‘God’ of crude oil trading sees oil rally benefiting shale since this isn’t ‘86

2/5/2015

BRADLEY OLSON

WESTPORT, Conneticut (Bloomberg) — The oil industry’s billions in spending cuts are paving the way for a price rebound that will make the best shale producers attractive investments, commodity hedge fund manager Andrew J. Hall told investors.

The current rout is distinguished from the crash in 1986—which left crude trading below $25/bbl for four years—because OPEC countries today have almost no spare capacity. This time, shale oil will soon be needed to make up for production declines all over the world, pushing U.S. prices to as high as $65/bbl, the head of Astenbeck Capital Management wrote in a Feb. 2 letter obtained by Bloomberg News.

“Prices at current levels (or lower) are not sustainable for very long,” Hall said in the letter. “The current surplus could thus easily set the stage for a future deficit.”

Major producers and drilling companies are cutting more than $40 billion in spending and firing thousands of workers after crude plunged to more than half its level seven months ago. The kind of price recovery Hall expects won’t be enough to justify spending on major energy projects needed to boost global output, he wrote.

That will make shale producers a “very attractive investment” as they already operate at lower costs, and those costs are likely to fall further, Hall said.

West Texas Intermediate, the U.S. crude benchmark, fell 9.4% last month and has rallied 14% in the past week to $50.48 at the close in New York on Thursday. It’s still 53% lower than last year’s peak in June.

Astenbeck funds were up 4.7% in January, according to sources familiar with their performance.

Dubbed ‘God’

Renowned among fellow traders for his track record of anticipating major market swings and dubbed ‘God’ by some, according to Tom Bower’s 2010 book “Oil,” Hall rose to prominence in 2009 after receiving a pay package of about $100 million while at Citigroup Inc. The trader became a lightning rod for criticism over compensation at bailed out banks.

Hall isn’t alone in pointing out that significant spending cuts are likely to lead to a supply shortage. Abdalla El-Badri, Secretary-General of the Organization of Petroleum Exporting Countries, warned last week that prices could boomerang to $200/bbl.

Some analysts including Bob Brackett at Sanford C. Bernstein & Co., who since Nov. 3 has recommended buying the shares of U.S. producers EOG Resources Inc., Anadarko Petroleum Corp. and Apache Corp., have said prices will have to rise to meet marginal costs.

Many in the industry don’t see a rebound coming soon. Goldman Sachs Group Inc. on Jan. 11 predicted a $43/bbl global crude price for six months and a 12-month forecast of $70. BP Plc CEO Bob Dudley, who said Feb. 3 that it will be “a long time” before oil sells for $100/bbl again, compared the oil crash of the last few months to 1986, when oil slumped from $30/bbl to $10 and didn’t recover until Iraq invaded Kuwait in 1990.

Different Times

Hall and several people close to him are taking different lessons from 1986. The most important difference for Hall, according to his letter, is that at the time OPEC had about 25% of spare capacity. Today’s surplus is only 2% higher than global oil consumption, “and it will have dissipated by the end of the year, if not sooner,” he said.

Steven Kopits, managing director of Princeton Energy Advisors who is working on a book commissioned by Hall, said an oil shock could come as soon as the second half of next year. The reason is simple, he said: demand will rise due to lower prices, and supply of conventional oil production will fall by as much as 2.4 MMbpd, he said in an interview.

Current forecasts by OPEC, the International Energy Agency and the U.S. Energy Information Administration don’t predict a significant response to low prices. In 1986, the impact was immediate. Consumption rose 5% in the quarter after oil’s precipitous fall, he said in a Jan. 20 note.

Sudden Drop

Conventional production also fell quickly, he said. If the same patterns repeated today, it would lead to higher demand, reduced supply and a much higher price, Kopits said. U.S. production has slowed so quickly that it may peak this month or next month, he said.

“The market is beginning to feel like this supply-demand balance is going to readjust faster than earlier expectations,” he said. “We are going to have some price signals in the second half that stimulate some incremental production.”

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