I haven't written about crude oil in my Real Money column for a while, and that is indicative of the Pax Arabica that has hit the markets. The bust period of fall 2014 to spring 2016 seems so far away, and those saying oil is headed straight to $100 per barrel have also been proven wrong. Saudi seems intent on stabilizing the markets near these levels, and, as usual, many of the other OPEC countries are a mess politically. Add in benign inventory levels in the United States -- still about 20% below the year-ago figures despite this week's small increase -- and this is a good time to be producing crude. Stability is important.
The CBOE's measure of the volatility of crude oil futures prices, OVX, looks close to a flatline in the six month rendering, and that kind of boring market is a godsend to producers. Few understand this, but when a company produces a commodity it is actually effectively short that good in the intermediate term. It is the buyers that are really the longs, and thus the pressure is on the producers to put floors under their near-term production levels.
Predicting these levels is not an exact science, and I have met some in-house oil traders that I would love to compete with in games of chance. There are some pretty ugly hedge books out there, and the oil markets' continuing state of backwardation surprised some players. The amount of backwardation is at a workable level now, though. As of this writing, the front-month WTI contract is quoted at $68.53, the December 2018 contract is quoted at $66.45 and the August 2019 contract is quoted at $64.05. That still doesn't take into account the physical cost of storing the crude (which normally produces higher prices for future months contracts, a situation known as contango) but, really, if a company cannot make a positive return on capital at $64/barrel crude, it should be in another business.
So the discount that the oil exploration and production companies (E&Ps) are afforded by the markets owing to volatility of the underlying commodity prices is not warranted. The stock market just doesn't seem to grasp this Pax Arabica, and the bond markets are even worse.
The heightened volatility of the equities belies the peaceful state of the commodity markets, and that scares some away from my favored smaller E&Ps, such as Evolution Petroleum (EPM) , Denbury Resources (DNR) and Sanchez Energy (SN) . If you've missed the moves on those names, hopefully you have dipped into "super-independents" like Diamondback (FANG) or Pioneer (PES) or are long-term holders -- as I am -- of stable supermajors like Exxon (XOM) and BP (BP) . XOM is not exactly (AMZN) in terms of performance, I get it, but those dividend payments are a nice gift each and every quarter.
So, as an asset manager, it is an opportune time to lock in the cash flows from crude being produced with a positive margin. In my last RM column on energy I mentioned Sanchez Energy's 1/2023 Senior Notes and the 10% preferreds issued by Callon Petroleum (CPE-A) as two major holdings of my firm. I check the prices of those securities weekly, not hourly, and I plan on having my clients enjoy those elevated yields. Our yield on CPE-A is just under 10% and I bought the Sanchez bonds well, so we're getting a 17% annualized rate.
The cash flows from those securities allow me to sit back, relax, and completely ignore the daily machinations in the NYMEX oil pits. Life isn't that easy, though. As an energy investor one must always have a view on the intermediate term price of the commodity. My view: no change. That sentence could clearly qualify for the famous last words category, but the elevated yields my firm is receiving on these securities make boring actually a lucrative call on the markets.
As a corollary to the wise dictum "haters gonna hate," commodity investors know that "speculators gonna speculate." Just ignore them and you'll do fine.