There's a bit of a conundrum going on in oil these days, as money continues to pour into energy companies and their bonds, mostly through fully subscribed secondaries. Valuations are still very high compared to $50 oil, and cash-rich companies like Exxon Mobil (XOM) are chomping at the bit to buy core assets from the walking dead.
All this money makes for a very bullish picture on oil, right? Contrast that with a U.S. oil market that's about to reach full saturation, without a drop of storage left in a few weeks, and you've got two colliding ideas.
Looks to me like more pain is ahead for those who are getting too enthusiastic too early -- I think oil is headed back down again first.
Major names in oil are still being valued by oil prices in the far back of the curve. While we know quite well that oil prices are unsustainable below $75 forever, that doesn't mean the weeding-out of weak players does not have to happen first before a recovery can begin. Right now, it's hard to see where that blood is going to come from. Even the most financially challenged oil company has had some success in finding new financing to extend their time limits. Look at Oasis Petroleum (OAS), which easily oversubscribed a $400 million secondary, even though shares immediately traded under their inside pricing. They follow Diamondback Energy (FANG), Noble (NBL), Bonanza Creek (BCEI) and others in being easily able to raise fresh capital and extend their timeline before assets need to be sold.
CEO Rex Tillerson of Exxon Mobil held a conference on Wednesday saying they were looking for value and there were "no limitations" on what they would consider purchasing. Exxon follows Blackstone (BX) and Apollo (AINV) to the forefront of cash-rich players ready to toss massive money at cheap assets, should they become available.
Of course, knowing the wolves are ready to deal gives the prey some confidence not to look so desperate and wait as long as they can for the best deal.
On the other side is this chart of crude in storage, from my friend Chris Jarvis of Caprock Risk Management, showing an all-time high of 29 days:
Some physical fundamentals can't be ignored. In three weeks, maybe five, there'll be not a drop of storage left to accommodate another drop of oil being produced. And yes, rigs may be getting laid down by the dozens, but production isn't going down one iota -- it's going up.
What happens to the price of something when the glut gets so large there's no place to put it anymore? That's not a hard question to answer -- prompt barrels are going to get awfully cheap in a hurry.
Unless the U.S. government gives a one-time dispensation to export crude barrels in light of a glutted storage system, oil prices almost certainly have to drop again.
At that point, there will be a rather abrupt break in the "money chase" from Exxon, Blackrock, Apollo and, frankly, from retail and institutional investors ready to buy still-expensive shares of failing oil companies and who think that oil is done going down as pundits again find reasons to predict $35, $30 and $25 barrels.
Of course, then they'll be the over-exuberant ones -- and again the market will have shown its ability to fully screw the largest number of participants it can at any one time.
For now, though, keep your powder dry and don't chase the oil trade -- yet.
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