Colin Fenton, keynote speaker for the 2015 Annual Meeting of the PBPA, addressed the past, present and future of oil and gas—here and around the world.
Colin Fenton, managing partner at Blacklight Research and Columbia University fellow, was the keynote speaker at October’s PBPA Annual Meeting. Hailing from the Ivy League, the corporate banking world, not to mention the East Coast, Fenton brought a unique perspective with him on his visit to the Permian. Based on audience reactions, Fenton’s address was raw, eye opening, and even refreshing.
“The bad news is that we probably do have some more pain to come,” said Fenton. Though he began by opining that $20 barrel-price predictions were too extreme, he added, “I do think that you do have to take seriously the idea that it might still be another nine to twelve months of resolution…”
Even as Fenton cautioned the two hundred oilmen and women before him, his restraint served to set up his surprisingly bullish presentation. That presentation, titled “How To Survive The Competitive Destruction,” came to focus on the idea that the world needs America’s oil and gas, particularly that of the Permian Basin, and this need will bear fruit sooner rather than later.
“Whereas… this emphasis on ‘lower for longer’ will have you believe that prices will stay in the 40s, I’m sure policymakers, that’s what they hear,” said Fenton. “Maybe you can filter it better as producers, but a policymaker hears, ‘I don’t have a problem. I don’t have to worry about inflation. I don’t have to worry about pass-through effects.’ A market person like me sees that the all-time low in realized volatility… happened in June of 2014 at 11 percent annualized.
“If you’re not familiar with this kind of statistic, all we’re saying is, ‘how much did it change day-on-day?’ and then give me an annualized number. Eleven is the lowest ever back to 1988,” Fenton continued. “By the time we get to February 2015, it’s at 60, the 94th percentile. The month has ended, [it’s at] 69, the 97th percentile. Think of this in statistical terms. You went from the all-time low to the 97th percentile. That is the stomach-churning volatility that you feel and see, and is in your secondary businesses. It is absolutely absurd to talk about lower for longer when the one thing that is not happening is stasis in the price. That would be the way I think about it.”
From highlighting the chaotic swings in pricing, Fenton widened his gaze to the international stage. He proceeded to offer his interpretation of supply and demand implications both domestically and in China.
“July 3rd, the high was 62 dollars in the middle of the day. July 7th, 55, we lost 7 dollars out of nowhere. Having done this game for a very long period of time, I’m guessing prices. I knew that something important had just changed. Usually when you see a break like that, it’s on the demand side and usually it’s international… remember, we knew the Chinese stock market was falling apart at that time. I looked at the FTSE, on the shares of PetroChina traded in Hong Kong. The reason I did that was I figured the guys running the Chinese oil companies probably knew more about Chinese oil demand than I did.
“Sure enough, those puts went straight up. In other words, the right, but not the obligation, to sell the stock at a certain price was becoming a more and more valuable security. We all know what happened next: China falls apart. By the end of August we get to 42 dollars. At the time, I appeared on Bloomberg, I said China’s actually in economic contraction. Then we got this next move. What’s happening here? Back on August 31st, already 54 dollars, and as you know, we’ve been bouncing in that 40-50 dollar range.
“That is, all of the people on the supply side who thought they were going to re-activate rates said, ‘Okay, I got the message. I’m going to tighten up again.’ This is the portrait of the year, that’s the way that I see it. When you then look at supply and demand, something very important happened in the year 2015. In April, at the exact same moment that the United States started having its production curve fall down sequentially, China supplanted the United States as the largest crude oil importer on this planet. That was not sustainable yet, you can see they’re fighting with each other, competing with each other…”
Fenton continued his international analysis:
“It’s been somewhat stymied in the last month or two because the purchasing manufacturers’ index in China is telling us everything was okay to June. Then it was the ‘speed bump,’ as some call it. I used a stronger term, an actual economic contraction… There is a fellow in China who’s now the number 2 political official, Premier Lee. When Premier Lee, an engineer, was running one of the provinces of China, he got so sick and tired of fabricated data coming to his desk, that he said, ‘I’m going to create my own index. All I want to know about is electricity generation, rail freight traffic, powered by diesel, and loans, because that is really hard data to manipulate.’
“That’s how he looks at Chinese growth. This is the current number two person in China. According to his own index, in July of 2015 growth was 2.5 percent and in November ’08, at the trough of that recession, it was 2.4. What the 15 to 20 engineers who run China are assessing their own economy right now [are saying is that] it’s really bad. The first inclination they got was when the stock market was imploding. They did all sorts of things like imprisoning journalists and arresting short-sellers, just recklessly behaving in a way that wasn’t going to solve anything.
“Now they’ve settled down, and they’re really trying to pay attention to the fact that whether we look at exports or freight indices, rail traffic, consumer confidence, or even the PMIs, the industrial production statistics of the world, there’s a pretty consistent story. The countries are rank-ordered from the United States [referring to a chart], the wealthiest country in the world, down to number 38. Basically, [the top 38 countries] is about 88 percent of global GDP. We’re getting a story here of a world that is slowing down.”
