Daniel Yergin, oil prices will remain closer to $25 a barrel for the remainder of the year and possibly a lot longer depending on how bad things get in the global economy in the second half of the year.
The end of nuclear-related sanctions on Iran on Jan. 16 has freed the OPEC member -- once the group’s second-biggest producer -- to revive crude exports slashed in half by almost four years of restrictions. Impatient to claw back lost revenue, the Persian Gulf nation issued a directive to restore daily output by 500,000 barrels as soon as possible.
“The lifting of Iran sanctions will in my view continue to add supply, so I don’t see a bottoming-out of oil prices and a re-spiking any time soon,” said UBS Group AG Chairman Axel Weber. Depressed prices give Iran’s rivals, such as OPEC leader Saudi Arabia, all the more incentive to keep pumping, he said.
Unprecedented cutbacks in spending on new supply -- a 16 percent investment reduction this year will follow last year’s 20 percent decline -- is setting the stage for a recovery, but it will be 2017 before this materializes, the IEA’s Birol predicts. The scale of the spending cuts means the rebound will be all the harder when it comes, according to Crescent Petroleum Co.
“This will have an impact in the future, making the cycle more extreme,” Majid Jafar, chief executive officer of U.A.E-based Crescent, said in an interview.
Still, crude won’t recover to levels seen during the boom years, said Daniel Yergin, vice chairman of consultants IHS Inc. Oil prices will probably be a “good deal higher than they are today” in the second half of 2016, but “not $100, not $70, not $60,” Yergin said.
When it comes to crude, I pay attention to what Pierre Andurand of Andurand Capital says. Along with a few other energy hedge funds that made money while oil plunged, his fund gained 8% last year and he told investors last month that oil may fall to $25 a barrel or lower in the first quarter:
The plunge in oil prices has dragged down much of the energy sector with it. Yet, some energy-focused hedge funds managed to avoid the carnage entirely.I personally feel like a lot of the big declines we're seeing right now in oil, commodities and commodity currencies are driven in large part by large CTAs and big trading outfits that are leveraging this trade up as much as possible. Once that trend stops and we get the unwinding of the mother of all carry trades, oil prices will spike and then stabilize for a long time (at low levels).
Lansdowne Partners - one of Europe’s largest hedge funds with $22-billion (U.S.) - gained 14.8 per cent last year in its long- short energy-focused equity fund, according to a person familiar with the matter. Some commodity trading advisers, or CTAs, posted gains of more than 25 per cent in 2015.
Breaking even was an achievement last year, when the price of a barrel of oil dropped 30 per cent and the Standard & Poor’s 500 Energy Sector Index lost 21 per cent. Energy-focused equity funds fell 10.7 per cent last year, according to eVestment’s latest hedge fund performance report. Oil has fallen about another 21 per cent in 2016, trading below $30 for the first time since 2003.
Landsdowne bucked the trend with a majority of its gains from short positions, the person familiar with the matter said. Other key drivers at the $140-million fund, managed by Per Lekander, were long and short bets on utilities, energy infrastructure and renewables, the person said. Lansdowne spokesman Matthew Goodman declined to comment.
Brenham Capital Management, a Dallas, Texas-based long- short equity hedge fund run by John Labanowski, gained 23.2 per cent last year, according to an investor letter obtained by Bloomberg. The $824-million fund focuses on small- and mid-cap energy stocks. Dawn Blankenship, Brenham’s director of investor relations, declined to comment.
The energy sector had a few strong performers despite the overall turmoil. Parsley Energy, an Austin, Texas-based exploration and production firm, rose 15.6 per cent in 2015. Bets on the stock helped Zimmer Partners, the $1.9-billion hedge fund firm, post a gain last year, according to a person familiar with the matter. Its fund, which makes long and short bets on U.S.- based energy companies was up 3.5 per cent, according to an investor letter obtained by Bloomberg. Melanie Ashmore, Zimmer’s head of investor relations, declined to comment.
Refinery stocks were a relative bright spot over the past year, though they were hit hard recently by the U.S.’s lifting of the crude export ban. Many investors have said the end of the ban will eat away at U.S. refiner’s access to cheaper oil. The McGinnis MLP and Energy Fund, which was long on refinery stocks, ended the year up 1.4 per cent after a 10.4-per-cent plunge in December wiped out most of the year’s gains, according to someone familiar with the returns.
