Hedge Funds Increase Long Bets Even Further

In the latest edition of the Numbers Report, we'll take a look at some of the most interesting figures put out this week in the energy sector. Each week we'll dig into some data and provide a bit of explanation on what drives the numbers.

Let's take a look.

1. Refining margins surge on temporary outages

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- An unusual spat of refinery outages have cropped up in different parts of the world. Unexpected fires have knocked refineries off line in Asia, the U.S., Russia and the Middle East.
- Bloomberg estimates that at least 13 major refineries suffered fires and outages, taking 1.8 million barrels of gasoline and diesel production offline in January.
- That led to a sharp jump in refining margins in Europe and Singapore, with a more modest increase in the United States. Singapore saw benchmark prices rise by nearly half to $7.25 per barrel in January.
- The outages work to the benefit of companies not affected, as rising margins are coming at the same time as inventories fall and demand remains strong.

2. Speculators continue to add bets on rising prices

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- Hedge funds and other money managers continue to pile on net-long bets on WTI, betting that prices will rise further.
- Net-long positions grew by an additional 24 million barrels to 396 million barrels for the week ending on January 24. After a slight pause in the prior weeks, net-long bets are rising again.
- Money managers have now amassed the most bullish position on oil in at least a decade, an indication that nearly everyone thinks that oil prices will continue to rise.
- The flip side of that is that the danger of a backsliding is even more acute. If investors have overextended their bets, a liquidation could come at a moment's notice.
- The risk of a sudden short selling could push oil prices down.

3. Natural gas demand seeing structural increase

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- U.S. electricity demand is highly seasonal, but the long-term trends are clear: demand is set to rise.
- That is because the utility industry continues to build new gas-fired power plants. The industry will add 11.2 gigawatts of capacity in 2017 and a whopping 25.4 gigawatts in 2018. The additions will expand gas-fired capacity by 8 percent.
- They will replace the wave of shuttered coal plants - over the past five years, 47 GW of coal-fired power plants shut down.
- The coal-to-gas switch will ensure growing demand for natural gas, which will put a floor beneath prices. At roughly $3.20/MMBtu, Henry Hub prices are already twice as high as they were a year ago.
- Shale gas production declined last year, but could rise again with higher prices and new drilling.

4. Permian still red hot

- The oil industry spent $28 billion to buy up land in the Permian Basin last year, more than triple the spending from 2015, according to Reuters.
- The Permian also accounted for almost 40 percent of the value of all acquisitions. By way of comparison, the next largest destination for investment in acreage was in the Marcellus, which accounted for only 10 percent of the value of acquisitions in 2016. Meanwhile, the Gulf of Mexico, the Eagle Ford, the Niobrara and the Bakken all accounted for less than 5 percent each.
- The Permian is king because of its multiple stacked formations, an extensive pipeline network, and its lower breakeven cost.
- Many wells in the Permian are very profitable with oil trading in the low-$50s per barrel. Meanwhile, other shale plays often require oil prices above $60 per barrel.
- ExxonMobil's (NYSE: XOM) just spent roughly $6.6 billion on acquisitions in the Permian, which was only the latest multi-billion-dollar deal in the West Texas shale basin.

5. Exxon production falling

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- ExxonMobil (NYSE: XOM) reported disappointing earnings for the fourth quarter of just $0.41 per share, badly missing consensus estimates of $0.70 per share.
- The company also surprised by writing down $2 billion worth of assets, the first time Exxon has taken an impairment charge since oil prices collapse more than two years ago. It was the ninth consecutive quarter of declining profits.
- Worse, Exxon's total production continues to deplete. Output fell by 3.9 percent from the prior year, down to 4.1 million barrels of oil equivalent per day.
- Its share price has remained resilient, however, moving up and down on prices rather than its falling production.
- Still, as mentioned above, Exxon made a large bet on the Permian Basin, which should allow it to boost shale output. It also will develop a large offshore discovery in Guyana.

6. Backwardation could make oil investing profitable again

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- Oil futures have dipped into a state of backwardation for the first time in more than two years, which means that near-term contracts are trading at a premium to longer-dated futures.
- That is an indication that the markets think that short-term supplies are contracting, and tighter conditions are placing a premium on near-term deliveries.
- For investors, the backwardation means that buying and holding bets on commodities could be profitable again. Over the past two years, it was difficult to turn a profit on bullish bets because oil ETFs required contracts to be renewed on a monthly basis, forcing funds to buy more expensive contracts each month because of the contango. That ate into the returns for investors.
- Now the reverse is true. ETFs won't have to buy more expensive contracts each month. "In that environment, it's hugely more attractive," said Doug King, chief investment officer of RCMA Capital LLC, told Bloomberg. "For a financial investor, that's like the glory days of market management from OPEC."

7. Shell finally trimming debt

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- Royal Dutch Shell (NYSE: RDS.A) missed consensus estimates by quite a bit, reporting the worst full-year results in a decade. But Shell has now posted two consecutive quarters of positive cash flow.
- Shell's purchase of BG Group turned it into the largest exporter of natural gas in the world, but it also made the company the second most indebted oil company in the world behind Petrobras.
- Shell's $78 billion in debt in the third quarter raised questions about the company's ability to continue paying such a hefty dividend to shareholders.
- But because it is now cash flow positive, it has started to trim its debt pile. Its debt declined by $4.5 billion in the fourth quarter.
- In fact, 2016 was one of the worst years in recent memory for the oil majors, but they are optimistic that 2017 will be much better. Most of the majors are now cash flow positive.

That's it for this week's Numbers Report. Thanks for reading, and we'll see you next week.