Fenton continued, “Geo-politically, we’re all aware that the Saudis are attacking the Yemenis. We’re aware that Egypt has bombed Libya, the Russians are in Syria, and on and on. At some point, the question has got to be asked, ‘How many regional wars does it take to count as a world war?’ At what point do you stop saying, ‘I’m not going to take as many people out of Afghanistan as I said I would,’ and you actually start enforcing supposed red lines, and you actually start doing your job? We’re there, we’re at that point where you can feel, globally, this disgust with the way that this has been proceeding.
“The Bulletin of the Atomic Scientists [on] January 22nd, informed us that we’re three minutes to midnight. What they mean by that is you have been in no more dangerous geo-political situation at any point since the end of World War Two. With all that background, I get off the plane in Houston a couple of months ago and I’m going down the jet way, and I see this advertisement. Total is a solar energy company now. When you see this kind of advertising and you see this sort of positioning, you know where you are relative to what the polity wants you to believe.
“Moreover, when I look at the BP Statistical Review, it is true that in 2014, global primary energy demand growth captured by solar—so this is the proportion of energy demand growth globally that went to solar—was the equivalent of 234,000 barrels per day. It was almost as important as coal and natural gas. Of the entire set of statistics, that’s the one that most took my breath away. You can feel here, there is some real investment happening on the solar side, but it is still, as you heard earlier, such a small fraction of the total U.S. energy deck, and especially the world energy deck, that we’re going to need oil and gas and so on for decades to come.
“What I would say is rather than focusing on my price forecast or anybody else’s, here’s my Brent mean price by quarter. Again, you’re engineers, you’re scientists, you don’t care about averaging, you care about variance. You need me to give you an idea of what are the edges of this forecast. I’ve been publishing, for the past several months, a P-10 and a P-90 number, and that means there’s a 10 percent probability, for example, in 2016, the Brent price will average 32 dollars and 68 cents, based off of all the information we knew as of Tuesday, October 6th. There was an identical probability it would average 77 dollars and 50 cents.
“I would argue that’s the right way to start thinking about this. Don’t get dogmatic on price, realize that if something goes south in Syria, you might suddenly have a 90 dollar average price in 2017. These are conditional probabilities; that number can be 200 before you even knew what happened to you. That’s important. What it says is if you’re protecting your companies, you definitely want to be looking at options, because if volatility is the highest it’s ever been, basically, that means these are very richly priced securities.”
Fenton set up the next focus of his address with a history lesson about the oil business in the 1980s.
“In 1981, Saudi Arabia’s oil production did $10.3 million per day. They had a 13 percent world share in the early ’70s. That number was down to about 3.6 million barrels, 6 percent share by late 1985, early 1986 and the Saudis said, ‘why am I accommodating the Russians, the Mexicans, the Canadians, and eviscerating my business?’ Without really any warning, they switched to this system of boosting production but importantly pricing their product on a net fast basis. They literally went to the refinement and said… ‘I’ll have to take the residual off of that.’ Absolutely destroyed the competition. The Russians, the Mexicans, the Canadians, yes, even in the United States. very sharp deceleration in those production streams.
“Prices collapsed 50 to 60 percent within seven months… U.S. petroleum product supply zoomed higher. These were the plus days of the ’80s for consumption if you think back to what 1986 felt like. Huge increases in demand and from the perspective of the consumer, the price of retail gasoline dropped as much in one year as it had in the previous four… a 25 percent decline and again, as the previous speaker talked about money… the [consumers] spent it.
“Now, in April of 2014, while I was still at JP Morgan before I did my disappearing act, I wrote a piece called, ‘Defame Russia’ with the 1986 oil tactic. This was a ‘what if’ kind of piece. What if, because while oil production increases, that we all knew about, and because of the history that many of us lived through or had studied, what if that happened again? I pointed out that a comparable price drop today would bring WTI to about $40 per barrel by year end and once the Saudi competitive strategy was in place in 1986, there was little the Russians could do to prevent the economic [consequences] that followed.
“The point was, if you’re president Obama, you do not want to send 50,000 18 year olds to Poland, Estonia, Ukraine, whatever? You should allow crude oil exports. You should allow this room to compete on the world stage. I also had an intended idea that he should allow for… strategic petroleum reserve and basically go to the producer community and say, ‘I will be your buyer of last resort. You are essentially a defense contractor of the United States. I’ll bid 5,000 barrels per day, $65, for as long as we need to do that. You can fill the SPR production… and so on.’
“Now, I happen to know that this report did get to the government of the United States because I was the one who gave it to them. In April… it went to the number two fellow from the department of energy. I personally gave it to the deputy of national security advisor and… footprint of JP Morgan, I also gave it to the Saudis. This is research. This is for knowledge, for everybody who is a client of JP Morgan.
“Now, it was interesting because that’s a seat that I felt very privileged to sit in and I really wanted to emphasize one point. We can foresee possible futures and it’s certainly an advantage when you can hand your research to the guy that might actually be able to implement it but it does not mean you can foretell the future. It is not possible to foretell the future… It is the most important lesson you can learn when you’re doing commodity analysis or any of this kind of forecasting. It’s not possible. You’re going to tell me you can predict the next hurricane, the weather, the… There are too many statistic variables.
