Looking at oil futures (WTI) since last year we have noticed some very interesting developments. Like most other technical analysts the major one was the head and shoulders pattern. This was in formation for a while and was perfectly symmetrical. To us, we were just anticipating Oil to continue this technical pattern it was forming throughout the year (head and shoulders) and it has worked out well for us. Now we feel a shift in the reasoning behind the oil price action. We feel it is more of a macro theme now than a technical one and the geopolitics are the reasoning for oil’s movement now. There are a few major factors we feel affecting the future movement of oil. First, and most importantly, Saudi Arabia tried and failed to put the shale companies out of business completely by pumping more oil and flooding the market to drive the price down. They did this while inflicting tremendous pain on themselves and their economy. Everybody knows Saudi Arabia has tremendous social programs and they are heavily weighted in their budget. Saudi Arabia thought that because their costs to produce are so much lower than everyone else’s this strategy would work. What they didn’t count on was that the US Banks were knee deep and maybe more into energy loans for the very same shale drillers that the Saudi’s were trying to put out of business. Of course, some drillers went out of business but most of the bigger energy companies with good wells made it through. There was some fiscal maneuvering and restructuring of debt to these companies but in the end the US Banks knew that it was a waiting game and the Saudi’s could not support their social programs at these artificially low oil price levels. Looking back one major turning point in our view from negative to positive on oil in general was that none of the shale company bankruptcies ever really caused a sustained strain on the stock market as a whole. As we analyzed the US Bank’s loan books we realized that there was a lot more exposure than was originally thought to energy companies (as later came out and Banks upped their reserves for bad loans). So in taking a macro look into this we had to look at all the players in the game and all the parties involved. Then we said who benefits from what and laid it all out (on two big whiteboards in our office). What we started to realize was that oil can just not stay under the $40 level anymore and probably not under $50 either. Venezuela started to have major cash issues causing a huge strain on the population. We looked at some of the OPEC countries and realized they were going to have these exact same problems unless oil prices rose. Lately, reports have come out showing how much the Saudi’s have tapped their reserves in recent months. This is not sustainable and with the Vision 2030 program can’t happen. They tried some austerity measures but we all know that Saudi Arabia is a monarchy that is ruled by using tremendous social programs to keep the ruling family in power. Cuts to social programs can’t be too deep or severe. Next, the Saudi’s Vision 2030 basically rests on the IPO of Saudi Aramco. Reports are that they will IPO 5% of the total company. Reports are that Aramco could be worth 2 trillion dollars and the IPO could be worth 100 billion. Those reports were in October and oil is up significantly since then. What does that do to the IPO value? We believe it raises the value as Aramco is valued solely on it’s reserves in the ground and the price of oil. We believe Saudi Aramco wants to keep oil around the $60 mark up until the IPO. These are our theories on why oil will be up in the near future and stay up in 2017 even with more shale coming back online. Lastly, remember refined shale oil can’t be exported yet so what we produce here is mostly for our consumption. We think Saudi Arabia will make up the difference of what we don’t import from them with Asia and Europe. My only concern is that as great investor Mark Yusko of Morgan Creek Capital Management said on CNBC, and I’m paraphrasing, that dealing with OPEC is like “herding cats.” I hope Saudi Arabia has their lassos ready? Or something like that?
Hedge Fund Manager , METS, JETS, Islanders fan. Views are my own, unless you disagree then my account was hacked.