Takeaway: OPEC cut or not, the risk is to the upside
Before reading our expectation on the likely course of action from OPEC (we expect no action), the next few charts should be more concerning for USD Longs/commodity shorts than OPEC jawboning pre-meeting:
- In the first chart below, going into today, commodities have been crushed, yet protection is most expensive NOW (OVX back over 50). The market is heavily short commodities
- Volatility expectations for this year’s meeting are grossly higher than last year – protection is near its most expensive point since summer of 2014 (tighter stops on lower volatility expectations causes more volatility (last year’s 10%+ down day post OPEC meeting)
- The Commitment of Trader’s Report from the CFTC suggests the market was heavily short commodities and long dollars into this week. That doesn't get unwound in one day. A catalyst to take commodities lower from here is hard to find with renewed rate hike expectations.
We’re seeing the risk to one-way consensus positioning front and center, as outlined in a note earlier today titled Is This the Beginning of the Great Unwind of USD Consensus Longs?
This story looks a lot like the end of August pre- Jackson Hole and rate “lift-off” expectations. You could see more of what you’re seeing today on a bad jobs report tomorrow, and this move would be exacerbated if the Fed decides to push a rate cut.
Last year at this time the world was contemplating whether or not OPEC would conspire together in an attempt to move global energy markets. We wrote about the unlikeliness of that happening (OPEC CUT? NOPE. ) The point of the note was to dispel the relevance of OPEC quotas. It’s worth a read as a primer.
A cut was expected by many at $73 on WTI. Now, at $41, the expectation is that OPEC quotas will remain the same at 30MM B/D. For the significance of quota levels, see the chart below which shows that:
- Out of the 48 months over the last four years that OPEC quotas have been set at 30MM B/D, OPEC collectively has produced under that quota in just 4 months (8.3% of the time)
- Since the beginning of 2014, production has averaged more than 1MM B/D above the collective OPEC quota level
- Any reason for production below quota levels has not been voluntary. At the end of 2013, a civil uprising reminiscent of the Libyan Revolution in 2011 was successful in reducing Libyan production by over 1MM B/D in several months (That accounted for two of the months below official OPEC quotas)
- Of the 9 of 12 OPEC producers in the global production table below, only 2 of them has reduced production Y/Y
- Of the 4 largest producers in OPEC, production is up double digits in all but Saudi Arabia where production is still up significantly. That’s a market share story:
- Saudi Arabia: +8%% Y/Y
- Iraq: +27% Y/Y
- U.A.E.: +10% Y/Y
- IRAN: +14% Y/Y
If Saudi Arabia had any plans to cut production they probably wouldn’t be racing to cut official selling prices to Asia into 2016. On a spread to the Oman/Dubai benchmark, Saudi Aramco undercut that spread in both light and heavy crude for January:
Keeping a grip on dwindling market share is the goal. In a commodity-producing business, a low-cost producer (Saudi Arabia) with the most reserves is not incentivized to cut production. OPEC’s global market share is about 36% currently, but they hold 60-70% of the world’s proven reserves.
Like last year, Russia has already said it has no interest in complying with collective production cuts or even attending the meeting.
Most of OPEC’s spare capacity is with Saudi Arabia. The way they see it, they are doing their job. Given any need to accommodate Iran post sanctions, it would be hard to envision lower targeted quotas unless it was purely a smoke and mirrors exercise to boost prices in the short-term. As outlined in last year’s note, OPEC ANNOUNCEMENTS have an ability to move spot prices for about 15-20 days, but there is no evidence that production levels are at all influenced.
We think the argument the Saudi Arabia would cut production despite the fact that they are a low cost producer with endless reserves (and all of the spare capacity in OPEC) is just newsiness. FX Reserves are only down 12% from an August 2014 high, which is hardly a dent with oil prices declining 56% over that same time period. Prices could remain low for years, and they’d be in good shape.
Deflation has taken a hold of the market for the last 18 months, and the catalyst to reverse deflation’s dominoes will be behaviorally and policy-driven. Look for a real catalyst with tomorrow’s jobs report. A bad one could perpetuate the currency move seen today.
As always we welcome any comments or questions.
"... Yellen was grasping for #LateCycle employment reasons to raise rates," Hedgeye CEO Keith McCullough wrote in today's Early Look. "Never mind the data – she really wants to hike."
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Takeaway: Our Energy analyst Kevin Kaiser has been spot on with Kinder Morgan.
Here's what Jim Cramer had to say back in August 2014.
“It turns out we were stubborn and we were right, and Hedgeye was flippant and disrespectful and wrong. We chose to believe in Rich Kinder, and not in his critics, because we believed him when he always said his companies are "companies run by shareholders for shareholders." It looks like it wasn't worth waiting for the market to prove Hedgeye right -- because, alas, when it comes to Kinder Morgan and today's huge bid, it never, ever will be.” – Jim Cramer, “Cramer: Kinder’s Triumph,” 8/11/14
Here's what Jim Cramer had to say yesterday.
“With the headwinds ahead of it, it's become seriously undervalued here at $21. And I'm recommending it, as well as buying it myself.” – Jim Cramer “Dicker/Cramer: Kinder Morgan Down 7% Today -- Now Is When You Buy,” 12/2/15
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Takeaway: We added FII to Investing Ideas on the long side on 11/24.
THE HEDGEYE EDGE
We think that Federated Investors (FII) is set up for upside being that its core business should experience both an increase in profitability and volume. FII is a leader in the management of money market funds, an asset class that has been out of favor for the bulk of this cycle.
However, even marginal rate hikes from the Federal Reserve would greatly improve the profitability of money funds. Secondly, cash products tend to be attractive in the latter part of the economic cycle as investors get defensive and move out of risk assets.
The company is conservatively managed with a solid balance sheet and solid free cash flow dynamics. FII pays a 3% dividend yield which ensures return on the stock as the core money fund business improves both profitability and balances.
INTERMEDIATE TERM (TREND)
The company has been waiving over $300 million in revenue on an annual basis for its clients to maintain a slight net positive yield on the $250 billion it manages in money fund assets. As short yields increase on the margin, the firm will recapture some of these forgone fees. The entire fee waiver opportunity is $0.50 per share in earnings and with current annual baseline earnings at $1.50 per share, this creates potentially growth of over 30%+.
There are few financial companies that are as asset sensitive as FII and, given this earnings trajectory, we think that makes the stock appealing into 2016 and 2017.
LONG TERM (TAIL)
Over the past 7 years, more than $1 trillion has been redeemed in money funds and reallocated to stock and bonds, sourcing the big bull market in risk assets. With the economic cycle eclipsing 72 months, we think it is time to get defensive.
In addition to improved profitability from even marginal rate hikes, this $1 trillion becomes a longer-term opportunity for all money fund markets as investors reallocate and back out of risk assets in the latter stages of this market/economic cycle.
With roughly 9% market share in industry money fund assets, FII will recapture these funds as they come back out of stock and bond markets. We have modeled +$200 billion in positive money flow for the money fund industry in 2016 and +$400 billion for 2017. This assumption reflects some conservatism allowing for some funds to remain outside the money fund channel.
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