OPEC's failure to cut production was a declaration of war on the U.S. shale industry and the first salvo may have been a knockout punch.
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OPEC met in Vienna on Thursday and despite a lot of posturing they elected to keep the current 30.0 mbpd production target unchanged. They are already over producing that target with 30.9 mbpd last month. The official statement suggested they were comfortable letting oil prices seek their own level in an over produced market with slowing demand in Europe and Asia. They may regret this decision.
In reality Saudi Arabia and the GCC states of Kuwait, Qatar and the UAE would have been expected to bear the brunt of any announced cuts. The other 8 OPEC members led by Iran and Venezuela would never have honored any production cuts but they would have benefitted from cuts by the GCC states. Apparently OPEC has died as a price fixing cartel. It is every country for itself and Saudi Arabia is holding the winning hand. Saudi Arabia's cost to produce oil is under $10 a barrel. They currently produce over 9.0 mbpd and if they take off their current internal production limits they could conceivably produce another 2.0 mbpd within 6 months. They would still be making money on their oil and the extra 2.0 mbpd would offset the lower prices.
Meanwhile the other OPEC nations with costs of $30, $40 and even $60 a barrel will barely be breaking even with Brent at $70. Saudi Arabia has not only declared a price war on the other OPEC nations it has declared a war on the U.S. shale industry.
Many of the shale producers have costs in the $60-$70 range and they will not be able to continue their aggressive drilling programs without oil prices over $80 a barrel. Shale oil has a large percentage of super light condensate and it sells for a lower price than WTI. There is also the transportation factor from the shale fields to the refineries and with a shortage of pipelines a lot of the oil moves by rail. This transportation cost also lowers the price producers get for their oil. Typically Bakken crude sells for $7 to $10 under WTI prices and sometimes at even more of a discount.
The breakeven point on the Tuscaloosa-Marine Shale in Louisiana and Mississippi is $79.52 a barrel because the wells are 2 miles deep vertically before they turn horizontal. These wells cost more to drill. Bloomberg produced a chart of the highest cost U.S. shale areas, which produce about 413,000 bpd. Link to article I think it is safe to say there will be very little new production from those areas.
With WTI closing at $66 on Friday that means shale producers could be forced to sell their oil from $55 to $60 and at or below costs. While existing wells will continue producing those drillers will be hard pressed to fund many new wells. Lending covenants for many producers could be in trouble. We could see some forced sales and significant M&A activity along with a dramatic decline in active rigs. Without the solid cash flow produced by $85-$100 oil that drillers have seen for the last 3 years there are serious concerns that many drillers will not be able to pay their bills.
Energy companies are heavy borrowers in the debt market. Analysts claim energy companies are responsible for 15% to 20% of all the high yield debt in the market. If their cash flows dry up this debt is going to come back to haunt them along with the current holders of that debt.
The carnage in the energy sector was huge. The smaller drillers and service companies were decimated with declines in the -20% to -30% ranges. This hit the drillers, frackers, sand companies, rail car companies and even the railroads.
Sorted by percentage loss
The larger companies posted huge dollar declines with the percentage losses in the teens on average. Continental Resources (CLR) was especially hard hit because they closed their hedges for 2014 and 2015 a couple weeks ago thinking the worst was over and prices were going to return to $85-$90. Continental produces more than 10,500 bpd from the South Central Oklahoma Oil Province (SCOOP) and the breakeven rates for the region range from $79.28 to $186.73 per barrel. Sandridge (SD) pumps over 23,000 bpd from the Mississippian formation and the breakeven there is between $78.56 and $163.51 per barrel. The company has 1.85 million acres under lease.
Exxon (XOM) is not at the top of the losers list because they only declined -$4 and -4%. Conoco (COP) declined -$5 and -7% and Chevron (CVX) -$6 and 5%. They are diversified and their average cost per barrel is significantly less and they have plenty of cash to weather the storm.