Steve Henderlite, chief operating officer at Mission Advisors, the San Antonio, Texas-based energy-focused hedge fund that runs the McGinnis fund, is still bullish on refineries.
“We don’t think the removal of the ban has significantly changed the story for refiners,” Mr. Henderlite said, declining to comment on the returns. Even without a ban, refiners will benefit from cheaper oil from Canada and Mexico, he said.
One of the most profitable strategies has been to bet against the price of oil and other commodities. Hedge fund manager Pierre Andurand, whose commodity-focused hedge fund gained 8 percent last year through Dec. 11, told investors last month that oil may fall to $25 a barrel or lower in the first quarter. Global supplies will continue to grow while global demand growth will slow, which could result in “a test of maximum storage capacity” and “significantly lower crude prices,” he said in a letter. His London-based firm, Andurand Capital Management, manages $615-million.
Shorting strategies helped some commodity trading advisers post double-digit returns last year. Red Rock Capital’s long- short systematic commodity strategy gained 31.3 per cent in 2015, according to an investor letter obtained by Bloomberg. Half of last year’s profits were generated by short positions in energy futures such as crude oil, natural gas, gasoline and heating oil, Thomas Rollinger, managing partner and chief investment officer, said in an e-mail.
The $103-million Millburn Commodity Program gained 25.6 percent last year, according to a person with knowledge of the matter. The quantitative fund got about half of its returns from energy bets, according to Barry Goodman, co-chief executive officer of Greenwich, Connecticut-based Millburn Ridgefield Corporation, which manages $1.4 billion.
“So far in 2016, our models are forecasting continued near- term declines for crude and the other instruments within the energy sector, although it is important to note that the models can be reasonably quick to adapt when they determine the environment has changed,” Goodman said in an e-mail.
CTAs, which tend to be trend-following, were helped by energy price’s “slow and steady decline over the past two years,” said Melanie Rijkenberg, London-based associate director at the $9-billion fund of hedge funds, Pacific Alternative Asset Management Co. However, “once the trends stop, CTAs tend to struggle, particularly if we enter a directionless regime.”
Betting against energy and energy stocks won’t work forever, Ms. Rijkenberg warned. “As the market settles down and oil finds a bottom, there will be more value opportunities to capitalize on,” she said.
But that doesn't mean that oil prices can't overshoot on the downside just like they did on the upside. Let me show you two charts on the CBOE Crude Oil Volatility Index (^OVX). First, look at it this year as it surges higher (click on image):
Then pull back and look at a longer time frame which includes the 2008 crisis (click on image):
The thing that baffles me is how oil's nightmare not only dominates Davos, it's dominating the stock market. I wrote a comment on Monday stating that I thought the bloodbath in stocks is over, but stocks keep flushing lower. It amazes me how stocks have not decoupled from oil so far this year.
Still, my reading of the volatility (fear) VIX indicator (VXX) tells me extreme pessimism is completely out of whack and the algos are having fun taking out all the stops, forcing retail and institutional investors to sell in a panic (click on image):
What else? To my surprise, the Bank of Canada held its key interest rate steady at 0.5% on Wednesday. "The dynamics of the global economy are broadly as anticipated," the BoC said in a statement. "The bank … judges that the current stance of monetary policy is appropriate, and the target for the overnight rate remains at 0.5 per cent."
The BoC cut its growth forecast but sees an upturn ahead. Hope it's right but have my doubts. I guess the precipitous decline in the loonie made it hold off on further cuts, for now. If growth doesn't pick up, it will be forced to cut rates later this year or maybe much sooner.
Below, amid the global market turmoil, the Federal Reserve is more likely to ease than tighten interest rates again, Ray Dalio, founder of the world's largest hedge fund, said Wednesday at Davos.
I agree, the Fed will backtrack on that dumb decision to raise rates in December, cut rates, engage in more QE, or risk seeing the greenback going to the moon and plunging the world into a prolonged debt deflation disaster (which is coming anyway but we need to lessen its effects through monetary and fiscal stimulus).
Anyways, stay tuned, things are getting very interesting for the rest of the week and next week. If markets keep selling off, I expect to hear something from central banks very soon.
My advice is to stay cool, calm and collected. The Power Elite meeting in Davos can't afford to see another market crash and global economic crisis. Something has to give very soon or else this great Ponzi scheme which has benefited them for so long will unravel fast and threaten them in profound and unimaginable ways (remember what Adam Smith wrote about relying on the benevolence of the butcher).
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