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Tuesday, December 30, 2014

Crude oil: are we in yet another cycle?

We often hear that the oil industry is a cyclical one. This partly due oil prices' dependence on GDP growth and global economies. Several times, we have seen how recessions have affected prices and created most "cycles" for this industry. Some of these cycles have lasted for months and some longer  have lasted even years. However, these are demand driven cycles characterized by an "oversold" condition in the market and a subsequent sharp recovery of prices. Pretty much as we saw after the last financial crisis in 2008-2009.

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We have had supply driven cycles twice before once in 1986 (prices from 30USD/bbl to 12USD/bbl) and lasted for 4 years. The second time was in 1998, due to a supply glut created by non-compliant OPEC members, but this was short-lived. 

Today there is oil everywhere, but the most significant difference is that this new oil (i.e. shale oil) its safe and reliable oil (unlike most OPECs). It does not bring any geopolitical risk. It does not need to be transported long distances to the consumer (e.g. refineries in USA) and it can be produced almost as you would produce a car in an assembly line. This is really, high volume, low risk cheap energy.

If you ask a veteran oil man, you might hear, yes, this is another cycle. why? well, the demand for energy only goes up as there is more people in this planet, and oil provides an efficient way to solve this issue. This is what I call the "standard demand" (no allegations to Standard oil". On the other hand, the supply is limited and will eventually decline. What can be different this time around: cell phones!

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Only a few years ago, we all had different technologies in our hands and I remember asking my friends what kind of phone they had to compare. Those days are gone, we all have smartphones now, they are all touch, made with the same materials and pretty much the same functionality.

This off-road story is to highlight the demand side of this picture. We are entering a supply driven "cycle" while being on a relatively high oil-related-energy demand period. But this might change in a few years, maybe in only a couple of years. What if we get a demand shock while we are still at this supply driven cycle? say China's economy, Eurozone crisis, or even more unlikely but yet more shocking, a transformation of the OECD countries' car fleet. A massive move towards cheaper, safer, reliable and extremely powerful electric cars which by the way come with an incentive. Alternatively, a war-like scenario, Russia-Ukraine, Libya disruptions, could offer a breather to the bearish giant, but don't get fooled. People are trading the future volumes now, the supply glut needs to be sorted out by the market itself, forget OPEC, only a visible reduction in shale oil could make this market bounce back hard. CAPEX cuts by majors only delay projects out in time, they don't necessarily cut production. What is happening now looks less and less like a cycle, and more and more like a change in the way the world of energy is set to work from now on. We only need the demand reduction to fill the gap. Sorry bulls...