“Now, we are seeing the ‘86’ tactic being practiced today to some degree. The Saudi’s have increased their production by almost a million barrels per day since that infamous November OPEC meeting, the one before the one I went to. Incidentally, the back-story on that is I invited myself. I basically called them up and I said ‘Can I come?’ To my utter astonishment, they said yes. I went, I was in Vienna, and I literally was there in headquarters and there were all the ministers over there, all the press people over there. I felt like I was at a high school dance. I didn’t know which side I was supposed to be dancing with. I went because I wanted to see the body language of how these human beings treated each other and they were exceptionally rude to each other. The disgust and dislike was powerful. They don’t like each other. Every time I read in the paper about how much the Saudi’s are trying to hit Midland, Texas, no, the Saudis are trying to hit Iran. They can’t stand… They don’t even want to be in the same room with each other.
“When you are about to sign a P5 plus 1 deal and the Iraqis are also increasing their production, it’s important to keep that in mind. These three countries are in competition with each other and what they’re trying to do is recognizing that Iran is going to send crude oil through China. They’re all trying to position themselves to get to the top of the lead chart. Number one [for supplying crude to China] is Saudi Arabia, two is Angola, three is Iraq with the August 15 data.
“The reason you had supply increasing as Chinese demand was falling in the month of July and then into August was because they all were responding to our P5 plus 1 deal. They were trying to box out the Iranians. We heard earlier from several speakers that if you want to have a hedge on the P5 plus 1 deal, what you should do is allow the U.S. to export crude and then undercut the Iranians at every moment. What’s your offer? $56? Mine is $55. You’re $54? Mine is $52. You can do that… because of the supply of the United States.
“The Chinese are very, very good traders. In fact, probably some of the best physical oil traders in the world. Right now, [crude oil imports into China] it’s about 6.5 million barrels per day. Every single day. They need 6.5 million barrels. It’s a flabbergasting number. Occasionally, they’ll buy more than they need. It’s a working capital. It’s a restocking inventory kind of concept.
“The way that I think about the last year and a half is in the first part of 2014 when Brent was averaging 108, 109. The Chinese were refilling their SPR. They were basically worried about Frangia [sic], they were worried about Russia. They would take 693,000 barrels per day on top of their normal appetite. The first time we all ever heard about ISIS was in June of 2014 and the price of Brent averaged 112 that month and spot terms went to 116. How did the Chinese behave? Buyers strike. In five of the next six months, they took less than the normal appetite. That was the demand softness that really began to feed through the system.
“As the rest of the world producers began to panic when Brent got to average 50 in January of 2015, what did the Chinese do? Talked down the market… Terrible. Don’t ever try to get… I’ll take everything. Eight hundred thousand barrels per day on top of 6.5 and then look at April that month when they surpassed the United States as the top importer of the world. You don’t really want to be the top importer in the world.
“I’m watching very carefully to see what happens if we do get to a price level significantly below where we are today. I think that one big concept here is you see a lot of analysts—particularly ones who haven’t really studied this for a long time—making an assumption that a surplus market is various for price. Absolutely not. It can be, but it can be actually quite bullish for price because what you’re trying to find is the bottom. In a surplus market, you may very well have supplied the… demand. You may very well have high and rising inventories but it’s critical to remember, these are not barrels of oil rolling down Wall Street in Midland, Texas, that nobody owns that’s kind of like a junk bond.
“Every single barrel is an asset owned by somebody. If you want it, you had better pay for it because it’s a privately owned asset, and you have to dislodge it at a price. That price is not going to be $20 or $25. What I would expect to see happen is you’re going to find the Chinese and others increasingly tighten up the market even as it looks like it’s in surplus and there’s going to be a diminishing availability of accessible inventory and I’d argue that’s already happening. If the United States is wise enough to allow crude oil exports, it’ll happen like that. All of a sudden, there will be all sorts of deals that will be done between the Chinese and the Americans, public and private, and the benefit to the United States would be astronomical.”
Fenton backed up his support of the United States becoming an oil exporter by outlining several intriguing peculiarities happening on the world stage.
“The Russians have been one of the targets of this 1986 strategy but they’ve actually seen their production go straight up. I’ve been surprised by this. I would have thought it would have been weaker by now but both the Russians and the Norwegians are desperately doing anything they can to try to offset lost revenue by increasing volume. So far, it’s worked, particularly because they’ve allowed depreciations of their currencies. We actually get pretty good polling data in Russia, believe it or not. We really do. The Russian Public Opinion Polling Center, which is the equivalent of the Pew Center, has been asking since the 1990s, ‘Do you approve the activities of Putin as President, PM, of Russia?’ In June, 89 percent said they did.
“Now, as Americans, our initial response is to say, ‘Give me a break. That’s just ridiculous.’ He is a… dictator, is he scary, does he intimidate people? They say yeah, he’s really good at that.
“You can actually go talk to Russians and they’re not so happy about this. This is the data that proves it. Now, like most human beings though, they are susceptible to nationalism. In November of 2013, the approval rating of the Russian Government was 39 percent. In fact, there were actually people in the streets in that 2011 period when the disapproval rating was above the approval rating.
“As an analyst, I look at this and I see Crimea and the annexation, totally illegal, took that number from 39 to 66. It began coming down again, and we literally just got the September number in the last couple of days, starting to go up again … Why? Because they hit Syria. Very scary. That’s how regional wars start, and you are seeing all of the elements that we have seen in the ’30s over, and over, and over again and the complete denial that you see in the United States Government is scary.
