Turkey, Iran and Shale
Oil prices are trying to balance the risks to oil supply versus the risks to demand. The risk to the demand side of the equation is coming out of Turkey. Turkish President Recep Tayyip Erdogan is vowing not to be brought to its knees even as it is him that has driven the Turkish economy into free fall. The Turkish central bank says it will provide all the liquidity that the Turkish banks need. That brought the crashing Lira and stock market back a bit, but it is unclear whether that will provide lasting support. Turkey's stock market has fallen 17%, and government borrowing costs have risen to 18% a year. The Turkish inflation has hit 15%. The turmoil has caused the dollar to hit a 13 -month high against the euro and is causing pressure on gold which saw speculators pile into the short side for an 8th week in a row. We have seen buying in U.S. treasuries as well and oil is being held back from supply concerns as the dollar weighs on prices.
Fear of a fallout contagion are overshadowing reports and the ability of shale oil process to produce profitably, and reports that Iran fired off an anti-ship missile in its war games in the Strait of Hormuz. Bloomberg reported that “oil earlier rose higher amid supply concerns as Iran’s foreign minister said the OPEC nation won’t meet with the U.S. at the United Nations General Assembly in New York in September. The Trump administration has forecast that international buyers will cut Iranian imports by as much as 1 million barrels a day once renewed sanctions take effect, according to people familiar with the matter.”
How the market is going to make up that 1 million barrels is unclear. With strong global demand and if the fears of Turkish economic contagion are overblown, we could see a very tight oil market. The International Energy Agency (IEA) warned as much last week and I agree. Spare oil production capacity is at a historic low and we can’t afford any outages if Iran exports are cut.
Shale oil woes continue even after Baker Hughes reported that oil rigs rose by 10 to 869 last week, the highest level since March 2015. The Wall Street Journal reported that “American oil companies—primed to reap the benefits of rising prices after years of wringing more from wells for less—are seeing profits erode in the face of rising costs. Those operational challenges make balancing lofty growth objectives and demands for fiscal restraint increasingly difficult. If the companies continue to stumble, the result could be a higher cost of capital to finance the ongoing U.S. energy boom or a slower pace of growth.”
“Two-thirds of U.S. oil producers failed to live within their means in the second quarter, even as oil rose above $70 a barrel. Collectively, 50 major U.S. oil companies reported in their second-quarter results that they have spent $2 billion more than they took in, according to an analysis of free cash flow by FactSet. The Journal says that in second-quarter earnings, more than a dozen shale companies either lowered this year’s production targets, and said they would have to spend more to extract roughly the same amount of oil and gas or missed analyst expectations for growth. To be sure, many continue to expect their production to increase compared to last year, but they are having to spend more to meet those goals.”
On top of that, truck shortages and labor shortages, as well, as pipeline capacity constraints are causing their costs to rise. Bottom line, we believe that the Turkish situation will be contained. We look for oil to consolidate, setting the stage for a last quarter rally. Look to use weakness to buy long term options as oil volatility levels are low. You should be buying great value.