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October 24, 2014

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Takeaway: A production cut from OPEC near-term is unlikely, especially with new competition threatening to take global market share.

The argument that OPEC is making a strategic move to put its foot on the gas from a production standpoint to test unconventional production sources ahead of a meeting where it will cut production targets will disappoint as a bullish catalyst in our opinion.

For one, we have no reason to believe OPEC has a good understanding of the technological advancement in production efficiency in North America.


We’ll be hosting a call with analysis on this topic next Tuesday, October 28th. Please email for access.


Real Cost of Producing Tight Oil and Shale Gas: Fact vs. Fiction


Secondly, at no time in recent history has OPEC leveraged itself, banded together without internal conflict, and proven to be a functional organization. All of the countries within the Organization of have played this chess match internally with one another throughout history while continuing to produce at whatever levels they deem necessary to boost the domestic economy. When conflict has reduced capacity between OPEC members, others have stepped in to ramp up production and take market share.

Now most OPEC economies are completely dependent on oil production:

  • OPEC holds an estimated 60% of the world’s reserves and 30% of total supplies. Venezuela, Angola, and Iran (all higher cost producers) have all reportedly pushed for collective supply cuts
  • Oil and Gas accounts for roughly half of GDP and 3/4ths of export earnings on average among OPEC countries: Each member is constantly seeking an increasing share of the global marketplace
  • OPEC’s largest producer, Saudi Arabia, receives 85% of its export earnings from the oil and gas sector

OPEC Losing its Strength


Even if the organization collectively agrees, for the first time since the 70s and 80s they run the risk of losing major market share to those outside of the organization.


OPEC's NEXT MOVE - Global Oil Demand


While spare capacity within OPEC countries remains relatively constant…


OPEC's NEXT MOVE - OPEC Spare Capacity


Of most significance to the expectation of an announcement of FORMAL production cuts, the vote must be unanimous among member countries

In article 11.C of OPEC’s Statute, it says “Each full member country shall have one vote. All decisions of the conference, other than on procedural matters, shall require the unanimous agreement of all full members.”

Member Countries agree by unanimous vote on any such production ceilings and their allocation to the respective member countries. At the same time, each member country retains absolute sovereignty over its oil production.

In just the last ten years, the expectation of a fair oil price has been much lower than current levels:

  • In 2002 OPEC agreed that a fair price on crude oil should be set between $22 and $28 a barrel
  • By 2006 Qatari Energy Minister Abdullah Attiyah maintained that a fair market price for crude oil should be in the range of $50 to $55 a barrel
  • $80/barrel will now spark unanimous collaboration in cutting production levels? Doubtful.

The largest producers can handle oil much lower and they will not agree to production cuts as OPEC’s collective grip on controlling global energy prices is waning.

Assuming we did experience a decline in oil imports from OPEC members, we’re closer to self-sustainability even if we don’t lift the export ban.


OPEC's NEXT MOVE - DOE U.S. Crude Imports From OPEC


However, in a recent note we outlined the current pressure on Washington to lift the export ban which would be even more threatening to OPEC’s influence:


Can the U.S. Shale Boom Be Stopped


The following piece is an excerpt from the note:



  • export ban on oil implemented after the oil embargo in the 1970s
  • The Jones Act (1920) requires that oil has to be shipped by Americans in smaller ships:
  • It costs around $5-$6 a barrel to ship crude from the Gulf of Mexico to the US east coast on a US-flagged vessel, but only $2 to ship to Canada’s east coast on a foreign-flagged vessel

South Korea and other NATO allies have verbally challenged the U.S. ban on the back of our recent increase in domestic production capacity. Last week the EU’s commissioner for trade, Karel De Gucht, emphasized the need to free up more sources of oil and gas for a wider and more effective free-trade agreement to be instituted.     

The Office of the U.S. Trade Representative and the NSC have held internal discussions with the Obama Administration on how to deal with a challenge from the international community. Washington was able to make a national security argument for implementing the ban back when it was importing most of its crude oil, but the added production from the Shale boom is challenging the credibility of that argument.

With added geopolitical tension globally this year, both Asian and European allies are pushing for diversified supply lines. Strengthening their argument, the U.S. just took China to the WTO earlier this year and won a case accusing Beijing of hoarding raw materials and precious metals. Under International Trade rules (General Agreement on Tariffs and Trade), the argument for upholding the restrictions on the exporting of U.S. fossil fuels may be too hypocritical to justify.”

However, Iranian spokesmen came out Tuesday and said that they weren’t concerned about prices at these levels which seemed interesting in crafting the argument that OPEC is testing new and unconventional energy plays. As difficult as it’s been to pin down the per unit production costs associated with U.S. shale plays, public comments from member nations suggest they are still getting to the bottom of production breakeven costs from unconventional sources in other parts of the world.