“Now, I shouldn’t say complete. There are some glimmerings that we’ve been trying to bolster the Turks in particular. On the right hand side [referencing a chart], you can see that the top 10 destinations for treasury flows in the past year. After you get through all the money centers, the Caribbean, Ireland, Switzerland, this is basically all the hedge fund money going to the Cayman Islands. Turkey received 46 percent more treasuries than a year before. That looks to me like somebody, CIA or somebody, has been basically saying, ‘My response to ISIS is I’ve got to bulwark Turkey.’ Think about what the stories in the past month have been. The Russians incur into the Turkish airspace. They got close to the American fighter. You may not be aware that a German patriot missile battery, two months ago, on the Turkish-Syrian border got hacked.
“As we’re here talking about the office of personnel and management, and all these other things, there have been missile batteries on these flash points that have been out of [the] control of NATO for meaningful periods of time. History is going to look at this whole period where there’s obviously this insider-outsider dimension right now in American politics, but there’s also this focus on the wrong stuff. Eventually there’s going to be a flash point that happens. It’s going to affect oil and gas prices. Then my successors 20, 50, 100 years from now are going to be like, ‘I can’t believe they didn’t pay any attention to this.’”
He then shifted to highlighting a few domestic peculiarities, shedding light on American attitudes toward energy, energy costs, and consumption.
“Of course there was an effect on oil and gas prices. For now, global demand last year grew by 0.9 percent. Normal is 2.5. With the drop in prices, product-demand is screaming in the United States. At one point a month ago, it was up 4 percent year-over-year and gasoline, in particular, is what’s driving it. Here again, you will appreciate this in Texas; the second the average retail price got below 2.50, sales of [Ford] F-150s just went straight up.
“Our society talks a good game, but you give them that price, [and] light truck sales are going to be up 16 percent and passenger cars nobody wants. Down five [percent]. That’s just the data. That’s the evidence. That’s the proof. Our society thinks these prices are too low. If you go to them and you say, ‘Are gasoline prices too high?’ everybody will say yes because they are conditioned to. If you just give them the price and you watch what they do, they will do this… Proof the price is too low.
“In fact, if I look at café standards, fuel efficiency standards, all the way back to the ’70s, and I say, “Well, how many motor vehicle miles are being traveled on public roads in the past few years, especially the last 12 months?’ A multi-decade trend toward fewer vehicle miles traveled has been completely reversed. This is an 18 trillion dollar economy getting a $2 gas price and laughing all the way to driving up into the mountains. Completely reversed. It’s up 4 percent percent year-over-year.
“Now Tesla is the company that’s done a fantastic job positioning itself at the intersection of technology and clean energy. You know the whole deal. June, for me, was a month that was really interesting. In addition to all the leaders meeting in Germany and ponderously saying that oil and gas will go away forever. I’ll get to another thing that happened [at] Swarthmore College in a minute. Elon Musk, who I think we can all agree, has done an amazing job creating a business. He’s a visionary… [Referring to a slide featuring a new car model] Consumer report says it is the best car that they’ve ever reviewed. You gotta take that seriously.
“Listen to what he said at his June shareholders meeting. He was asked, ‘What about superchargers?’ These are the stations you can go to and power up your Model S. In particular, one had just opened up in Mountain View, California. He said ‘Well there are a few people who are like quite aggressively using it for local super-charging. We also send them just a reminder note that it’s cool to do this occasionally, but it’s meant to be a long distance thing.’
“Translation: he sold a bunch of these cars to billionaires in San Francisco and promised them, ‘I will let you have free electricity for the end of time.’ Even the billionaires said, ‘That’s cool.’
“He gave them a valuable thing for free, and he’s discovering their demand for that is infinite…(laughs) I love this quote. ‘It’s cool to do it occasionally, but it’s meant to be a long distance thing.’ He wants you to drive from San Francisco out to the desert and get to my home outside of Boston and not have range anxiety.
“You’re seeing here, a fellow who is basically my age, learning like in business you gotta be careful what you promise. He’s got a great car. He’s going to learn that already he pays a lot for gas, fire, and electricity. At some point, he’s gonna have to confront the decision of why he just goes straight and has natural gas powered vehicles to get past the 500,000 units.
“So if you’re a gas producer that might be something you want to pay attention to because right now, the natural gas vehicles share a total gas consumption in the United States is 0.12 percent. I am going to go really out on a limb here. I’m gonna predict it’s going to be higher in the future. I think you can get a little bit long natural gas vehicles and your downsize is not so huge.
“Now, petroleum consumption, because of the low price, is going [to] be up something like 1.7, 1.8 million barrels per day year-over-year. It’s one of the strongest in the industry’s history. It’ll be up a good number next year as well. This is a very busy chart. All I’m trying to show you on here is supply expectations had gotten to be very strong at $100 oil prices. Then they got to be lower in the environment that we’ve just been in. They now are getting even lower for 2016.
“We crossed the world and projecting out to 2030, this is BP data, not mine, just to sort of give it to a third party. All the best indications are that our civilization not only is not going to get off oil and gas, it needs 13 million barrels per day of new liquids just to get to 2030 because all the people in China and India want to drive too. Tesla’s at their current price and infinite electricity still have the problem of needing back-up power. That’s the reality of it.
