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Guest Post: Daniel Carlson – Time to Buy Oil

on 12/10/2015

Guest Post: Daniel Carlson has posted a number of insightful articles on Linked-In & SeekingAlpha. His work encompasses both sector pieces like this one and individual stock picks. Here's a concise view on oil.

I have no prior or existing business relationship with Mr. Carlson or any company he's written about. 

Time To Buy Oil

I'm drawing a line in the sand. Pun intended. It's time to buy oil. Let's review what we know.

1. OPEC didn't really increase their quota, they just approved the amount that is currently being produced. OPEC is producing at their maximum. This is as good (bad?) as it gets. OPEC volume is up around 1,500,000 bpd over the last two years. See chart.

OPEC will not be increasing production from here and it might begin to decline a little. Iraq has already started to roll over due to lack of investment. The Saudis are maxed out. This is a problem that's in the rear view mirror.

2. World volumes during this time have increased about 5M bpd. This is due to the US. Here, volumes are up 3M bpd during that time. We are, however, rolling over. Don't believe the press that "volumes are holding up despite low prices". We had a tremendous backlog of well completions. This is dwindling. Meanwhile, the rig count has plummeted. Can we ramp production? Sure, but that won't happen until prices hit $60...and stay there.

Thus, expect US volumes, which are now 500,000 bpd off their high, to continue to go lower. I think we will lose over 1M bpd of US production during the next twelve months.

Screen Shot 2015-12-10 at 9.56.05 AM

As an interesting exercise, check out Texas volumes. The state is down over 20% from its high and is now at 2013 levels...and dropping quickly. I expect North Dakota to follow shortly. Fracking volumes will plummet; took longer to happen than expected, but it will happen.

3. Non-OPEC volumes are flat at best. Iran is coming back and they will bring 500,000 additional bpd, this is true. But, there are problems elsewhere as no one is investing in production. Russia, like the US, will see declining volumes soon. Brazil is a nightmare. Argentina as well. They all are suffering, don't expect this group to increase supply overall, despite Iran's increases.

4. Concensus says we are 2M barrels per day oversupplied. Let's say that's the case. In 2016, I am predicting 1M less bpd from the US, no change from OPEC and no change (+500,000 from Iran, -500,000 from elsewhere). So, that takes us to 1M bpd oversupplied assuming flat demand. However, according to all sources, demand for oil is set to increase next year by well over 1M bpd. See chart.

Conclusion

World oil demand is increasing. Supply will drop in 2016. There will be a tipping point where demand exceeds supply and that tipping point is coming earlier than people realize.

When that happens, how long do you think oil can trade at levels below the marginal cost of production? It can't be for long. Marginal production from the fracking industry is likely close to $60. However, to see serious ramps in fracking, I think oil needs to be over $60 for quite a while.

I expect oil to be the best performing commodity in 2016 and returns from oil are likely to exceed those from the broader market. Investment cycles are like clockwork. They move to extremes in both directions. The stock market has never had 7 straight up years in the history of the S&P and oil is down over 60% from its high. Buy oil for outperformance in 2016.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Peter Epstein, CFA, MBA | December 10, 2015 at 10:06 am | Categories: Daniel Carlson, Guest Posts, Interviews, Oil & Gas | URL: http://wp.me/p5Jnik-1Ep


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