Altana Quarterly Market Outlook February 2016
Profiting from the Oil fall part 2
In February of last year, I wrote my quarterly piece on profiting from oil. The article is shown on the following section. Oil at the time was hovering just above $50. The December 2020 future was trading around $70. The average price that could be locked in by oil traders over 5 years was therefore around $60. We predicted we would see oil in the 20’s and fast forward to 2016 and oil has fallen to below $30 having been as low as $27 with the forwards at $47 and the average 5 year price now at $38. Why do I keep mentioning the forwards? Any sensible lender or investor to oil companies be they services, exploration or production will look at the expected realised price over time to determine whether they will fund a project. So when Royal Dutch’s CEO defends his deal with British Gas by saying we can make it work at $50 oil we still shrug our shoulders and say ‘so what, oil is sub $40’. The CEO of Wells Fargo on reporting that they had $28 billion of shale gas loan exposures was asked ‘what percentage of that is below investment grade?’ to which he replied ‘substantially all of it’. We doff our cap to his honesty but if one of the world’s largest banks has 1.5% of capital exposed to just this sector not to mention the other mining sectors then they will need to raise more tier 1 equity before they lend to new projects. To me, we are in sight of the bottom for the simple factor that there is no lending ability from oil producing nations, from neither banks nor investment grade bond funds. Only distressed funds and private investors participate. This is true of other commodity sectors. Take the mighty Glencore which financed a revolver of 15.25 billion with 60 banks in 2015 at 100 bps but now sees its bonds trading nearer 10% yield. Glencore is one of the stronger names. Banks have lent at the wrong spreads and are feeling the pain. They will have to reprice risk and take some pain. Glencore had interest expense of 1.36B last year at those low spreads. Put them at market prices and a 2015 pre-tax profit of $1.02B would become a loss of $2-4B. Don’t forget many companies hedged their 2015 output at much higher levels but those hedges have fallen off so results will be materially worse going forward. In essence commodity prices are reaching interesting levels. Given we all have a future liability for food, energy and clothing we are being offered a great entry point to hedge our risk and even go long exposure.
What happens next? The low could be the $27 we have already seen, or even the inflation adjusted 20 year low of $15. It is difficult to say without hindsight. However, what the market may be underestimating is how long it stays low. Absent a material event that disrupts global production we see different players causing oil to stay low.
- Oil producing countries with reduced budgets, weak currencies and external debt repayments keep pumping oil at lower prices so that they can keep economy running, pay debtors and hence keep their jobs.
- Debt encumbered oil companies producing oil, not spending money on capex but trying to survive and pay the bills.
- Companies in bankruptcy in USA, taking 9-15 months from end of 2015 to work through chapter 11 will have no debtors but need to keep pumping oil to show they are viable.
- Companies bought out of bankruptcy at prices implying a break even in oil at significant discount to forward prices. They will want to pay back investors to increase IRR as soon as possible so will keep pumping the oil.
Hence, we don’t see a V shaped recovery as in 2009. We see at least 12 months of low and volatile prices as the debtors are repaid or take ownership. Once it is clear the remaining non bankrupt companies will likely survive then oil will rally. Any supply shock at that point will be more significant. Oil demand in the US for example is close to supply [the use in plastics and other consumer goods is simply amazing]. We are also clearly in a manufacturing recession. When that ends and the weaker players in the oil sector exit bankruptcy we could see a big move upwards. We think more likely 2017 than either 2016 or 2018.
We’d love to see Oil below 25, copper below 150, silver at 10$ etc. and we just might this year. Already under one year corporate bonds in many names is yielding 10% for large corporations with liquidity coverage. Equities are getting interesting. Royal Dutch Shell had a 10% dividend yield in January and it survived the loss of 60% of its assets in WW II.
As I told a good friend – I am so pessimistic that I am optimistic. By that I mean prices are getting so low, that I am optimistic that we can invest and make very profitable returns on a 3, 5 and 10 year view in the commodities, related currencies such as NOK, MXN, distressed bonds and of course the related equities.
Profiting from the Oil fall part 1 published Feb 2015
“Gold is the money of kings, Silver is the money of the working class, Barter is the money of peasants, but Debt is the money of slaves” Anon
Many theories are espoused as to why the oil price is going lower and why is has fallen 50%. For example, too much supply, yes but that wouldn’t crush prices 50% so quickly given the rate of change of supply has not drastically moved. Too little demand, more likely given shipping, railcar transport rates have fallen dramatically to multi-year lows in many cases plus world slowdown that has hurt, but again would not explain the smooth, constant move from over $100 to under $50 a barrel. Manipulation from OPEC to hurt Russia. Possible but seems unlikely, given this could have happened during the winter of 2014 to cause greater Russian pain. We note that a large US oil firm, Schlumberger, has just bought control of a large Russian driller – Eurasia Drilling. Makes you think US-Russian relations are not as strained as the press would have you believe. As is true in 90% of cases, follow the money rationally and the answers are become clearer.