“When you see this price chart, again it’s a volatility story. ‘Lower for longer,’ terrible way to look at it, in my opinion. The guy who coined it is a friend of mine, so I’m not trying to be personal about it. It’s not helpful if you’re gonna run a real business, or if you’re going to try to make a decision about what to do with your rigs. Back in May, if the price is at 70 and possibly 80 by the end of the year, and that gives you a positive rate of return, you should reactivate your rigs.”
Fenton’s attention turned toward the Permian, domestic oil and gas production, and their connection with international markets.
“Moreover… well productivity in the Permian is up 62 percent year-over-year. When I see the production per new rig, daily production, and I’m looking at numbers in the 300, 400, 800. The engineers have really done something pretty remarkable here. There is obviously a technological learning process that has accelerated in the last twelve months that has helped offset the loss of the rig. Again, I know I’m telling you all stuff you know, but just to reiterate the point, the path of U.S. laid tight oil production is falling sequentially. The decline rate is now 341,000 barrels per day, per month.
“Let me put that in context in case the numbers are kind of squishy. In 2013, the second fastest grower of oil on the planet at the sovereign level was Canada, and it grew by 250,000 barrels per day in a year. This number is one and a half that in a month. What it means is if Wood Mackenzie, a consultancy, who recently came out and said that 1.5 trillion dollars of projects are under water, so you can expect that…to be chill for a while. That’s right. You very well could see this green line [referring to a chart], which is new production, came close to zero. Suddenly, we’re not growing. We’re losing 300,000 barrels per day, per month. The entire growth of the last four years can be lost in one year. You tell me what prices do that. Although, go right back up to $120 because we need this oil.
“Growth rate in March was up 1.2 million barrels per day year over year. Now it’s up 135,000 looking across the seven basins. Look across all these bars. Look at the only basin that has still held its ground. This basin. The Permian. Very revealing chart. I was in Denver, as I said. The DJ is in trouble. By the way, they kept on asking, ‘Why are those guys in the Permian putting out rigs?’ And I’m like, ‘I’m about to eat lunch.’ It is such a valuable asset. It is so close to the Gulf of Mexico. It is so prime for what is about to happen through trade that even that transportation differential up to Colorado and Wyoming, it matters.
“What am I talking about on backlash? OPEC’s production capacity today is lower than when it initiated this path back in June of 2014. What I mean by that is not only have they cut into their spare capacity by definition by increasing production, Libya and other countries have actually lost their ability to have capacity. They’re finding that especially [at] these prices mature fields, some of them are going away forever. As of right now, according to the EIA, spare capacity in OPEC is only 1.5 million barrels per day. So, you tell me what you think the probability is of upset in Saudi, or Yemen, or Algeria, or Nigeria, or Venezuela in December when they have their parliamentary elections, or whatever it might be. It is a razor-thin spare capacity.
“In fact, here is another way to think about it. In Iraq, which surprised everybody a few months ago, especially me, is suddenly having this huge month-on-month increase in the month of June. Its total power capacity is less than what Japan built on solar last year. Japan just added 9.7 gigawatts of solar capacity last year just by fiat. The government paid for it just in that society. The entire power capacity of Iraq is about 9 million in terms of what’s available. They need something like 25 billion dollars to get that up to scratch. They’re 22 billion dollars below their budget for this year. Not gonna happen.
Here’s the thing that really worries me. Again, I pointed this out in Canada. Canada every year through its producers association publishes a report that gives us expected supply out to the year 2030. In the 2015 report, they took down the 2030 number by 1 million barrels per day. Cumulatively from today until then, that’s 3 billion barrels of supply – poof – gone in the supply-demand balance.
“It’s 135 billion dollars of revenue at today’s prices. Looking at the delta since 2013, it’s more like 3.88 billion and 291 billion dollars at $75. This by definition means the world just got more dependent on Russia, on Nigeria, on Venezuela. I would put to you this situation cannot sustain. This cannot last. This production is too important, so there are two areas in the world that I think are gonna get a lot of love in the next two years, Texas and Canada. The correlation of the Canadian oil prices would cash the WTI Cushing, had at times been as low as 31 or 44 [percent]. It’s now 90 percent. A 90 percent correlation. What that means is Canada is basically going to follow the United States.”
At this point in his address, Fenton pivoted to speak about many environmental factors facing oil and gas.
“Now let’s talk a little bit about Paris because I gave you a little teaser on that. Last year, China dropped coal consumption to plus 0.1 percent growth. It basically had no increase in its coal consumption in the year 2014. It’s emission of CO2 atmospheric emissions got to be about the level of the United States, 87 million tons versus 53. I’ve actually gone through all of the hourly data compiled by the U.S. Embassy in Beijing and summarized it here, so you don’t have to do the homework, I did it for you.
“It’s true that the air quality readings that are measured here, this is 2.5 particulate matter. This is the really nasty stuff that gets into your lungs and causes lung cancer and all sorts of horrible things. Those readings have gone from being on average in the 100s to now being about 73, where the average is 95. That’s improvement. Even the highs are a little bit less than they were before. What it’s showing us is that part of this was policy, so they just by fiat said, ‘Stop burning coal.’ Part of it more recently was because the manufacturing activity in that economy has just fallen apart.
