Speculators Bullish Despite Bearish Fundamentals

Friday, May 6, 2016

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. Crude oil inventories continue to rise through first quarter

- Crude oil storage levels continued to climb despite the fact that prices for WTI and Brent are up about 70 percent since February.
- Inventories are above 3 billion barrels in OECD countries, sharply above the five-year average. In the United States, storage levels continue to break records. In the last week of April, inventories rose to 543 million barrels, once again setting a new record high.
- These data points show a dramatic disconnect between the run up in prices and the fundamentals. The IEA said recently that the bottom for oil prices is probably over. But with stocks this high, prices will bump up against a ceiling until inventories begin drawing down in earnest.

2. Chevron cash flow negative

- Several of the oil majors reported earnings over the past week. Chevron revealed a loss of $725 million in the first quarter, down from a $2.6 billion net profit in the first quarter of 2015.
- The result was not as bad as many had feared, given that oil prices are so low. But looking at Chevron's cash flows is a bit more worrying.
- In the first quarter, its cash flow from operations - $1.1 billion - was not even enough to cover the $2 billion dividend payout, let alone the $5.6 billion in capex. Chevron had to dispose of assets and take on more debt to cover the shortfall.
- The oil major said that maintaining and growing its dividend was a priority. But Chevron, and other majors, will have trouble cutting their way towards positive free cash flow. A strong rebound in oil prices will be needed over the long-term.

3. LNG prices have crashed

- LNG benchmark prices have plunged along with crude oil prices over the past two years. But LNG markets are arguably in a worse state of oversupply than oil. Export capacity is rising much quicker than demand.
- LNG export developers, particularly in Australia and the U.S., have scrambled to build export terminals in order to ship gas to Asia, where prices have been above $15 per million Btu (MMBtu) for several years.
- But Asia is starting to disappoint some companies that have spent large sums on infrastructure, assuming there would be a wide arbitrage opportunity between, say, Henry Hub and Asian spot prices. Japan shed 3.1 million tonnes per annum (mtpa) of LNG demand last year, a decline of about 3.5 percent, according to the International Gas Union. South Korea's LNG demand fell by more than 11 percent last year.
- That leaves little prospect for a rebound in LNG prices for the near term, something that will worry large LNG exporters such as Royal Dutch Shell (NYSE: RDS.A) and Chevron (NYSE: CVX), as well as smaller ones like Cheniere Energy (NYSE: LNG).

4. Banks hit by energy losses

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- Banks have come under heightened scrutiny because of their exposure to bad energy loans. Canadian Western Bank is one such lender that is facing pressure.
- The bank's shares plunged 12 percent when it revealed that it would have to set aside more money to cover its energy losses.
- Canadian Western is based in Alberta and is much more intertwined with the oil industry than some of its peers. It reported losses of CAD$33 million for the first quarter related to oil and gas.
- Out of the CAD$329 million in loans to energy companies, the bank racked up about 10 percent in losses.

5. Oil speculators bullish on oil…for now

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- Speculators taken the most bullish position on oil prices in nearly two years, with net-long positions rising to a record 663 million barrels for the week ending on April 26.
- As Reuters notes, the bullish bets are way above the trend line for today's oil prices. With net-long positions so high, there is an increasing risk that positions are liquidated as traders take profits. Short bets have been squeezed out of the market.
- With the fundamentals in the physical market still murky, the conditions are ripe for a price correction downwards.
- Put simply, speculators can move prices in the short-term, but fundamentals will prevail in the long run. The 70 percent rally in prices over the past two months is probably as far as speculators can push up prices for now. Prices could fall back, and wait for another bull run when fundamentals improve.

6. Cheaper energy boon for consumers

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- The collapse in crude oil prices has been painful for producers, but a gift for consumers.
- The chained consumer price index for urban consumers in the U.S. fell by 1.2 percent between January 2014 and February 2016. That comes despite increases in food costs (+2.5 percent) and housing costs (+5.1 percent). The fall in the CPI can be greatly attributed to lower energy prices.
- Brent crude declined by 71 percent over that time period and Henry Hub natural gas prices fell by 56 percent.
- U.S. household expenditures on energy peaked in 2008 at about $5,300 per year. That total was down to about $4,500 in 2014.
- It is still early, but U.S. households could end up spending the least on energy in 2016 in at least ten years.

7. Oil majors slash spending

- The oil majors have dramatically reduced spending over the past few years, and their combined spending in 2016 will be about 31 percent below 2013 levels.
- Shell (NYSE: RDS.A) in particular is a big spender, outspending even ExxonMobil (NYSE: XOM). The Anglo-Dutch company has not reduced spending at the same rate as its competitors, laying out $54 billion for BG Group. Shareholders have pressured the company to reduce spending to $30 billion this year, trimming $3 billion from its previous plan. Shell also announced that it will sell off $30 billion in assets.
- Shell earned $800 million in the quarter, down 83 percent from a year earlier. But the addition of BG group did boost production, adding 0.52 million barrels of oil equivalent per day.
- Consecutive years of combined spending reductions is a rare thing for the industry, but 2016 is the third consecutive year of decreases from the oil majors, and 2017 will see another drop of 7.7 percent.

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