All the investors know the fundamental problems behind the slump of the real estate sector in the U.S. a few years ago. Given that no fundamental improvement can take place overnight, it took the real estate sector in the U.S. a few years to recover from its lows in 2009.
I am sure now that many readers wonder why I talk about the real estate sector in an oil-related article. What is the relation between the real estate sector and the oil markets?
I mention this example because I strongly believe that the oil price will recover like the real estate sector has recovered from its bottom over the last three years. But, there is also a big difference here. The recovery of the oil price will be much quicker than the recovery of the real estate sector, given that this slump of the oil price has been driven by lame thinking, arbitrary speculation and sentiment, while having nothing to do with evaporating geopolitical risks around the world or a material deterioration of the global supply-demand fundamentals.
On top of that, there are some additional geopolitical clouds on the horizon that can make oil jump by H1 2015. For instance, the current low oil price has brought many OPEC members to their knees, while the holders of those countries' sovereign debt are toast as long as oil stays at the current levels. Iran, Iraq, Libya, Algeria and Venezuela are not prepared to withstand low oil prices for long and they are now in serious danger of political upheaval at current prices. According to yesterday's news from CNBC, the first signs of an escalating social unrest in Venezuela are already there, and things will definitely get worse over the next weeks.
Furthermore, Russia and Saudi Arabia will be anxiously watching the rapid depletion of their sovereign wealth funds, which will make the political situation in these two countries dicey over the next months.
In other words, I obviously agree with Andrew John Hall, who is known as the God of Crude Oil Trading. Although many investors and readers do not know this oil legend, Hall is secure in his view that the price of oil is destined to rise sooner rather than later, mocking those who are convinced that a U.S. shale boom will mean long-term cheap, abundant energy.
My Takeaway
Fellow investors, please educate yourselves for your own benefit. Everyone talks about buying low and selling high, but he often does the opposite. The typical investor often buys high because he feels good. And he sells low because of panic and lame thinking.
Therefore, this is the essence of my investment thesis. This oil price fall is a sentiment-driven slump. This is short term and sentiment-driven noise in the big picture story.
And to get it better, please check out what Kuwait's oil minister said just a few days ago. He said that he believed surplus production in the oil market would be absorbed soon, but that the extent of the surplus was not clear. Asked about the size of the overhang in the market, he replied: "We do not know how big it is."
Did you read his statement? The direct participants in the oil markets who make their living by selling oil for decades now, do not know the extent of the surplus. Also, they believe it will be absorbed soon, which implies that there is not such a huge surplus that can justify a slump of 40% in the oil price.
Nevertheless, the media and many analysts who see gas only when they pump gas into their vehicles, have made you believe that a drop of 40% is the appropriate drop for the oil price. This is funny, isn't it?
Right now, oil has come to the point where it is unloved, which is exactly when you have to expose yourself to the sector. This oil downturn cannot last long and oil will bounce back by early 2015.
On the supply side, there are not any "elephant" conventional discoveries over the last years, and this is why the conventional oil production from the U.S., the North Sea, Mexico, North Africa and the Middle East has been falling over the last years. Cheap and easy oil is gone forever, and the global marginal barrel currently is in the $80 to $90 range.
Due to the current low oil price, oil supplies will become critically tight by early 2015, largely because production leader Saudi Arabia is not able to pump as much extra oil as many people believe. In fact, Saudi oil production has peaked at approximately 10 million bopd over the last years, as illustrated below:
On the demand side, the investors must not ignore that world population keep growing at a satisfactory rate in an energy intensive world, as witnessed by the GDP growth rates and the GDP per capita for the world's biggest oil consumers mentioned above. As a result, global oil demand continues growing unabated at average of 1 million barrels per year.
Meanwhile, the geopolitical tensions are escalating and the crude oil price is best proxy for geopolitical risk.
After all, how can the investors weather this temporary storm and benefit from this oil price shock? Well, big fortunes will be made to those with the patience and foresight to pick right and hold tight. Just pick quality oil stocks with low key metrics (i.e. EV/EBITDA, EV/Production, EV/Reserves), sit tight, and you are going to do very well given that the strong players will remain and the weak ones will vanish.
For instance, stay far from the heavily indebted companies with a high Net Debt to EBITDA ratio, because many highly leveraged U.S. shale producers will go broke over the next couple of years. The rising tide will not lift all boats. Even if WTI jumps at $85/bbl tomorrow, several U.S. shale oil producers will not avoid bankruptcy while others will be sold for pennies on the dollar. Beggars cannot be choosers.
And now you know why I sent out last Thursday a Market Update to the subscribers of "Nathan's Bulletin," urging them to load specific quality picks. And when Brent crests that $90 mark again, they will be glad they did.
AI