“So when you hear two months from now that China has made so much progress on coal, remember this chart because you’re going to hear about this. It’s going to be in the news a lot in the first week of December. What actually happened is yes, they did get their 2.5 particulate number down, but the most recent stuff is because of the economic… It’s the cause of the economic contraction.
“There’s no actual, real, do x-y-z like you might have in an engineering plan or a schematic. There aren’t actual things to do. It’s like, ‘support the environment.’ ‘Yes, I support the environment, too.’ And you had, basically a real promise, from Merkel in particular, to phase out the use of fossil fuels by the end of the century. Now, if you actually read the document it does get a little bit more nuanced. Are they talking about decarbonization meaning the intensity per unit GDP? It’s a little bit unclear but Merkel has completely abandoned whatever was in the document and she is basically going out saying, ‘we are going to get rid of all oil and gas by the end of this century. Oh, and by the way we’re going to raise a hundred billion dollars from public and private sources to fund renewable fuels and I assume the U.S. will get at least a sixty percent share of that and many of you in this room will be taxed to fund this hundred billion dollar bogey.’
Unbridled enthusiasm… ‘Elma Delivered,’ said Greenpeace. I’m not going to make any polemical points here about what you should believe. I’m going to put to you that when the entire conversation after thirty years of discussion has come down to two numbers; atmospheric CO2, nothing about the trees, nothing about the oceans. Just a single laser on top of Mauna Loa in Hawaii and a data series that goes back to 1958, that’s what’s on the left hand side. And annual temperatures, in this case back to 1880. We heard in the prior industry’s session that a lot of these time series start around the year 1880 when newspapers and USGS and others really start paying attention to it.
“Think about what you’re reporting here, right? On a 4.5 billion year old object, you invent lasers in the twentieth century and you point one of them in the sky and you start having some time series. That’s fine. But the entire thing now hinges on these two numbers. Now in the famous Inconvenient Truth movie, you had an argument, earth’s real natural warming cycle did this. This goes back six hundred thousand years and then there’s this hockey stick that comes out above it. My problem is this: this is actually what science knows about. In 1997, the history of atmospheric CO2 was charted back six hundred million years, not six hundred thousand years, six hundred million years.
“So if you’re going to go in front of seven billion people six weeks from now and you’re going to say, “I believe in science and my detractors don’t,” it begs the question, why have you not shown them this chart? I’m a fellow of Columbia University, not exactly known for it’s conservatism, and I will tell you that there is something deeply unethical about this that really bothers me. If you really want to be honest about it, you’ve got to point out that the whole point of this whole vegetative period and the carbon sinks and everything that happened in three hundred, five hundred million year period ago, was precisely because atmospheric CO2 shrank to some of the lowest levels that we’ve been able to reconstruct.
“Again, I’m not trying to polemical. I’m trying to prepare you for a backlash that I think is about to happen. I would argue that when you look at that in the context of we’ve already had the guy who invented the hockey stick chart, get caught in Climate Gate, remember that?
“They get rid of media but one period switches the start date a year. A drift higher. There is the famous hockey stick chart, published in 1998, ‘99. There was a backlash… Somehow made all into one report by the fourth session the report in ’07. It was given only one, of ten or twelve slots, so it was diminishing the importance [of the film]. The report that they’re going to talk about in Paris, excludes it. It [the hockey stick chart] is literally being excised as fraud. It’s stunning. Why is it important? Why I’m I hopping on this, because sophomores at a college in Pennsylvania that is extremely well regarded. Still to this day… Without any sense of irony about the supply of coal in West Virginia. That they used to bang on their little MAC-AIR books. Took over the president’s office and said, ‘The most important issue in human history is this,’ apparently unaware they had been discredited ten years ago. Sleeping, 18 year olds, earnest as can be… Those who had parents like me, your heart can go out. You know what to do.
“In May of this year… It’s actually very interesting that way. I didn’t expect… The trustees of Swarthmore College gathered to listen to the petition of these students, these students. It said, ‘Let me get this straight, so your argument is you consumed to much energy to have too large of a carbon footprint, your consumption and your solution is, I, the trustee, has to go to the endowment, which funds half of the operating expenses of this school, and I’ve got to cut assets from it to basically hurt the staff and faculty to basically forgive your consumption.’ No way, it doesn’t even remotely make sense… ‘[The] endowment, which by the way, is 3.4 billion, and by the way, only 4 percent of the holdings are in fossil fuel. We are going to make you have mandatory observation of your consumption.’
“The trustees put, as far as I understand it, greater consumption limits on the students. That was in June, May, but around the same time but here is what I’ve been leading into and again, this goes back to science and the ponder-less nature of… ‘Oil and gas people don’t know science.’ Think about this, lawyers in Massachusetts telling engineers and geophysicists in Texas that you don’t know science. Six weeks ago, [a] nature magazine published a new survey about the count of trees on this planet. Very interesting. The number now believed to be 3.04 trillion trees. The prior number, i.e., when the G7 leaders met in Germany in June was 400 billion, so think of … Just pause for a second though, what that means. We just found 2.64 trillion trees.