Sorted by dollar loss
This oil war could easily have some seriously unintended consequences. For instance the U.S. dollar remains the chief reserve currency of the world mainly because of the money the U.S. spends on oil imports. These petrodollars go to oil producing countries around the world and they put those dollars to work buying goods from other countries including the USA. In 2006 this petrodollar outflow peaked at $511 billion a year. That is windfall cash for producers exporting to the USA. They recycled that cash and provided dollar liquidity though out Asia, Europe and South America.
According to BNP Paribas 2014 will be the first year of negative outflows in 18 years and much of that is due to the plunging price of oil. The BNP chart below shows the net outflows by region. Note that the purple (Middle East) share is declining rapidly and Latin America in orange has disappeared for 2015.
What this means is that instead of swimming in dollars as in the past the oil exporting nations have very little dollars flowing into their central banks. Their budgets were built on exporting oil to the U.S. and using those dollars for purchases elsewhere. Without the inflow of dollars they are forced to withdraw capital from the markets to pay their bills. Essentially they are being forced to eat their reserves. Oil exporters are being forced to pull liquidity out of the markets rather than using dollars as their purchase currency.
The sharp drop in oil prices plus the rapid expansion of U.S. production means significantly less revenue for oil exporters. Just like in every business or personal scenario less revenue in means less spending. This means U.S. exports of other goods like clothing, computers, etc, will slow. The rising U.S. dollar means other currencies are worth less. Not only are oil exporters faced with falling income denominated in dollars but their own currencies are declining in value.
BNP believes net capital outflows by energy exporters will decline -$253 billion in 2014. That is $253 billion less liquidity for the global markets. With oil prices imploding late in 2014 this means the 2015 numbers are going to be even worse. This will result in lower amounts of trade between countries around the world.
The falling oil prices will result in lower global GDP by -0.5% or more. Effectively all the oil producers just saw their income fall by nearly 40% compared to 2013. Lower income creates lower spending and lowers GDP. Oil and gas exporters account for 26% of total emerging market GDP and 21% of external bond demand.
The OPEC nations are playing a dangerous game here. As their income declines the amount of money available for social programs declines and the risk of social unrest increases. The difference between $90 oil and $70 oil could be the difference between a stable government and a collapse. Just look at Libya for an example of what could happen if these tightly controlled governments begin experiencing cash shortfalls.
The petrodollar is dying. The U.S. House is considering allowing oil exports and that will make it even worse. If we begin exporting oil it will further decrease our net dollars spent on exports. Since our oil exports will be priced in dollars it will require other countries to suck dollars out of their financial markets to pay for our oil. India, China, Russia and Brazil are already trading oil in currencies other than dollars. This is weakening the long term outlook for the dollar as the reserve currency. There are troubling times ahead as a result of the implosion in oil prices.
I wrote an article on OilSlick.com last week on why the U.S. should use oil as a weapon against Russia, Iran and Venezuela. I received quite a few positive comments on it. This drop in oil prices makes our oil production an even stronger weapon. Read it here
The crash in crude prices is going to create a dot.com type disaster in the energy sector. The companies with a strong business model and low debt will survive but the companies operating on highly leveraged debt to cash flow are going to disappear when their cash flow disappears. These crude prices are probably going to stay with us for the next six months at least because OPEC does not meet again until June. They could call an emergency meeting if the financial bleeding becomes too bad.
Meanwhile the U.S. consumer is going to reap a windfall gain in the decline of gasoline prices. The national average on Friday was $2.79 and the lowest for this period since 2009. Analysts believe it could decline to $2.55-$2.60 by Christmas.
There is a positive side to the OPEC decision. Dramatically lower oil prices rapidly increase demand and stimulates the global economy. This painful decline in oil prices could end up doing more to stimulate the global economy than Mario Draghi and Shinzo Abe combined. Goldman has said for every 25 cent drop in oil prices the daily demand for oil could increase +500,000 barrels. If gasoline prices to drop to $2.60 on average that could increase demand by well over 1.0 mbpd in 2015. We have already seen one restaurant chain beat on earnings because the lower gas prices boosted traffic on the interstates. Cracker Barrel (CBRL) beat on earnings and raised guidance because of higher traffic. Multiply that all across the world and it becomes a powerful economic stimulus.