In summary, there two major factors threatening OPEC’s stance in the global energy trade:


1. The U.S., the world’s largest consumer, is much less reliant on OPEC production and U.S. supply continues to surprise on the upside according to weekly DOE inventory data released yesterday:


OPEC's NEXT MOVE - OPEC.U.S. production Ratio


Supply (beat to the upside)

  • DOE U.S. Crude Inventories 7111K vs. 2800K est. (8923 prior)
  • DOE Cushing, OK Crude Inventories 953K vs. 716K prior
  • DOE U.S. Gas Inventories -1299K vs. -1560K est. (-3995K prior)

Demand (Less than Expected)

  • Crude Oil Implied Demand 15395K vs. 15416K est.
  • DOE Gasoline Implied Demand 9283K vs. 9489K est.


 2. The U.S. is continuously closer from an infrastructural and regulatory standpoint to becoming an exporter which means we could step in and take share (or at least create the expectation that we’ll take share) if OPEC were to cut production targets.


OPEC is scheduled to meet in Vienna on November 27th for one of two annual meetings, and a few members have called for an emergency meeting beforehand, but current price levels are not a threat to the largest producers making any collaboration among members of the organization highly unlikely.

  • OPEC pumped 30.96M B/D on average in September vs. its 30M B/D target (30.15M B/D in August)
  • OPEC’s own estimates are for its crude demand to be 29.20M B/D ( verbally attributed to the U.S. shale boom and other unconventional supply elsewhere) on average in 2015, well below what it’s currently pumping.

OPEC's NEXT MOVE - OPEC Excess Supply




Please feel free to reach out with any comments or questions.


Have a great evening.


Ben Ryan



Video | 3D Printing Marketplace [Conference Call Excerpt]

The Hedgeye Industrials Team hosted a conference call with David O. Smith, former COO of Shapeways, on October 20th, 2014. David discussed the current 3D printing landscape and the future of the democratization of manufacturing. 

Ping sales@hedgeye.com for more information or to gain full access to this call. Please note if you are not a current subscriber to our Industrials research there will be a fee associated with this call. 






The Hedgeye Macro Team will be hosting a conference call next Tuesday, October 28th at 11:00am EDT on two misunderstood but heated topics in the energy space:

  1. The technological advances in oil and gas extraction from shale resources and its impact on the marginal cost of tight oil and shale gas production
  2. The opportunities and obstacles for U.S. participation in global LNG trade

On the call, we will be joined by specialist Leonardo Maugeri, former executive of Eni S.p.A., Italy's largest energy company. Dr. Maugeri is currently an associate with the Geopolitics of Energy Project and the Environment and Natural Resources Program at the Harvard Kennedy School's Belfer Center for Science and International Affairs.



  • Dispel the un-factual conclusions creating the wide variance in perceived production costs associated with U.S. shale plays with an analysis of the wide differences in production costs within just one shale play (regional analysis within Bakken). As a whole, consensus underestimates the technological and logistical advancement of oil and gas extraction from shale resources.
  • U.S. LNG is the most competitive of any non-traditional source globally, but because of all the essential infrastructural and logistical investments that must take place, current natural gas prices are a large burden for private investment.



  • Toll Free Number:
  • Direct Dial Number:
  • Conference Code: 494176#
  • Materials: CLICK HERE (slides will be available approximately 1 hour prior to the call)

Ping for more information.




Dr. Maugeri is currently an Associate for the Environment and Natural Resources Program at Harvard's Geopolitics of Energy Project. Prior to his current post he held the title of Executive Chairman of Polimeri Europa, Eni's Petrochemical Branch, from March 2010-June 2011. Before Polimeri, Dr. Maugeri spent eight years as Senior Executive Vice President of Strategies and Development at Eni S.p.A. from 2000-2010.


Dr. Maugeri has gained recognition for researching and predicting the shale gas and tight oil boom In the early 2000s. He has written four books on energy including the following:

  • The Age of Oil: the Mythology, History, and Future of the World's Most Controversial Resource
  • Beyond the Age of Oil: The Myths and Realities of Fossil Fuels and Their Alternatives

In addition to his involvement in the Geopolitics of Energy Project, he is a member of MIT's External Advisory Board, an International Counselor of the Center for Strategic and International Studies (Washington, D.C.), a member of the Global Energy Advisory Board of Accenture, and a senior fellow of the Foreign Policy Association (New York). 


Macro Team


UA - Market Share Math Matters

Takeaway: If people believed UA's guidance, it'd be a $35 stock. Need to justify nearly $2bn in extra market share to back into current valuation. No.

