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Dan Dicker

Dan Dicker

Dan Dicker is a 25 year veteran of the New York Mercantile Exchange where he traded crude oil, natural gas, unleaded gasoline and heating oil…

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The Break-Even Myth Is Suffocating Oil Stocks


Oil prices, as I have said for the last few columns, seem range-bound. But rarely do they remain range-bound for long. As oil’s pessimism begins to gain steam, oil stocks look less and less like an exciting investment, at least for the next few months of the summer.

Last week we were able to predict and use a rally in oil prices that came from a very large financial short covering move from speculative hedge fund and energy traders. That was busted briefly on Wednesday as the markets, back from the July 4th holiday, decided to take advantage of the rally to re-initiate short positions. And while that move has also been punished on Thursday by the unexpected 6 million barrel drop in stockpiles, that return above $46 has not managed to pull oil stocks strongly along.

We’ve been quick to note why, in several previous columns: I don’t care what oil executives say, including this frankly hilarious graphic that supposedly outlines ‘break-even’ costs in the Permian and other shale plays:

(Click to enlarge)

The idea that U.S. shale producers make money at less than $40, and that more than 6 respondents are claiming break-evens in Midland BELOW $24 is beyond laughable. If that were true, Lord knows we would have seen far better 1st and 2nd quarter results from these Permian producers, and far higher stock prices.

For while the oil price in 2017 has been range-bound, the stock prices for U.S. shale have hardly been – they’ve been on a one-way trip lower.

It should be noted in the above graphic, however, that there are at least SOME CEO's in the Permian who are correctly gauging their break-evens in the upper $50’s and even above $60 a barrel. This price is much more believable, even if I think it’s still a bit optimistic.

One interesting article I saw this last week that makes even the most optimistic oil trader far less so was from legendary oil trader and ‘permabull’ Andy Hall of Astenbeck Capital. Despite letters to his fund customers of incredible, stoic bullishness in oil prices for 2017 and beyond, his latest letter, while not bearish, certainly tempers much of the optimism he previously had.

What’s interesting is not only his fundamental view of the oil markets: He notes the increasing production from U.S. shale players without profitability and the increased Libyan and Nigerian production from OPEC members. He also notes the slowdown in global oil demand and U.S. gasoline demand, although on these thoughts we should also point out that he is being deterred by a slowdown in the acceleration of demand, not the numbers themselves.

But what stands out about his letter, and what makes it most interesting for me is his notes concerning the sentiment surrounding oil. On this score, his long experience is very much like mine. In short, in order to be a great long-term oil trader, as Andy Hall has proven to be, you must also be able to look past the fundamentals and get at the attitude towards oil.

Why? Because the ultimate price of a barrel of oil is not determined by the fundamentals – it is arrived at through a financial marketplace that matches buyers and sellers. If there are more buyers than sellers on any given day, the price for oil is going to go up, no matter what the fundamentals say. The opposite is of course true when there are more sellers than buyers.

Those that know me and have read my columns and books know that I also believe that these financial absolutes trump everything else when dealing with the oil market. Find out where the next batch of buying or selling will be coming from and how much will be there and you don’t need to know a thing about fundamentals. The rest of the story will write itself.

And here, Hall makes the right point about sentiment. It has turned pessimistic not just among the speculators, but among the commercials that ultimately drive price. And with that universal sentiment overhanging the markets right now, we might see a short-term upwards blip or two in the next mid-term for oil prices, but for the next few months, we’ll likely see a fairly hard top.

In short, not the best time to be adding to oil stock positions. In fact, a great time to lighten up positions and wait on the sidelines.

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