Also, falling oil prices are going to dramatically impact inflation in the U.S. and keep the Federal Reserve on the sidelines for a lot longer than previously expected. Citigroup started the ball rolling by moving their estimate for the first rate cut to December 2015. Several other analysts have now moved their targets to early 2016. Analyst Richard Bove believes the Fed will not be able to raise rates until well into the future even if they wanted to. With the global economy slowing and U.S. inflation set to decline the Fed is trapped. If they raised rates the dollar would strengthen even further at a time with Europe, Japan and China are actually devaluing their currency.
Crude production in the U.S. was 9.077 mbpd last week and the highest since 1986. Production is still expected to increase over the next six months because of projects already underway. The money has been spent and the rigs contracted for several more months. The IEA expects U.S. production to rise to 9.4 mbpd for the full year. Gulf of Mexico production is expected to increase by 500,000 bpd over the next two years as several massive projects underway for the last several years finally begin to produce.
Friday's oil crash was not limited to oil. Natural gas prices declined -6% in sympathy even though a slowdown in shale drilling for oil would also generate less gas. This was a "dump anything energy related and ask questions later" day. First Solar (FSLR) fell -5%, SolarCity (SCTY) -3% and SunEdison (SUNE) -5%. Even Cameco (CCJ) a uranium miner declined -4%. Neither Cameco or those solar stocks have anything to do with oil. Cheaper oil will not impact the need for natural gas or uranium.
On the economic front there were no reports on Friday. All your government employees were out shopping on Black Friday.
The calendar for next week is full of important reports. The Week starts off with the ISM Manufacturing, which is a national report. After the volatility in some of the regional reports this will be of great interest. A fractional decline is expected.
The ISM Nonmanufacturing (services) report is out on Wednesday and analysts are expecting a fractional increase.
The big news for the week is the ADP Employment on Wednesday and the Nonfarm Payrolls on Friday. The ADP report is expected to show a minor increase of +5,000 jobs over the 230,000 new jobs reported for October. The Nonfarm Payroll report is expected to show an increase of just over 20,000 jobs from the 214,000 reported for October. That October report is expected to be revised higher.
The challenge here is that the weekly jobless claims have been rising for the last three weeks and posted a 12 week high at 313,000 last week. Rising jobless claims are an indicator of falling employment numbers. I would not be surprised to see the Nonfarm number fall below 200,000 new jobs despite the strong temporary hiring for the holidays.
More negative news out of Japan, China and India plus a drop in Eurozone inflation to 0.3% sent investors into treasuries once again. The yield on the ten-year fell to 2.19% and a six-week closing low.
There was very little stock news on Friday but there was plenty of stock movement. Airline stocks soared on the OPEC decision and the drop in crude prices. United Airlines (UAL) spiked +8% on the oil news with Delta (DAL) gaining +5%, Alaska Air (ALK) +5% and Southwest (LUV) +6%.
Even Carnival Corp (CCL) gained +5% on the oil drop. I have a hard time trying to decide why Carnival would be so dependent on oil prices but they do use a lot of fuel. I suppose they could get a minimal boost from consumers paying for cheaper gasoline but I have a hard time justifying a 5% boost in the stock price.
Retailers, led by Walmart (WMT), rallied on early reports that the malls were packed and shoppers were carrying bags of merchandise. Of course Walmart will also benefit from the lower gasoline prices for consumers and lower diesel prices for their fleet of 6,500 trucks that drive more than 700 million miles a year. Walmart shares rallied 3% on the drop in oil.
UPS (UPS) rallied +3% on the drop in oil prices even though they won't see much of the savings. They went to a fuel surcharge program several years ago so shipping prices fluctuate with the price of oil. Obviously it will benefit them because of their huge fleet of trucks and planes but shippers will benefit as well. UPS workers were out in force on Friday after UPS cancelled their normal Black Friday holiday they had enjoyed for years. I talked with my UPS driver when he delivered on Friday and he was not too upset. Like most guys he never rushed out on Black Friday to shop. Men would rather go to the dentist than stand in line and fight the crowds. He said having Black Friday off always meant they worked until long after dark on Monday to catch up with the packages that result from the pre Friday sales.
