Feb. 2016 $54.95
We'll be coming back to this, there are at minimum three important ideas embedded in this piece.
From FT Alphaville:
$80 oil,$70 oil,$60 oil,
$50 oil and counting… If you suspect the structure of the oil market has fundamentally changed, you may be on to something
There was a time when all you needed to balance oversupply in the oil market was the ability, and the will, to store oil when no-one else wanted to.
That ability, undoubtedly, was linked to capital access. For a bank, it meant being able to pass the cost of storing surplus stock over to commodity-oriented passive investors and institutions happy to fund the exposure. For a trading intermediary, that generally meant having good relations with a bank which could provide the capital and financing to store oil, something the bank would do (for a fee) because of its ability to access institutional capital markets and its reluctance to physically store oil itself.
On the flip-side, if a shortage of oil appeared in the market, there was a time when all it took to balance the market was a release of stored supply by trading companies, oil companies and/or national producers. If that didn’t work the market would await an increase in production by producers with spare capacity.
If the shortage persisted, then for banks this was an opportunity to transfer institutional capital directly into oil infrastructure investment. For oil companies of all sorts this was thus a time to leverage up and go drilling, but only if they could be assured that the high prices that make such efforts worthwhile would be sustained.
Now, because filling an oil supply void could take up to a decade of prospecting, development and organisation, prices had to be pretty hight to make that situation worthwhile.
This, indeed, was always a key part of the late Matthew Simmons’ argument about peak oil. As he told Opec News Agency in 2003:
“Money doesn’t always go where it’s needed. It flows to places where it is attracted by low risk and high returns,” he affirmed. “Money doesn’t like high risk or unpredictability, and the money markets are extremely clever,” he stated. Over the past 20 years, investments in energy projects had seen poor returns for financiers, he maintained. “Due to the volatility of the oil price markets, the move to pricing on spot markets, returns have been lousy,” said Simmons.Because lenders did not like this kind of volatility and unpredictability attached to spot oil prices, they wouldn’t invest unless prices were ridiculously high, to cover the fear of losses. This, he believed, led to under investment in oil infrastructure, leading to an effective self-squeezing effect, that ironically would lead to even more volatility.
To get around the spot price volatility and overshoot problem, Simmons recommended the industry move to long-term pricing contracts instead....MUCH MORE
