It's stunning how behind the times the analysts can be. It is, in fact, the one thing to our advantage as independent investors -- we care only about being right and less about not being wrong.
When oil began dropping below $80 a barrel in early 2015, I admitted my mistake, abandoned my thoughts of a constantly bullish oil market, analyzed the real inputs that were causing the collapse, realigned my thinking for investing in the space and even wrote a book on the whole affair.
Meanwhile, oil companies were whistling through the graveyard -- dropping capex projections while continuing to pump oil until the wells that were already on tap were producing at greater volumes than ever. "Keep calm and frack on" was the battle cry I heard at every conference in the early months of 2015, as I was telling readers that the time for investment in the oil space wasn't going to re-emerge for months, perhaps years. Oil companies laughed at the idea that oil prices would remain low, and assumed the drop couldn't possibly last more than a quarter or two.
Now, everyone is starting to believe it -- even to the point of ridiculousness. Two of the most influential analysts in the energy sector -- both Goldman Sachs (GS) and OPEC itself -- are betting oil prices won't reach $80 again for the next five years at least.
Again, this is where I push forward the reality check. Now the pendulum has begun to swing too far in the opposite direction.
You could forgive both for their pessimism. It would be a far greater sin for either of them to advise oil clients, as is the case with Goldman, or oil-producing countries, as with OPEC, that prices are returning to solid profitability soon -- be wrong on that prediction and you'll destroy whole economies. It is far easier to be overwhelmingly pessimistic and be wrong -- happily wrong in the case of either of these two powerhouses -- if oil goes over $100 sooner, as I believe it must.
The economics of oil simply do not support the production numbers that both of these analysts are using in their reports to predict forward supply. They look at current projections from oil companies and forget that consistently low oil prices will continue to require fast and drastic changes in budgets and new projects.
Look at Shell (RDS.A), for example -- recently sinking billions in new exploratory drilling in the Alaskan Arctic. If both Goldman and OPEC are correct, every dime of that investment has been wasted; not a drop of Arctic oil comes out of the ground for less than $70 a barrel, and most of that oil going forward needs prices upward of $85 to make it worth the unique technical difficulty the Arctic poses. If prices remain here for even another two years, Shell is going to look awfully silly.
They won't be alone. Virtually every deepwater project undertaken in the last two years relies upon a $65 or greater oil price -- and whether that project is in the Gulf of Mexico, in the Frade fields of Brazil or offshore in Australia, there are a lot of barrels that are going to be sold at a loss.
Perhaps Shell can afford to do that for a year or two, or Chevron (CVX), or Woodside -- perhaps.
But the oil world is made up of more than just the majors and their deep pockets. Those smaller players drilling smaller projects will just cease to exist -- they have already begun to disappear. Even the countries that rely upon oil revenue to survive will need to slash production, no matter how badly they might rely upon even negative revenues to keep things going. Venezuela and Iraq will find it unable to continue to finance operations in a negative revenue environment that lasts so long.
I see a different timeline, one where the clearing in global gluts is already beginning, albeit slowly, to take place. I see the signs everywhere. As redeterminations from the banks sign the death warrants of three dozen other oil companies this month that are still hanging on by a thread with worthless stock and unsecured revolver credit lines, we'll finally see the avalanche of small producers shut down and turn their 3 million barrels a day of production over to their bondholders -- who won't know what to do with them.
That's not an outcome that happens in 2020 -- it happens later this year and in early 2016.
And that is when this oil glut starts to take on the look of a supply squeeze.
And OPEC, and Goldman, will gladly rethink their pessimistic gloom.