God didn’t die in 2017, but he did throw his hands up.
Andy Hall, the oil trader blessed with that nickname, caused a stir this summer by closing down his main hedge fund after long arguing for oil prices to rally and reportedly suffering big losses.
Hall didn’t declare oil was dead; indeed, he warned his withdrawal could be a contrarian signal (which turned out to be prescient).
Hall’s capitulation was a warning of a different kind. And while it may be mere coincidence, the appearance of something called OilCoin four months after God bowed out is a fitting coda.
In his letter to investors, Hall said a combination of algorithmic trading and uncertainty about shale-oil output had upended his approach based on fundamentals around supply and demand. Shale was screwing up the supply model and, in the absence of such an anchor, prices swung around on a heady mix of sentiment, positioning and momentum.
He was right about shale oil, sprung upon an unsuspecting market less than a decade ago and defying expectations ever since. Thought just a few years ago to need oil prices north of $70 or $80 a barrel to keep going, U.S. shale output looks like it went up by more than 500,000 barrels a day in 2017, when West Texas Intermediate crude averaged about $51.
OPEC, which has struggled to get its arms around the competitive challenge, recently published a big upgrade to its medium-term projections for North American tight-oil production:
Confusion still reigns: While OPEC projects U.S. liquids production to rise by just over a million barrels a day in 2018, analysts at Rystad Energy think it could be 1.6 million (the International Energy Agency and Energy Information Administration lie in between).
So Over It In 2017
Shale development is faster than for conventional oil fields and more modular, with multiple small wells rather than the big, multi-year process of, say, a deepwater field. This has made frackers more responsive to moves in oil prices, relying on deep capital markets in North America to finance operations and hedge future output. It’s no accident that the shale boom coincided not just with triple-digit oil prices prior to 2014’s crash, but also a sustained drop in the cost of capital:
The ability to tap into medium or long-term financing, as well as take advantage of occasional oil-price rallies to hedge cash flows, has been vital to shale’s resilience. Investors have effectively provided capital with a tenor of several years to fund operations executed in a matter of months:
The resulting crowd of competitive North American producers is the antithesis of the controlled market sought by OPEC and earlier would-be cartels dating back to Standard Oil. One thing critical to loosening their hold has been the establishment of liquid futures contracts way back in the 1980s. And that marketplace has gotten a lot bigger and more frenetic in recent years:
At the same time, the trading population has changed, with many pure-play energy hedge funds disappearing and financial or algo-driven participants entering.
An updated white paper published by the Commodity Futures Trading Commission in March compared trading trends for products listed on the CME in two periods, November 2012 to October 2014 and November 2014 to October 2016. Automated trading in crude oil contracts rose from 54.3 percent to 63 percent, with all of that increase reflecting transactions that were automated on both sides. The speed of trading also picked up (as it did across virtually all products).
This increasing financialization of oil has reached a new level with the appearance of OilCoin, slated to launch early in the new year. Like Bitcoin and all the other new kids on the blockchain, OilCoin owes much to the erosion of faith in fiat currencies and institutions by 2008’s financial crisis and the subsequent years of zero rates, quantitative easing and the rest of it. Those same policies, of course, pushed more investor dollars toward riskier stuff like high-yield energy debt and passive oil-linked ETFs, helping to fuel the shale boom.
OilCoin’s claim to fame is that, unlike other cryptocurrencies, it is backed by physical barrels of oil. Exactly how that will work isn’t clear yet, because it seems to involve a mixture of oil futures, barrels in storage and reserves in the ground — all of which are priced (or modeled in the case of reserves) at sometimes radically different levels. As a selling point, though, that physical backing could lure both the crypto-curious uncomfortable with Bitcoin’s metaphysical nature, as well as the ETF crowd.
Whether or not OilCoin becomes an actual means of exchange, it represents a further step away from the “fundamentals” Hall prized in his letter; especially as, if OilCoin gained enough scale, it could potentially move oil prices as money flows forced rebalancing of the coin’s physical backing. There’s even a shale-linked aspect here, too, as OilCoin’s touted stability rests implicitly on an expectation that drops and rallies in oil prices will be moderated by North American producers adjusting output relatively quickly in response.
On the same day Hall’s letter went out, Royal Dutch Shell Plc’s CEO Ben Van Beurden was creating a stir of his own by talking about “lower-forever” oil prices. Similar to Hall, Ven Beurden wasn’t saying oil prices would never rise again, just that Shell couldn’t bank on that to support its business model (the original sin of both the industry in general and OPEC).
His other implicit message, chiming with Hall’s explicit one, concerned long-term oil prices and just how difficult it is to form a view on what they are because of shale, hedging, speculative flows, electric cars, geopolitics and all the other things that have crowded into the marketplace.
OPEC (along with some new frenemies) has spent much of 2017 trying to impose its own brand of order on things — albeit in a way that, by supporting prices, simultaneously undermines its long-term control. How the organization’s efforts fare from here, having already been extended far beyond the original schedule, will be the central drama of the oil market in 2018. God’s withdrawal this year in a fountain of American oil and stateless tokens do not augur success.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.