Here is another mystery. Constellation Brands (STZ), a distributor of beer, wine and spirits, surged 2% to a new high on Friday. I don't see any oil connection so I am assuming it was simply a dose of holiday cheer. Lower gasoline prices may leave consumers some left over cash for an extra bottle or wine but that is the only reason I could see for the rally.
Vodafone (VOD) said it was considering a deal to buy Liberty Global (LBTYA) to create Europe's largest phone, Internet and TV company worth more than $130 billion. Vodafone said it was analyzing the financial and regulatory hurdles as well as investor support for a share based transaction. The company said it also had concerns about the debt levels of the combined company. Shares of VOD rose +2.9% and LBTYA rose +7.4%.
Best Buy's (BBY) website crashed Friday morning for an extended period as an army of shoppers clicked in to see what specials they had available. The company said "A concentrated spike in mobile traffic triggered issues that led us to shut down BestBuy.com in order to take proactive measures to restore full performance,"
About 5:30 the site went down again with the company claiming "record levels of traffic" were affecting site performance. People taking to social media to complain also said it was briefly down late Wednesday night and again around 9:AM Thursday morning.
Best Buy quit releasing comments on the repeated outages and simply posted the message below.
U.S. markets posted a strong gain for the month with the Dow and Nasdaq finishing at new highs. The S&P suffered a -5 point decline that was purely related to the drop in energy stocks. The S&P closed at 2,067.56 with the 5-day average at 2,068.07 to end the consecutive day winning streak. The S&P had closed over that short term average for 29 consecutive days and the longest streak on record. The streak really has no relevance and is more of a fun fact to follow but it does give us an idea on the staying power of this rally.
The markets are very overbought but they just keep rising. The S&P has rebounded +11% since the October 15th low. The gains in November were lower with the Dow and S&P adding +2.5% with the Nasdaq adding +3.5%. Stronger than expected earnings and guidance along with positive expectations about Q4 retail sales and profits have stimulated investors. The upgrade in the Q3 GDP to 3.9% also helped. It is often reported that new highs tend to attract money from the sidelines faster than flies to a picnic.
Once the impact of the oil crash on energy stocks has passed the S&P should return to gains in the week ahead. There are 43 energy stocks in the S&P-500. Friday was month end and the next couple days should see some retirement money being put to work. However, early December is when tax selling begins. Whether we see that cycle or not is unclear after the nearly -10% drop in October. If managers were planning on taking tax losses in December on specific stocks the October dip could have accelerated that process.
The S&P has plenty of support levels just under the 2,067 close so it would take some concentrated selling to push it much below 2,050. At this point buyers would love to see a dip and every intraday dip continues to be bought.
The S&P is overbought with 84% of stocks trading over their 50-day averages. The 84% to 88% level has been a top for the last two years. However, December is the most bullish month in the year. Since 1950 the S&P has been up 48 times in December and down 15. The average gain was +1.7%. We can remain at this level for weeks given the historical trends and the bullish fundamentals. Eventually we are going to revisit lower levels but probably not until January.
Only 73.8% of the S&P stocks have a buy signal on the Point & figure charts. This gives us room for further upside gains with 85% the normal peak.
The Dow chart is still locked in a resistance battle at the 17,850 level with 17,800 current support. It was a miracle the oil crash did not knock the Dow for a big loss with the three biggest energy losers giving back $15 or the equivalent of -120 Dow points. Fortunately the retailers carried the day with Walmart, Home Depot, etc all packing on gains.
The Dow only added 18 points for the week but managed to close at a new high. That shows you just how tight the trading range was for the Dow. The chart below shows it perfectly with four spikes out of congestion that were immediately sold to knock it back to the 17,825 level.