“I’m not trying to be some pain in the rear, here. I’m just trying to point out, that seems important to me. If you’re going to argue that, actual contribution to CO2… The ocean that you’ll have to include and the trees which we have include… You have to include everything. …By the way that number was supposedly, 40 percent of CO2 came from the trees. Natural sources. You just found 2.6 trillion. You guys tell me which number changed. Are you going to change the share because now there is so many of them. You’re going to maintain constant understanding of the intensity of carbon update by a tree. A curvature. Are you going to say, “We’re going to keep the share of the same but I have a radical understanding of what a tree does but you have to change something. You’re not allowed… That doesn’t matter. If it is now 3 trillion trees… Think about what that means. If you cut down or plant any given tree, its less important than you said four months ago. By definition.
“If you’re a 19-year-old in Swarthmore College and you think it is okay to put as much CO2 into the atmosphere as you want as long as you buy a carbon off-set and plant a tree. What’s the price of that? You see where I’m going with this? Now getting past what we’re joking about it, you’re going to go and say, ‘I’m going to destroy 3 trillion trees… and I’m going to basically try to position my government…which are the winners and who are the losers and I’m going to have a…price… How do you set that price? I actually worked at a hedge fund that owned CO2 futures back 10 years ago. We thought we’re doing a good thing. We’re creating a price. We got killed when suddenly the Polish supply numbers changed and the price of CO2…I can remember, cratered in Europe and we lost millions of dollars of our clients’ capital. IV is very important. I think that charts very important because it shows also there isn’t a uniformity of the dispersion of trees around the planet.
Deforestation had been happening but it has been declining. Maybe at some point the backlash is going to be, I’m hitting the wrong industry. How much of the CO2 up taken from the atmosphere was the cause of deforestation in Brazilian Amazon forest? How much of this…expect these discrepancies between temperature and CO2 are because of Apple’s success in getting every single person in this room device on device that we look at excessively, and your consumption of paper has changed. I don’t know. The answer is nobody knows. That is the only correct answer. If you’re going to find 2.6 trillion trees in the space of a couple of months. You have to make an apology and say, ‘The truth is, I don’t really understand this. The truth is I don’t know.’ Its the only possible criteria. I’ve been in research now for 20 years, then I see this. What did we learn also in 2015? Apparently, there is liquid water on Mars. What have we learned on 2005; there is liquid methane, LNG, in pools on the surface of Titan, the moon of Saturn. These are actual photographs. This isn’t [a] very bad artist rendering. These are actual photographs taken by real surveyors.
“You tell me as an oil and gas producer, if you can just get mineral rights to all that stuff. It also begs the question, I mean this seriously. I think we’re also in the next couple of years going to have a real conversation about what is the source of hydrocarbons? Is it all biogenic? Is there a biogenic origin for some, if not all, hydrocarbons?
“I think that, especially, if you’re geologist or physicist in the room. You got to really look at that and say to yourself, ‘Did I really believe there were colonies of bacteria on Titan and that will help me get to my liquid methane?’ Under conditions of intense temperature and pressure are we about to learn some chemistry that we didn’t know about from Davy and all the guys in the 19th century?
“I will pretend that if you hear a politician say lets get off hydrocarbons all that you have proven to me is you don’t know that hydrogen is the first element in the periodic table and I’m already starting just drastically to lose confidence in you. Look at the top row, carbon six, oxygen is eight, nitrogen is seven, hydrogen is one. The truth is, our knowledge today is embryonic. We still use terms like dark energy and dark matter. We think dark energy as of now, I’m told is 72 percent of the composition of the universe. 23 percent is dark matter. What does that mean? All the stuff we think of is like the normal stuff around us. Is less than 5 percent and of that hydrogen is 74. These guys would not have done well on a wagon train.
“You can’t… If there is one thing I know, in the distant future we will still be using hydrocarbons. We might process them in a different way, we might quest them in a different way. We might have different processes. I don’t know, will find out, but oxygen is 3rd in abundance ranked in the composition of the universe and so I would pay attention to that. That’s a little bit of my—just thinking outside the box. Something’s about to happen. Finishing off on what the market is faring now. There is no doubt that exports are contracting on a global basis and as part of the reason why, you see bunker fuels… In particularly so weak and they’re saying higher inventories in Singapore from residual fuel oil stocks and like…stocks.”
Fenton began the concluding portion of his address by returning to his bread and butter, the current oil and gas market.
“As I said earlier, when I look at the global crude stocks in the water if I can measure it in real time thanks to the shift charter information. We are about 60 or 70 million barrels per day above normal and crude, and if not so…I asked a question, ‘how much of that 60 million barrels is already been purchased by the Chinese?’ My competitors will sit there and think, ‘Wow, we got clear 60 or 70 million barrels.’ By then I asked, what is the cash for it even to cost for a North Dakota oil production scheme? That is what the cost would look like by my math, and through September 8, when I last updated this, the average price was $43. At that price 422,000 barrels per day of production was losing money on a cash basis.
“Is it any surprise that you just learned in the August and September data that North Dakota has seen actual contraction in its output… Looking at about 6 million barrels per day a of barrel oil equivalence, I’m including dry gas and NGLs. Bought a full cycle basis to call that a 10 percent rate of return in… $65. In this industry, among all the industries I know, is the most competitive in clearing a market. It’s very, very efficient.
