This article was published by The McAlvany Intelligence Advisor on Wednesday, March 9, 2016:
With crude oil up more than 30 percent over the last week, and companies like SeaDrill and Chesapeake Energy up 125 percent and 250 percent, respectively, over the last five days, short covering has persuaded some that the bottom is in. Investors, especially short sellers, in the oil patch need lots of risk capital, a high risk tolerance, and a short memory.
Goldman Sachs called it a “premature surge” and a “false start,” while others are calling it “not sustainable.” Indeed, as this is being written on Tuesday, both SDRL and CHK are down 15 percent.
Big money investors have decided that if this isn’t the bottom it’s close enough. Since the first of the year, nearly $9 billion of new money has poured into companies like Pioneer Natural Resources, Devon Energy, and Hess. More new money has found a home in the energy sector in February than in any month in history, and it continues apace.
The underlying assumption is two-fold: First, supply is decreasing and demand is increasing. Second, sooner than later the twain shall meet, the market will be “balanced,” and long-term profits await the patient investor.
That investor is going to have to be patient indeed because each assumption is questionable. Despite rig counts hitting near record lows, the production from those still standing continues to increase. Thanks to improved efficiency and better technology, frackers are able to squeeze more and more production out of fewer and fewer wells. The Energy Information Administration just estimated that for 2016 oil shale production will be off less than two percent from previous highs. Add to that the announcement on Tuesday that Iran plans to start exporting refined oil products like gasoline as early as June, and it’s apparent that supplies will remain robust for the foreseeable future.
Demand isn’t increasing, either, at least when one looks at China and Japan. Reuters just reported that China’s trade numbers for February were “far worse than economists had expected, with exports tumbling the most in over six years … [just] days after top [Chinese] officials sought to reassure investors that [China’s] outlook remains solid.”
China’s exports fell a breathtaking 25.4 percent in February compared to a year earlier, with demand slumping across every sector. Imports fell, too, by 13.8 percent, the 16th straight monthly decline.
Earnings improvements necessary to justify the rebound simply aren’t there. Rolling 12-month forward earnings expectations across the globe are universally off their highs.
The market is behaving just as it should if nervous shorts are buying back stocks they sold earlier, according to MacroMan: “In some ways … it seems that the worse your fundamentals are, the better your price performance has been. That is a classic, if not the classic, symptom of short covering.”
There’s also an unsettling similarity to the head fake a year ago when crude prices jumped in March and April from $55 a barrel to $65, then declined to below $30 instead of moving still higher. Morgan Stanley looked at the history and wrote, “The rebound oil has enjoyed since early February bears an uncanny resemblance to [the] rally seen in the second quarter of 2015 that ultimately faltered.”
The new influx of capital is most certainly welcome not only for the oil companies, which have borrowed billions, but also for the banks that have made the loans. Much of the new money is going to shore up weak balance sheets and retire expensive loans while adding to rainy day reserves. Banks will shortly be recalculating reserves backing those loans and be calling some of them. That new money will meet those calls rather than sinking those companies into bankruptcy.
This bodes well for the future. OPEC has counted on rig declines to cut production from the U.S. as companies go into bankruptcy, leaving OPEC the last man standing. The bottom is a long way off according to the EIA and others, perhaps many months or even years. And investors really won’t know for sure until long after the fact.
Houston Chronicle: Oil gets a lifeline from Wall Street
Macro Man: HOT PRICES, COLD EARNINGS
Marketwatch: China’s exports tumble for 8th month in a row
Marketwatch: Japan’s GDP didn’t contract as much as estimated