By Joe Petrowski
Having traded many commodities over a 40 year career, the “old salt” wisdom of my mentors and contemporaries sticks in my mind…
“The cure for high prices is high prices. The cure for low prices is low prices.” (Short for markets work.)
“Trees do not grow to the sky, and do not short crap.”
“They do not ring bells at the top or bottom.”
“Markets rarely turn on needle point peaks or bottoms, but round and trough for a period of time.”
“Price affects are baking ingredients–they take time to manifest.”
“The time to be nervous is when you are relaxed; complacency is the great seducer.”
Applying this to the current energy situation the following can be said: We spent too long above $80/barrel when the marginal cost of production of the largest producer, Saudi Arabia, was $20/barrel. And as a result:
- We invested $3 billion per year in domestic energy production.
- We shed 3 million barrels per day in U.S. demand by efficiency and fuel shifting.
- We invested another $1 billion per year in alternate fuel technology like electric, hydrogen and nat gas.
- The backwardated market decreased the demand for above ground storage
- Users bought hand to mouth at high prices, and accelerated that trend as prices began to decline
Prognosticators spewed forth utter nonsense such as: “We are running out of oil; $100 to $150 is what we can expect.” While the mainstream press, academia and government officials were spending their time hand wringing, bloviating and exhibiting hysteria, the entrepreneurs, merchants and business visionaries were pouring capital into new production, fuel saving technology and innovative business models like Uber and Zipcar. Now the the oil price has collapsed, these same prognosticators are seeing an Armageddon of world deflation and a sector that will continue to spiral down. What they are now missing are:
- Announced capital cuts in new drilling and wells exceed 1 trillion annual which is almost 50% of new production budget
- With tanker freight rates at an all-time low, almost 500 ships representing 375 million barrels are in service storing both crude and products. That number could easily triple over the next two years with large price contangoes, low interest rates and low freight rates
- Non OPEC production, especially in Brazil, Mexico, and Russia is in steep decline.
- We have 1.5 billion barrels of terminal space in the United States. A 10% increase in inventory holds will create demand for 150 million barrels, or 500,000 barrels per day.
- We are seeing unprecedented increase in commercial forward purchasing of products that are adding almost 1 million barrels per day to the demand base. Just as high prices force demand forward, low prices pull demand from the future to the present.
- An emerging trend that has not taken hold but will have a very bullish impact is the creation of a retail market in fixed-price, fixed-gallon fuel cards. Natural gas, hydrogen and electric vehicle sellers will bundle these cards with GPS guided fuel locations at the time of purchase. Diesel and gasoline cards will also be bundled with loyalty offerings.
- This trend is being facilitated by financial players prohibited from proprietary and directional trading, as well as mobile technology. Retailers, product vendors and vehicle merchants will push this, and that will aid in pulling forward demand to the present when price dictates.
Because we are well supplied and the world economy remains soft, it is hard to see an explosive upside. But, just as we became comfortable with $100 oil and were shocked by its price collapse, we are getting too comfortable today with a moderate and low-priced oil market when we have: a change in Saudi leadership; and an Iran that may find itself under attack if nuclear negotiations fail; and ISIS in control of Yemen. Add in a Chinese recovery, a Europe that discovers the joy of quantitative easing and an America that rekindles its love of petroleum vehicles and larger SUVs and the fear of $20 barrel will be rightfully seen as another irrational panic.
Why oil bottoms at $35/barrel
- Marginal cost of production of most efficient producer
- With $15 crack spread makes wholesale gasoline $1.19/gallon and retail just under $2 where demand explodes domestically
- $35 for oil equivalent to $7/nat gas where accelerated switching occurs
- Foreign demand especially for diesel explodes
- Takes out Nov 1995 low
- With $1.50/barrel cost of carry/year puts 10 year forward at $50 not including optionality value of in ground/in tank physical supply benefit
- $35 is inflation adjusted price of $20 oil in 1970 (gas was 36 cents/gallon and you got a promotional glass. I pumped that as 16-year-old)
Joe Petrowski has had a long career in international commodity trading, energy and retail management and public policy development. In 2005, he was named President and CEO of Gulf Oil LP and elected to the Gulf Oil LP Board of Directors. In October of 2008 he was named CEO of the now combined Gulf Oil and Cumberland Farms whose annual revenues exceed $11 billion and that now operates in 27 states. In September 2013, Petrowski stepped down as CEO of The Cumberland Gulf Group. He is now managing director of Mercantor Partners, a private equity firm investing in convenience and energy distribution.