“When I see companies like PBC energy, which is a strong hedger small independent EMP, beating the refiners in valuation as processes have collapsed for the products it makes. What it put in the refiner, what it tells me is, the market is able to say, that if you survive and you grow the enterprise, I’m going to reward you. How do you survive? You hedge. Or you start to position yourself relative to crude exports. In our remaining time we’re just going to view a couple of charts on crude. A lot of people make the argument that WTI heard the oil prices fell as the dollar strengthened. It’s totally backwards. It’s not what happened. What really happened was, because the increase in production of crude, we saw the exports to Canada really begin take off at the end of 2013 because Canada is a… even allowed to ship into Irving in… By the time we go to that 300,000 barrels per day production. That appears to be the threshold where prices started to really weaken and it’s because up until that point, all the adjustments had been through finished product exports.
“In 2011, the U.S. becomes the net product exporter for the first time in 62 years, and then, it flat lines… In more recent years, all of the incremental exports had been through crude NGLs. Yes, process comes… so you can barely see on the charts and other liquids…
“Already in 2015 before we get rid of the export ban. More importantly, if you ask, ‘where is this stuff going?’ It’s more barrels going to more destinations and that means more uncertainties. If you’re a fiscal trader and a year ago or a year and a half ago you saw these barrels of unfinished oil going to 6 countries and it was about 69 thousand barrels per day, it matters a lot that now it’s 16 countries going to 343 thousand barrels per day. Propane, a huge over supply in the United States. We’ve grown a 100 thousand barrel-per-day market for U.S. propane since October of last year from 0 into China. Canada had been the largest conduit for some of those streams, now they’re looking over to China.
“Bottom line, when I hear all the talk about US crude exports, it’s already something we can quantify. We can already see that the oil exports that we’ve done, the dollar has strengthened. I can quantify exactly how much the opening of the upstream export channel has taken off the Brent stock price. That was about $10. I can also do a simple regression like this and say each 10 percent increase in U.S. upstream oil exports increases the value of the U.S. dollar by about 5.5 percent. Every 200 thousand barrels per day from here that we get will add $5 billion to GDP.
“Bottom line point, if you want my top 10 lessons in strategies, you should expect extensions. Make sure you’re not one of them. Anticipate and accept structural change. By that, I mean don’t try to fight the tape. Don’t try to fight the government. Realize that even this government will eventually realize that we should allow crude oil exports. The oil ‘86’ strategies and tactics will likely work faster than they did in ’86-’91. We’re already halfway through the adjustment process. I think by July of next year most of it will be done. Don’t be dogmatic on price level. Remember, we saw 11 and 147 within 10 years. Plan for the high vol—and the volatility that I talked about. If you find yourself saying words like ‘inconceivable’ and ‘impossible,’ just give yourself a little tap. Don’t do that. Practice scenario analysis. Do what we did with…Russia. For goodness sake, do not assign a probability to it. The second you assign a probability to something someone is going to say, ‘Oh, it’s only a 10 percent probability.’ They will immediately begin to not pay attention to it.
“You can manage the sequence of presence. When I worked for Stan Druckenmiller and other really talented risk managers, here’s my observation of why they are the Ted Williams’ of investing: They’re constantly in the present. They’re constantly aware of their current risk. When they start to feel like the wheels are coming off the bus they put their tail between their legs. As Stan once said to me, ‘Run away and live to fight another day.’ Very, very humble human beings, which might surprise you.
“Unfortunately, the headcount reductions that we’ve seen begin to emerge in E&P are probably going to extend. Up until the Chester Peak announcement we’d only lost 8 thousand people in E&P, 10 times that in services. That number, according to the productivity relationships, could be as high as 25 and 30 thousand. I’m sorry to report that we probably will see more headcount reductions. The really sad and pernicious thing is you’re going to need the exact same people back within months. If you lose a geophysicist or an engineer or somebody with talent and experience and skill, you know as well as I how valuable they are and how hard it is to get them back.
“Let me stop there. Danny, I don’t know if we have time for questions but I’m happy to take them. Does anybody have any questions? Yeah?”
Question: “In your opinion, do the redacted documents that come out 20 years from now on what happened in 2014, how much of an impact does our government and those… have potentially an impact on what we’re seeing right now? Did they follow your advice on that or do you think it’s probably unrelated?”
Fenton: “This may be the first time the following sentence has been said in Texas but I’ll say it. Some of the members of the Obama administration were really smart. You’ve got to recognize that this black and white, good guy, bad guy stuff is just crazy. It’s way too partisan and it’s nonsense. They’re fighting for power. It was a… That’s exactly what it is. They’re really smart human beings and they saw something they can do. What I saw happen was I personally gave it to individuals who may or may not be redacted and may or may not talk about it in the future. For them it was all in the context of the midterm elections.
“There I am like, ‘Please stop World War Three before we get there by doing this,’ and what they heard was, ‘Hmm, E&P is probably right. I can probably get the gasoline price down before the November midterms and maybe I won’t get beaten as bad.’ It was kind of disappointing for me because it constantly came back to this U.S. domestic us-versus-them thing, whereas I was talking about [how] I’m really worried about the Middle East. I’m really worried about… Are you aware there was a war fought there in the 19th century? Do you know the history of World War One? Have you paid any attention to this? I would say that the difference between this time and last is in 1986…and guys like that definitely persuaded people in the Reagan administration that, ‘You should bankrupt the Soviet Union.’ Between that and Star Wars they did, and it was a deliberate policy and it worked.”