Why you should care about the price of crude oil
The price of crude oil is in the price of almost everything. But unless your job is selling or buying crude oil, distillates, or crude oil futures, the concern about the price of crude oil is limited to occasionally observing that the price of gasoline is too high.
Companies which depend on crude oil and petroleum distillates face enormous economic risks. The cost of jet fuel is one of the major expenses for any major airline.
In 2008, the price of crude oil hit a high of $147 per barrel, a new all-time high. Almost all airlines were unprepared, considering crude oil prices were $60 per barrel January 2007.
Fast forward to 2015 when crude oil prices collapsed from $110 per barrel in June 2014 to $29 per barrel (WTI front month contract) in January 2016. Delta Airlines lost $2.3 billion on fuel hedging in 2015.
Very few experts were able to anticipate this decline in crude oil prices. But why?
Because veterans of crude oil markets could no longer read and understand enough information which would allow them to see the connection between geo political changes (unstructured data) and crude oil market fundamentals (structured data). One of the biggest contributors to the collapse in crude oil prices was the increasing output from US shale industry and Saudi Arabia’s decision to bankrupt it by ramping up production. Despite 130 North American oil and gas companies filing for bankruptcy since the start of 2015, US shale industry was able to significantly reduce the cost of extracting crude oil from shale patches. In 2016, crude oil could be extracted from Eagle Ford formation in DeWitt county at about $23 per barrel. New lower cost structure completely transformed the profitability of shale crude oil.
In 2017, Andy Hall, “The God of Oil”, closed his main hedge fund, unable to manage volatility affecting crude oil markets.
https://www.cnbc.com/2017/08/14/oil-trading-god-andy-hall-says-hes-met-his-match-robots.html
“Investing in oil under current market conditions using an approach based primarily on fundamentals has therefore become increasingly challenging. It seems quite likely this will continue to be the case for some time to come.”
In 2018, Wall Street Journal published an article indicating the closure of commodity hedge funds outnumbered launches for the first time since 2000.
The statement that “the market is evolving” highlights a different and a larger problem, the very problem TerraManta is trying to solve.
If the problem of understanding what drives long term behavior of crude oil prices is challenging industry veterans, what should an airline do? How can an airline make data driven decision to hedge fuel purchases? At what price?
What about a specialty chemical manufacturer facing the same decisions and trying to reforecast naphtha and other distillates’ prices EVERY month?
What about a bank that lent millions of dollars to an oil company? Interest payments are at risk if the crude oil prices drop beyond a certain point.
What about a commodity trader that missed the market shift from contango to backwardation and had to pay millions of dollars for no longer needed crude oil storage? If you are interested in learning more about this example, please contact me at any time.
The future is even more complex with greater risks ahead. United States crude oil output is expected to exceed Saudi Arabia’s by the end of 2018. Yet pipeline capacity and port capacity are constrained, making it difficult to export more crude oil. In addition, not every refinery can (or want) to process US light sweet oil. Oil and gas industry capital expenditures are finally increasing. ExxonMobil’s capital budget for 2018 is $25B, or $3B higher than a year before. However, at a certain price point the demand for crude oil will decrease, creating what industry analysts call demand destruction. Right now, the demand destruction may start when crude oil prices are between $80 and $100 per barrel.
That’s why TerraManta was born with a simple mission: build a platform for domain specific analysis of unstructured and structured data with initial focus on financial services and energy / resources sectors.
Our first product, TerraManta for Crude Oil, analyzes all three major elements of change using Natural Language Processing and machine learning:
- Almost all events which could influence the fundamentals. For example: unrest in Nigeria which may lead to increased militant activity, sabotage of pipelines, and decreased crude oil output / exports
- Actual crude oil market fundamentals reported monthly plus global demand and supply forecast from several sources: OPEC, IEA, BP, and others
- Daily price actions due to changes in fundamentals + geo politics; at the moment only WTI front month contract
I still recall a conversation with a potential investor last year who asked me, “I don’t understand what you are trying to do”. He was a very experienced retail industry executive.
Imagine retail and energy industry analysts sitting across each other in a conference. Let’s ask a retail industry analyst to become an expert in crude oil markets. Let’s also ask a crude oil analyst to become an expert in retail markets. Neither one can accomplish this goal in less than 2–3 years by working with other experts and reading as much as humanly possible. And the 2–3 year estimate is valid only if the underlying market drivers have not changed. And humans tend to develop biases as they learn.
The investor liked this example.
Still skeptical about the connection between geo politics, crude oil market fundamentals, and price actions? Could the price of crude oil increase to $140 again? The upward pressure on crude oil prices is already here because of sanctions on Iran and Venezuela.
I will conclude this article with a back story from Promus Ventures that invested in Kensho seed round. Kensho was acquired by S&P Global for $550M in March 2018.
“After we invested in Kensho back in 2013, it became comical how many people went out of their way to tell us that Kensho would never work. Many of these smart and respected people were VCs as well as Wall Street and hedge fund insiders. It is an all too familiar refrain: the best ideas are many times the most controversial, and industry insiders are often times the loudest voices doubting the innovation…until they’re not”
Does TerraManta for Crude Oil work? Incidentally, one of the most common questions asked is whether TerraManta for Crude Oil could be helpful when crude oil prices reached $29 per barrel in mid January 2016.
On January 7, 2016, TerraManta for Crude Oil generated a 3-week price forecast which correctly suggested the price of crude oil decreasing to $29 / barrel. The screenshot follows attached.
I am happy to share that two investors expressed interest in participating in TerraManta seed round. I want to thank them for believing in our mission to disrupt and transform how domain specific knowledge is acquired by human analysts in financial services and energy / resources sectors.
Learn about TerraManta. Invest in TerraManta. Join us.
Leon Kotovich
CEO
TerraManta
