Oil prices have taken a wild ride in recent years, and nobody knows exactly where they will settle.
Some market analysts, though, have a better idea than others.
Brent Berarducci of Blacklion Capital Management, namely, is one unique to the oil and gas financial market.
His boots have been on the ground (as well as 30,000+ feet in the air) and now his hands are handling cash.
As the principal and manager for Texas-based Blacklion, he works to close the disparity between those in the oil field and those in finance.
A Navy fighter pilot combat veteran and a former upstream operations manager (and current consultant), he has the tactical intellect and practical energy industry experience to decipher the most technical of elements and events in the oil market.
While discussing topics ranging from depressed rig counts, sustained anemic demand, OPEC, and President Trump, Berarducci offered up some unconventional insights into what’s really going on in oil and gas markets today.
- America is poised to become the world’s swing producer
- OPEC is really good at marketing
- President Trump won’t make things worse
- Rig count data isn’t a reliable indicator of market health anymore
- Demand remains weak as global economies recover from the 2008 financial crisis
- Why high storage levels aren’t impacting prices more is kind of a mystery
Roll up your sleeves and dig into the data to find the right numbers with the following interview:
Rig counts – New tech and changing data
Why is rig count data no longer a solid indicator of O&G market health?
Brent Berarducci: I think there’s too much emphasis on rig counts in general, and focusing on depressed rig counts has created a very large, long side bias.
The industry has undergone significant changes recently, particularly since around 2012.
Success rates were less than 50 percent during the early 2000s and in excess of 89 percent in 2011 [according to the Energy Information Administration (EIA)]. Unfortunately, that was the last time the EIA tracked this information.
I had a drilling superintendent tell me, “We don’t drill wells anymore. I manufacture holes. I’m a factory. Instead of the wells coming by my machine, I move my machine to where the wells go.”
From an efficiency standpoint, we are drilling footage and setting production casing at nearly the same rate as in 2011 through 2014, just by virtue of improved technology.
It doesn’t take much to sustain production rates at these very depressed rig counts. I think the engineers and the upstream operators get it. But I’m not sure everybody on the financial analysis side does.
O&G demand – Sustained anemia
Why hasn’t O&G demand improved?
BB: In many respects, both the U.S. and global economy haven’t recovered from damage caused by the 2008 financial crisis.
The U.S. tried to borrow our way out of a debt crisis. Additionally, more barriers were created, such as various regulations, progressive tax codes, and the Affordable Care Act.
As a result, anemic economic growth has been masked by a relatively benign unemployment rate because of low labor participation.
So, what does that mean? The enormous demand for hydrocarbons seen back in the late 2000s just isn’t there.
OPEC – What they say vs. what they do
Is OPEC’s rhetoric about production cuts misleading O&G markets?
BB: I think OPEC has first and foremost done an outstanding job of marketing. They have sold the world on their rhetoric.
But it’s very important to go look under the hood, so to speak, and do the homework to understand what’s really going on.
For clarification, I spend lots of time working with committed trader’s data. This data comes from the people best informed about what’s going on in upstream O&G, the commercial participants [such as producers] looking to use the markets to mitigate their price risk.
Now, OPEC is also a producer. And OPEC is welcomed to participate in these markets. There’s nothing that bars OPEC members or non-OPEC members from participating in the markets that are tracked by the commitment of traders.
But with every time there’s a microphone or TV camera, there’s somebody from OPEC with their face in it saying “we’re cutting production.”
If that’s the case, the best informed people who deal with the physical commodity every day would not be taking record short positions to hedge themselves against falling prices.
It seems that all OPEC is doing with their protests about cutting production is temporarily and artificially inflating oil prices. As a result, astute producers in the U.S. and abroad are hedging against lower prices.
And despite depressed prices, the oil field is alive and well. The U.S. is quickly becoming one of the most cost effective and efficient producers in the world. While OPEC continues to market their production cut rhetoric, U.S. producers are putting efficiency to work.
Considering this, I sincerely believe the U.S. is now poised to become the world’s swing producer.
But don’t just take my word for it, go look at what people are doing with their money.
The people who deal with these products every day are saying that OPEC’s rhetoric is a sham and that the U.S. is going to use this opportunity to hedge prices while taking up the mantle as the world’s swing producer.
O&G Storage – Near record levels
Why aren’t high storage levels hurting oil prices more?
BB: Record storage levels should be impacting oil prices more than they actually are, and that’s kind of a mystery right now.
Market analysts and investors can’t just look at crude oil in a vacuum, though. You need to look at the refined products and every stage of the value chain. But whether it’s the crude input or the refined finished good, storage levels are at all time record highs.
The only conclusion we can draw from this is that demand isn’t robust as estimated.
Now, going back to depressed rig counts and the long side bias it’s creating, we also start to see what’s called a normalcy bias.
For example, in February 2016 crude oil prices hit their low at around 26 dollars. At the end of the year prices were in the low 50 dollar range. That was a great run by anybody’s measure. But investors tend to think that trends will continue infinitely.
The current investor optimism seems to be a result of this normalcy bias, but it’s also due to the annual transition of refineries preparing for the summer driving season. Prices increase during this time of year because suppliers are trying to build storage, but we’re already at record storage.
With rig counts a third of what they’ve been in recent years, the common logic is that production must be constrained as well. However, production rates have been resilient. So, with storage at record levels, what more can the industry build upon?
There’s no one single indicator that’s going to determine crude oil or refined product prices. This is why being able to look at all the factors while addressing them coherently is so important. But I think, in general, that is not happening on the buy-side with a lot of investors.
President Trump – Looking forward
For better or worse, what impact will Trump’s presidency have on O&G markets?
BB: The short term answer is the market climate won’t get worse, and I think that’s already evident.
Furthermore, I think the days of implementing regulations from the president’s desk without first interacting with the legislature are over.
The U.S. is unique in that there’s private ownership of minerals. Due to this, direct impacts the federal government has on exploration and production are more limited than what most people think.
The business conducted between those individual owners (i.e. mineral owners, surface owners, and operators) is largely a private transaction. Often times, these transactions are impacted more by the states than the federal government.
During the Obama administration there were other issues, such as the Department of Interior declaring the conservation of some lizard in the Permian Basin. Creatures we’ve been stomping on for 100 years were suddenly the most protected thing on earth. As a result, the cost of drilling a well increased by tens of thousands of dollars.
However, congress has a huge role to play in this, too. For example, are we going to see the tax reform that was promised? Also, are we going to see the repeal of the Affordable Care Act? If we can lower the cost of hiring employees and bring on more talented people, our ability to produce oil and gas will increase.
I think that indirectly, with some of Trump’s agency appointments and his initial executive orders, he is creating an environment that has stopped being unfriendly to O&G.
But really, from here on out, the burden is going to fall on congress as much as it is Trump.
Closing statement – Proceed with caution
BB: By every single metric, whether it’s production, storage, or the market structure via commitment of traders, oil and gas markets are set up far more bearishly today than in July of 2014 when oil was trading over 100 dollars.
In February 2016 oil prices bottomed out at roughly a quarter of that. Currently, every factor compared to July of 2014 is more bearish. As such, how do you make a case for higher oil prices?
I’m not going to predict that oil prices are going to plummet from here. But I can’t make a case that they should go any higher, either.
This interview was edited for length and clarity.
Brent Berarducci’s weekly petroleum report blog can be found here.