Where does following the money lead us? Over the last 5 years the Shale gas revolution has gone from potential to reality. This extra supply means OPEC cannot easily control and drive prices higher over time. However, this revolution was funded with debt. Think about it, an investment venture with commodity linked return whereby you make a killing if the oil market goes up or bust if falls below say $60-80 should always be funded with equity. However, these companies have been funded with an ever increasing amount of debt over the last two plus years. According to the December Financial Times:
“Energy bonds now make up nearly 16 per cent of the $1.3 trillion junk bond market — more than three times their proportion 10 years ago,”
“Nearly 45 per cent of this year’s non-investment grade syndicated loans have been in oil and gas.”
I would recommend that all investors and students of history read ‘Confessions of an Economic Hitman’ by Perkins. Whether fact or fiction it explains how issuing debt at the right level can ultimately give you control of nations and key strategic assets.
So let us imagine, we were advising OPEC on how to maximise future profits from higher oil prices. We would not have advised them to invest in Shale gas over five years ago when it was high risk but unproven technology. Now it is a proven competing technology what would we suggest? Perhaps pushing the oil price lower to drive these indebted companies out of business? However, driving the oil price down would only cause the assets to change hands. When OPEC eventually tries to raise prices back to above $100 the same competitors would still be present. So we would advise OPEC to buy these companies out of bankruptcy thus controlling an even greater global supply. For this to happen oil will have to trade low for a longer period of time say 9-15 months because at first the indebted slaves will sell more and more oil to provide cash flow to their creditors before entering Chapter 11 and restructuring.
How do you profit? When you see Middle East money, SWF and companies with strong ties to the region such as GE, Haliburton etc. buying up these companies from bankruptcy we will be close to the point whereby OPEC lets oil prices rise much higher. At that point investors need to get very, very long oil futures and related investments. Worst case you have a hedge against your future energy consumption. Best case you profit from riding alongside a cartel.
We are pleased to announce that Altana Turnaround Stock Fund (UCITS Hedged version) has been formally launched on 4th January 2016, as a sub-fund under our Altana UCITS umbrella. We are happy to let you know that it is now open to outside investment. The Fund Manager, Thierry Vignal, has over 25 years trading experience across several disciplines.
Some of you will already have received the monthly newsletter for the fund, so you will be aware of the performance. Thierry has successfully delivered a performance of +2.39% year-to-date (from 31st December 2014 till 31st December 2015, hedged version) and +6.59% year-to-date (from 31st December 2014 till 31st December 2015, unhedged version), versus -0.73% for the relevant benchmark index (S&P 500, from 31st December 2014 till 31st December 2015). These performance figures are based on USD 1 million real money, which has been run in a sub-strategy within our Founder’s, Lee Robinson, private investment vehicles.
A brief reminder of some details of the strategy:
- The system behind the strategy screens for all stocks which have fallen >50% from their peak over the economic cycle with a minimum market cap of USD 1 Billion
- 19 turn around factors are analyzed to assess if the company has implemented a potentially successful turnaround plan
- Check if market has also recognized the turnaround by outperformance in falling markets and technical breakouts
- Enter and exit the trade with pre-defined stop loss and holding period until end of the calendar year
- Hedge with beta-adjusted futures or in the money puts removing market risk
Specific details on the UCITS fund:
- The UCITS has at launch AUM of USD 5 million.
- We offer institutional share classes for 1.5% management fee and retail share classes for 2.0% management fee. Performance fee 20%.
- The fund offers daily liquidity
- The fund has daily dealing and publishes daily to Bloomberg: ALTSTAU ID
As mentioned above, a hedged UCITS of the strategy is ready for inward investment under our existing Altana UCITS umbrella. If you wish to know more information, please contact firstname.lastname@example.org.
This report is prepared by Altana Wealth Ltd (“Altana”) authorised and regulated by the Financial Conduct Authority (“FCA”) in the United Kingdom. The investment products and services of Altana are only available to persons who are professional clients and eligible counterparties as defined in FCA’s rules. They are not available to retail clients. The distribution of this report may be restricted in certain jurisdictions and it is the responsibility of any person or persons in possession of this document to inform themselves of, and to observe, all applicable laws and regulations of any relevant jurisdiction. Past performance is not a guarantee of future results.