Since moving into #QUAD 4 in September, we’ve tried to keep our audience on top of the deflationary headwinds that exist when growth and inflation are decelerating at the same time. Riding our shorts in the energy (and the commodity space) from both a company specific and asset class perspective was one of our bigger calls in Q4.
To be clear, we believe the side effects of this trade will continue to play-out (#QUAD4 Confirmation from Darius Dale) . Included below are links to previous notes throughout Q4 in chronological order as we navigated through the sell-off:
October 16th: OIL HAS FURTHER DOWNSIDE BEFORE THE BOTTOM
October 23rd: OPEC's NEXT MOVE
October 28th: REAL COST OF SHALE PRODUCTION
November 26th: OPEC CUT? NOPE.
With our call being what it is currently, a sharp decline in rig count, major cap-ex cuts, and a blowout in high-yield energy spreads will all have a meaningful impact on the domestic production outlook. The next big opportunity in the energy space is logically on the long-side, but it may not be until:
1) Oil prices get cut by another 10-20% under the weight of #QUAD4 deflation
2) Realized and thus the price of forward looking volatility (the two are very tightly correlated. What has happened in the recent past will certainly happen moving forward!) compresses.
Regarding the second point above, this afternoon’s weekly release of the Baker Hughes Rig count provided another incremental data point that would logically provide price support. The number was largely expected, aggregate production has not yet peaked, and global demand is showing tangible signs of slowing even with the existence of stockpiling at the commercial and government (China) level.
Inventory data from the DOE on Wednesday showed that commercial inventories reached the 400MM barrel mark for the first time since 1982:
- DOE U.S. Crude Inventories +8874K vs. +10071K prior (+4000K est.)
We yield to the fact that the modern oil market may be more positioned to deal with supply demand shocks than it was in the past. An increase in storage and inventory capacity globally creates a cushion should supply begin to come off-line. This versatility implies a “U-shaped recovery” as many sell-side analysts have pinned now that prices have retreated. While this may be true, our process is top-down oriented and anchors on daily changes in market signals and economic data. As a macro team, we try to get in front of the price news with the belief that fundamental supply/demand dynamics will complement what the market and economic data is signaling.
Whether the market expected the sharp decline in rig count today or not, the behavioral, volatility-inducing ripple effects encompassing this huge move in oil pushed WTI crude oil up as much as +8% this afternoon. We reference volatility constantly in our risk management process, and getting the market’s expectation right is key to pegging real exhaustion signals on both the long and short side of intraday moves. When this input is higher when volatility is higher, today’s intraday moved needed to be higher for the “short-oil” signal.
Our key upside risk management levels in WTI remain intact post-rig report:
- Immediate-term TRADE resistance: $50.35
- Intermediate-Term TREND resistance: $64.69
With that being said, the decline in rig count is meaningful for the domestic production outlook, (REAL SUPPLY/DEMAND) and the decline in rigs has been drastic in January. This is BULLISH for prices fundamentally, but as mentioned above we believe big macro has more to say about global deflation near-term.
As outlined in a note after the release, OIL RIG COUNT: EARLY LOOK AT THE DAMAGE, the timeline between oil’s rout and the ensuing rig count reduction looks very similar to 2008:
“While the world was much different in 2008, E&P companies are very sensitive to oil prices under any circumstance. WTI declined 77% from July 3rd , 2008 to December 19th 2008. The oil rig count topped almost exactly 4-months after the July highs on November 7th , 2008 before being cut in half by June of 2009 (6-months after oil bottomed in December).”
We recognize that oil prices are now pressuring producers CURRENTLY, but we will continue to yield to our-top down contextualization of daily data to front-run the big macro turns. WE REMAIN BEARISH ON THE ENERGY SPACE as an asset class.
Please reach out with any comments or questions.
Ben Ryan
Analyst