Conclusion: Can't say enough great things about UA executing on its model. But the reality is that long-term guidance and consensus estimates explain away $35 in stock price. Unfortunately, UA is at $65. To justify the other $30 per share in value, we need to assume that UA grabs nearly $2bn in market share globally above and beyond current expectations. While UA is definitely a long-term winner, the market already knows this. We're still watching it from the sidelines, but if we had to go one way or the other, we'd be short.



There's no company we can find that compares to UnderArmour as it relates to having such a disparity between market value and its competitive position.  To it's credit, UA has not only taken a page out of Nike's playbook, but it's the only brand to rewrite it, and execute on it year after year without missing a beat. In the first 30 years of Nike's life it was good for a foul-up every 2-3 years. UA is delivering the consistency that Nike never did. 


But the reality is that if the market believed UA's guidance or Street estimates, this would be a $35 stock. So there are really two questions from where we sit. 1) Does the company REALLY believe that the guidance it handed out for next year is for real (and not a colossal sandbag)? And 2) with the stock at $65, what are the market's real expectations for both market share and margins, which will implicitly explain-away the extra $30/share in equity value that the market is fronting UA.


The short answers are 1) No, UA does not believe its guidance, nor does the market. 2) By our math, the current share price suggests that UA will capture an incremental $1.95bn in revenue by 2018, or an extra 50bps of share, which sounds easy until you factor in that its current share base is only 1.0%.


Let's look holistically  at the company's market share.  We can pick apart the US share, including the fact that UA just surpassed Reebok and is now the sixth largest footwear brand with 3.0% share (Reebok at 2.8%). But we think that the better way to look at this is on a global scale. After all, growth is incrementally coming from  International, which nearly doubled in the quarter. 


The chart below shows three things; 1) UA Apparel/Footwear market share based on the company's guidance/consensus estimates, 2) Hedgeye's estimates for market share, and 3) the share UA needs to hit in order to justify a $65 stock price.  What does market share tell us about UA’s current valuation?


1) We definitely respect the 'execution premium' for a quality story like UA. But for a stock that's trading at 70x ’14 numbers we need to look at share assumptions.

2) First a few key points and assumptions.

a) Over the past 5 years UA has traded on average at 35x NTM earnings

b) The 5 year earnings CAGR over that time period has been 31%

c) The point here (and one of the assumptions in our long term model) is that UA has traded at a 1.1x PEG.

3) The global athletic footwear and apparel market was a $38.4 bil industry in 2013; including, Nike, Inc   (15%), AdiBok (10.8%), VFC (3.1%), KER (2.1%), and Asics (1.5%). UA currently sits in 8th place on that list at just over 1.0%. We think the industry will grow at a 6% CAGR over the next 5 years, but on top of that UA will have to accelerate market share gains considerably to justify the current price. From 2007 through 2013, UA stole an average of 11bps in market share per year. To be fair, the slop of the line has looked much more exponential than linear.

4) If we were to simply 'extend the trend' (which we don't do) and extrapolate past trends into the future,  then we get the gray column in the chart below.

5) The column shows our estimate, as UA will be paying up in Selling and Marketing to facilitate it's share gain.

6) The blue column represents what the market is baking in to UA's valuation right now, based on an EBIT margin midway between where UA and Nike are today.

7) All in, we're looking at $1.95bil in sales at the cash register. Assuming that 25%+ comes from UA's own DTC network, that shows up on the P&L at $1.5bil.


UA - Market Share Math Matters - UA market share


In our analysis, we assume that EBIT margins go up to 12% -- but never higher. The reality of UA's growth is that it is becoming increasingly expensive. Footwear is a massively consolidated space with higher barriers to entry.  International is lower margin due to the nature of distributor model UA is running. But more importantly, the brand needs to establish relevance with a few hundred million consumers who don't know it exists. That takes both time and capital. 


In addition, UA is getting to the point where it is playing more aggressively with the big boys in the Athlete endorsement game. Note that with Kevin Durant, UA's bid represented a 34% increase to its athlete endorsement budget. Nike, who 'won'/kept Durant, boosted its budget by about 1%. Nike and Adidas will continue to drive the price of these assets on a global scale, and UA increasingly can't afford not to play if it wants to grow its top line.


As it relates to our estimates, we're above the Street, which is entirely due to revenue growth. But our gross margins are considerably lower, and SG&A much higher than company guidance.


UA - Market Share Math Matters - ua financials 2

Cartoon of the Day: Yelp

Cartoon of the Day: Yelp - YELP cartoon 10.23.2014


Yelp stock is plunging today following this morning’s earnings report when management guided revenues lower for the fourth quarter. Hedgeye Internet analyst Hesham Shaaban has been the bear on Yelp all year long.


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