The Transports should have been the big gainer but the morning spike to 9,310 was sold hard to leave the index with only a +2 point gain at 9,198 and -112 points off its highs. The selling came at the expense of the railroads, which have been transporting a lot of sand and oil and that could decline. CSX lost -4%, KSU -5%, NSC -5% and UNP -5%.
The Nasdaq big caps soared on Friday with a +20 point gain. This was by far the biggest index gain. The NDX came within 3 points of the uptrend resistance at 4,350. For the last three days Apple has stagnated and failed to push the index higher but I think that is about over. Apple closed today at $118.93 and only 7 cents below the historic high. Next week could see another surge begin.
The Nasdaq Composite traded over the round number resistance at 4,800 for most of the day but sellers appeared at the close to knock it back to 4,792 and -18 points off its high. It was still a new 14 year high and it is now only 5% below the historic high close of 5,048 set back in March 2000.
The Nasdaq has been pretty vertical since the 20th and should rest soon. It has added +150 points in only six trading days since the low on the 20th. Initial support should be around 4,755 followed by 4,700.
The Russell 2000 collapsed on Friday with a -17 point drop. The reason should be obvious since there are quite a few energy stocks that fall into the small cap category. While I don't think this is a trend change for the Russell I also don't think the selling is over. Investors that were at the malls on Friday are going to be setting at their computers at the open on Monday to dump those lousy energy stocks. Monday could be a capitulation day for energy equities.
The Russell fell back to interim support at 1,175 but we could easily test 1,150 on Monday. This is frustrating because Wednesday's gains pushed it over near term resistance and it was poised to target the old highs at 1,208.
Next week could be tricky. Monday and Tuesday should be positive unless the continued selling in the energy sector poisons the market. Month end retirement funds should be hitting the market to offset at least some of that energy selling.
The latter part of the week is facing the two big payroll reports and the beginning of tax selling season. Tax selling can take two forms. The first is when an investor sells underperforming stocks at a loss to offset the gains on assets that have outperformed. The second case is when an investor sells a position for a loss in order to offset gains elsewhere but then repurchases that same stock more than 30 days in the future. For instance an investor that has been holding Core Labs (CLB) in their portfolio since April. His basis is $200 and the stock closed Friday for $129. He still believes in the stock but he has gains in other stocks he wants to shelter. He sells the CLB position and takes the $71 loss to cover gains elsewhere. After 30 days passes he buys back the CLB shares to hold for the eventual recovery. There may be a lot of tax selling in energy stocks this year since the high for the year was in June. There are a lot of losses being carried in investor portfolios. I see this as an opportunity once the carnage is over. Oil will not stay low forever. The more production is knocked off line the faster prices will recover. Put some energy stocks on your shopping list for January.
According to the Stock Trader's Almanac 2015 should be a banner year. It is by far the best year of the 4-year cycle and especially in a second term president. Since 1939 the Dow has averaged a 16% gain, S&P +16.3% and the Nasdaq a +30.9% gain. Years ending in five have only had one down year in the last 13 decades. The average gain is 28.3% for the Dow, +25.3% for the S&P and +25.6% for the Nasdaq. For the current election cycle the current quarter and the first 2 quarters of next year average gains of 21% for the Dow and S&P and +34% for the Nasdaq. Finally, in the last 84 years there have only been 3 times where the markets were up double digits 3 years in a row. In each of those occurrences the 4th year was up an average gain of +23.1%. Let's all hope really hard that all those historical averages repeat in 2015.
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I hope you had a happy Thanksgiving and restrained yourself on the Black Friday shopping. A friend sent me this cartoon and I thought it was appropriate.
It is official. We kicked the Iranian can farther down the road. The administration's game plan appears to be "if we can't get a deal then postpone the deadline until we are out of office." After repeatedly claiming over the last six months that the deadline would not be extended and the sanctions would come back in full force on November 25th, the deadline was extended until July. The sanctions relief will remain in force until the next immovable deadline in July. Over the last six months since the sanctions were weakened in an effort to bring Iran to the negotiating table the country received between $4.6 to $11.0 billion in cash and non-oil imports that had been restricted under the sanctions. This program of relaxed sanctions will remain in place until July and they will receive another $5-$11 billion in cash and allowed imports. For a country that refuses to negotiate they are doing really well.
