When Mr Grice was at Société Générale he said one of the smartest things about commodities that you will ever see grace our pages:
Dec. 2010
Société Générale's Dylan Grice-"Commodities: ‘Their Expected Long-Run Real Return is 0%’"
Well duh.
Commodities are for tradin' not investin'.
And now Mr. Grice is hanging his hat at Calderwood Capital (co-founder) and writing at The Market.ch, February 8 (and I am trying to say 'well duh' less often):
The Stage is Set for a Bull Market in Oil
At the end of 2019, we recommended exposures in the oil sector. Given the pandemic, it turned out to be a bad call. But the fundamental attractiveness has not changed. Three reasons why the oil price will rise.In late 2019, we published a report and recommended an exposure in the oil and especially the oil services sector. Down by over a third since we first did our research back in December of 2019, and down by as much as 70% during the March crash, it has been our worst performing idea by a wide margin. Hence, we felt it was high time for an update.
We’ll start by retracing our original idea. Then we’ll try to understand what was missing from it, and why it went so badly for us. We’ll end by bring the idea up-to-date and in so doing, make the case that the oil industry has an essential role to play for coming generations.
Yes, energy transition is real and, for what it’s worth, something we are completely in favour of. The question is when it happens, not if it happens, but the implications from it taking several decades rather than several years vary enormously. The cornerstone of our thesis is really that the oil industry is being written off prematurely. From that premise, everything else follows.
A shortage of capital
In very simple terms, writing in December 2019, as the first reports of a mysterious virus circulating in the Chinese city of Wuhan reached Europe, we felt that the energy slump was behind us. The excesses which had led to the shale crash were being worked out, bankruptcies had soared, and capacity had been reduced. Yet the world still needed oil, and the oil majors were beginning to sanction large projects again. There was a shortage of capital, not opportunity.
We also liked the people driving capital allocation in the energy market. In particular, we liked that experienced and successful investors like Sam Zell and John Fredriksen were moving in, self-made billionaires who’d made their fortunes partly by buying things that no one else wanted over the years. On the other side, the «sellers», were politicians, bureaucrats and other non-economically motivated players (primarily ESG-driven investors).
We were comfortable that the energy transition was real but concluded that this was a) glacially moving, and importantly, b) a widely understood shift. Oil was still needed in the meantime, and so «low-risk» oil extraction from relatively low-risk short-cycle projects which could be quickly ramped up was more than merely viable, it was essential.
Only shale-oil players and the shallow-water projects fit this bill, but we’d had terrible experiences with shale oil producers in the past – they are hopelessly drill-addicted capital misallocators. Shallow-water drillers and servicers were our sweet spot by default. Given the near-term uncertainty in the space, we felt those with strongest balance sheets were best positioned to ride out any remaining volatility. We gave Tidewater and Standard Drilling as examples.
What happened?
Our thesis was coming good as we started 2020. The majors were increasing their capex targets. Our belief that the lower-risk shallow water deposits would be prime production targets was panning out too, with the number of jack-ups (shallow-water drillers) which were active globally clearly trending higher, in contrast to the activity of floaters (mid-to-deep water drillers) which remained stagnant.
Saudi Aramco awarded a string of contracts to Shelf Drilling, the majority of which were for ten years (maturities not seen since the heydays of the offshore drilling boom).
But then COVID hit, and the global lockdown led to a cessation of nearly all physical economic activity. There’s no need for us to expand upon just how ugly the macro data was during that time. Weekly US initial jobless claims rising by 244 standard deviations in the middle of March says it all. As far as the energy markets went, the collapse in world oil demand was more muted. The fall from 100 million barrels per day (mbd) to 80 mbd in the three months to April was only a 10 standard deviation event…
The world’s energy infrastructure wasn’t designed with such a sudden decline in demand in mind. The physical market was turned on its head as refineries turned away crude oil, as did storage facilities which had no capacity. Financial markets behaviour was even more chaotic with the WTI contract (which is for physical delivery) turning negative in case any of you had forgotten.
It seems as though the WTI-tracking ETFs which mechanically roll their futures at the end of each month weren’t paying attention, and as expiry approached, they were the only holders of the May contract....
....MUCH MORE
HT: ZH
And as a special gift for sticking with us this far:
The SocGen Cred and Credulity link is at the bottom of that post but the journey down is worth it, some first rate commodities pricing research.
