Here's the ZeroHedge version:
On Tuesday the market got yet another reminder of just how painful the "current commodity price environment" has been for producers when Chesapeake eliminated its common dividend in order to conserve cash.
After noting the plunge in Chesapeake’s shares (to a 12-year low) we subsequently outlined why the US shale "revolution" is now running out of lifelines as hedges roll off and as the next round of credit line assessments looms in October.
A persistent theme here - as regular readers are no doubt aware - has been the extent to which an ultra-accommodative Fed has contributed to a deflationary supply glut by ensuring that beleaguered producers retain access to capital markets. In short, cash-strapped companies who would have otherwise gone out of business have been able to stay afloat thanks to the fact that Fed policy has herded investors into risk assets.
In a ZIRP world, there’s plenty of demand for new HY issuance and ill-fated secondaries, which means the digging, drilling, and pumping gets to continue indefinitely in what may end up being one of the most dramatic instances of malinvestment the market has ever seen.
Those who contend that the downturn simply cannot last much longer - that the supply/demand imbalance will soon even out, that the market will clear sooner rather than later, and that even if the weaker hands are shaken out, the pain for the majors will be relatively short-lived - are perhaps ignoring the underlying narrative that helps to explain why the situation looks like it does. At heart, this is a struggle between the Fed’s ZIRP and the Saudis, who appear set to outlast the easy money that’s kept US producers alive.
Against that backdrop, and amid Wednesday's crude carnage, we turn to Morgan Stanley for more on why the current downturn will be "worse than 1986."
From Morgan Stanley
Worse than 1986? Really?
We have been expecting the current downturn to be as severe as the one in 1986 – the worst for at least 45 years – but not worse than that. Still, if oil prices follow the path suggested by the forward curve, our thesis may yet prove too optimistic.
Our constructive stance on the majors is based on four factors: 1) supply – we expected production growth to moderate following large capex cuts and the sharp decline in the rig count; 2) demand – we anticipated that the fall in price would boost oil products demand; 3) cost and capex – we foresaw both falling sharply, similar to the industry's response in 1986; and 4) valuation – relative DY and P/BV indicated 35-year lows.
So far this year, we can put a tick against three of them [but] our expectation on supply has not materialised: US tight oil production growth has started to roll over, but this has been more than offset by OPEC, which has added ~1.5 mb/d since February.
On current trajectory, this downturn could become worse than 1986: An additional +1.5 mb/d is roughly one year of oil demand growth. If sustained, this could delay the rebalancing of oil markets by a year as well. The forward curve has started to price this in: as the chart shows, the forward curve currently points towards a recovery in prices that is far worse than in 1986. This means the industrial downturn could also be worse. In that case, there would be little in analysable history that could be a guide to this cycle.
[There are] strong similarities between the current oil price downturn and the one that occurred in 1985/86. The trajectory of oil prices is similar on both occasions. There were also common reasons for the collapse.
A high and stable oil price in the preceding four years stimulated technological innovation and led to a high level of investment. This resulted in strong production growth outside OPEC, exceeding the rate of global demand growth. When it became clear that OPEC would no longer rein in production to balance the market (as it did during both the Nov 1985 and Nov 2014 OPEC meetings) the price collapsed.
And although MS notes that similar to 1986, costs and capex are likely to come in sharply while demand growth should materialize, the supply side of the equation is not cooperating thanks to increased output from OPEC....MOREAnd Bloomberg:
Oil Warning: The Crash Could Be Worst in More Than 45 Years
There's only one thing holding back a price rebound. It's a big thing.
Morgan Stanley has been pretty pessimistic about oil prices in 2015, drawing comparisons to the some of the worst oil slumps of the past three decades. The current downturn could even rival the iconic price crash of 1986, analysts had warned—but definitely no worse.
This week, a revision: It could be much worse.
Until recently, confidence in a strong recovery for oil prices—and oil companies—had been pretty high, wrote analysts including Martijn Rats and Haythem Rashed, in a report to investors yesterday. That confidence was based on four premises, they said, and only three have proven true.
1. Demand will rise: Check
In theory: The crash in prices that started a year ago should stimulate demand. Cheap oil means cheaper manufacturing, cheaper shipping, more summer road trips.
In practice: Despite a softening Chinese economy, global demand has indeed surged by about 1.6 million barrels a day over last year's average, according to the report.
2. Spending on new oil will fall: Check
In theory: Lower oil prices should force energy companies to cut spending on new oil supplies, and the cost of drilling and pumping should decline.
In practice: Sure enough, since October the number of rigs actively drilling for new oil around the world has declined by about 42 percent. More than 70,000 oil workers have lost their jobs globally, and in 2015 alone listed oil companies have cut about $129 billion in capital expenditures.
3. Stock prices remain low: Check
In theory: While oil markets rebalance themselves, stock prices of oil companies should remain cheap, setting the stage for a strong rebound.
In practice: Yep. The oil majors are trading near 35-year lows, using two different methods of valuation.
4. Oil supply will drop: Uh-oh
In theory: With strong demand for oil and less money for drilling and exploration, the global oil glut should diminish. Let the recovery commence.
In practice: The opposite has happened. While U.S. production has leveled off since June, OPEC has taken up the role of market spoiler.
OPEC Production Surges in 2015
Source: Morgan Stanley Research, Bloomberg
For now, Morgan Stanley is sticking with its original thesis that prices will improve, largely because OPEC doesn't have much more spare capacity to fill and because oil stocks have already been hammered....MORE