Not only are they profiting from the delays but the officials continue to be belligerent about the chances for a deal and warn that Israel's security is declining as each day passes.
The problem with getting an agreement last week boiled down to three things. Iran did not want to give up even a little on the uranium enrichment front and they still don't want to let inspectors into their nuclear research facilities. The third thing was a complete objection to any of the terms of the proposed deal by all of the Western allies. All the countries in the Persian Gulf objected. Saudi Arabia objected strenuously saying it was a bad deal. Israel objected vigorously and repeatedly. The other five western nations in the negotiations objected. Apparently the only person arguing for a deal was Secretary Kerry. The president is so anxious to get any win on a foreign policy initiative they were willing to give up almost anything. The final draft was so watered down Iran only had to agree to a 12 month window on enrichment. The draft deal supposedly prevented Iran from enrichment levels that would keep them from creating a nuclear weapon for a minimum of 12 months. That is not a deal for the West but Iran still opposed it. We can guess why. Our only hope now is that oil prices will drop so low that Iran will not be able to fund its nuclear research for the next seven months.
I wrote about Amazon's Web Services and their massive scale several weeks ago in the nightly commentary. As a former tech geek earlier in my career I find technical details about cutting edge technology fascinating. For an old guy that used to manage a datacenter for Exxon in the 1960s I cannot even comprehend the scale of Amazon's cloud. I found a new article describing the efforts they went through to build this massive cloud product. If you are not tech literate I doubt you will get much out of it but geeks of the world will enjoy it. The Massive Scale of AWS
With the drop in oil prices everyone is turning to the question of what does it cost to produce oil in various fields. By determining a field's breakeven cost and knowing who is drilling in that field you can decide who is likely to cut capex the most, who is likely to have cash flow problems, etc. Well your research problem has been solved. Ed Morse at Citigroup has put together a breakeven chart for not only all the shale plays in the USA but all the fields in the world. Yes, the world. He points out that there is a lot of oil available at $90 oil because producers can hedge their production to protect cash flow. However, at $70 or less the margins are too slim and there is no hedging capability in the futures markets. Here are the charts. Citi Cost per Field
Google has thrown in the towel on renewable energy. Back in 2007 Google promised to go green to stop global warming. They installed all kinds of renewable energy using wind, solar and several experimental programs. They spent billions on the effort. In 2009 the Green Energy Czar at Google, Bill Weihl boasted, we have a 50:50 chance of having multiple megawatts of plants installed over the next three years. Oops! No plants and Bill is no longer at Google.
Larry Page had a program called "Renewable Energy Cheaper than Coal (RE
Jeremy Grantham, fund manager at GMO, sent a letter to clients saying the market could surge another 10% from here before getting into bubble territory, which starts at 2,250 on his charts. However, he said picking stocks today was tough with many individual stocks over valued. He also points out that the best seven months in the third year of a second presidential term have averaged about +2.5% per month. Seventeen of the last 20 third year periods have been bullish with 3 bearish and averaging about a -6.4% decline. With the eurozone and Japan increasing stimulus it should help the equity markets.
Vladimir Putin is still projecting the Russian flag all around the world. Russian warships entered the English Channel for "exercises" on Friday. The four warships were led by the anti-submarine ship Severomorsk. The real purpose of the exercise is to remind everyone that Russia has a military force and is not afraid to use it. The flotilla was shadowed by the Royal Navy warship HMS Tyne.
On Friday Russia test fired a new Bulava nuclear ICBM from the Alexander Nevsky submarine from a position in the Barents Sea. Russia claims the sub launched missile has a range of 8,000 miles and can carry up to 10 nuclear warheads. Russia is spending $400 billion on new weapons and upgrades by 2020. The U.S. is cutting its military budget by $400 billion.
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