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Last
month
was
brutal
for
most
commodities
and
anyone
investing
in
them.
Except
for
the
very
nearby
contracts
oil
prices
fell
to
new
lows
for
the
year.
Precious
metals
prices
made
multi
year
lows
while
the
Bloomberg
commodity
index
touched
a
thirteen
year
low.
While
renewed
fears
of
Greece
exiting
the
Euro
zone
and
the
selloff
in
the
Chinese
equities
markets
provided
ample
macro
worries
there
were
other
reasons
provoking
the
declines.
For
metals
the
prospect
of
the
Fed
imminently
raising
interest
rates
provides
a
strong
headwind.
For
oil
the
successful
conclusion
of
the
P5
+
1
negotiations
with
Iran
over
its
nuclear
program
weighed
very
heavily.
Even
more
importantly,
the
perception
of
a
large
and
persistent
crude
oil
glut
is
now
endemic
and
has
triggered
a
massive
shift
in
sentiment
one
that
we
frankly
did
not
anticipate.
One
reason
for
that
is
that
we
see
fundamentals
continuing
to
improve
and
believe
there
is
something
of
a
disconnect
between
perception
and
reality.
That
perception
is
colored
by
the
IEAs
most
recent
Oil
Market
Report
(OMR)
which
estimates
that
global
oil
supply
in
Q2
2015
exceeded
demand
by
a
staggering
3.3
million
bpd.
For
2015
the
IEA
is
effectively
predicting
a
surplus
of
supply
over
demand
averaging
more
than
2
million
bpd
that
continues
through
2015
and
2016.
The
nearby
chart
shows
the
IEAs
implicit
forecast
of
the
cumulative
supply
excess
since
the
end
of
2014.
Its
supply
and
demand
balance
is
much
more
negative
than
the
others
we
look
at.
However,
the
IEA
forecast
is
the
one
used
by
most
oil
analysts
on
Wall
Street
as
the
basis
for
their
own
forecasts.
For
that
reason
the
consensus
view
is
now
extremely
bearish.
The
latest
data
from
the
IEA
is
difficult
to
reconcile
with
what
2000
1800
1600
1400
1200
1000
800
600
400
200
0
FORECAST CUMULATIVE TOTAL OIL SUPPLY SURPLUS SINCE 4Q 2013 ('000 BBL)
PIRA IEA
IOC
EA
[2.2] [Investor Letter 7-15.pdf] [Page 1 of 7]
1
has
actually
been
happening
in
the
oil
market
however.
If
there
had
been
a
3.3
million
bpd
surplus
in
Q2
the
contango
would
have
exploded
as
oil
would
need
to
price
itself
to
make
it
economic
to
carry
in
ever
scarcer
and
therefore
costlier
storage.
That
did
not
happen.
In
fact
the
contrary
was
the
case
contango
narrowed
for
Brent
and
WTI
and
the
Dubai
market
moved
from
contango
into
backwardation
by
the
end
of
Q2.
This
is
not
suggestive
of
a
growing
crude
oil
surplus.
Even
more
striking
is
the
absence
of
an
increase
in
observable
inventories
anywhere
close
to
that
suggested
by
the
IEAs
supply/demand
balance
for
Q2.
Preliminary
estimates
show
that
OECD
onshore
inventories
of
oil
built
by
a
little
over
700
thousand
bpd
last
quarter.
Inventories
(government
plus
commercial)
in
China
are
estimated
to
have
risen
by
about
400
thousand
bpd.
Oil
in
floating
storage
rose
by
about
600
thousand
bpd.
That
all
adds
up
to
about
1.7
million
bpd
leaving
1.6
million
bpd
of
oil
unaccounted
for.
Where
could
it
be?
Oil
in
floating
storage
is
monitored
ship
by
ship
in
real
time
and
data
are
available
for
most
commercial
entrept
facilities.
It
is
hard
to
believe
that
over
140
million
barrels
of
oil
could
go
unobserved.
The
more
likely
explanation
for
these
missing
barrels
is
that
the
current
surplus
is
not
nearly
as
big
as
the
IEA
is
estimating.
In
the
July
OMR
the
IEA
was
still
showing
a
balancing
item
for
unaccounted
oil
of
1.4
million
bpd
for
Q4
of
2014
and
900
thousand
bpd
for
the
first
quarter
of
this
year
(they
have
yet
to
analyze
the
Q2
balance).
Historically,
large
balancing
items
are
revised
away
by
changes
to
initial
estimates
of
demand.
Since
2009,
on
average
the
IEA
has
revised
its
initial
estimate
of
actual
quarterly
demand
upwards
by
over
500
thousand
bpd
over
the
ensuing
two
to
three
years.
On
four
2
Aug-14
Sep-14
Oct-14
Nov-14
Dec-14
Jan-15
Feb-15
Mar-15
Apr-15
May-15
Jun-15
Jul-15
It
is
not
only
on
the
demand
side
of
the
equation
that
we
can
question
the
scale
of
the
apparent
oil
surplus
predicted
by
the
IEA.
Compared
to
other
credible
forecasts,
the
IEA
supply
forecast
for
2015
for
NGLs
produced
by
OPEC
is
higher
by
about
500
thousand
bpd.
OPEC
NGL
production
is
a
notoriously
difficult
number
to
gauge
accurately.
Moreover
it
should
be
largely
irrelevant
to
a
discussion
of
crude
oil
prices
as
NGLs
cannot
be
processed
in
oil
refineries.
Crude
oil
inventories
have
already
started
to
fall.
Unsold
West
African
oil
that
was
floating
on
tankers
until
June
has
now
been
sold
to
refiners.
Crude
oil
inventories
in
the
Atlantic
Basin
the
epicenter
of
the
global
oil
excess
-
have
fallen
55
million
barrels
from
their
peak
at
the
end
of
April.
Based
on
the
balances
we
look
at,
crude
oil
inventories
should
on
average
fall
over
the
rest
of
the
year
albeit
with
a
hiatus
during
the
fall
turnaround
season
in
October.*
But
these
green
shoots
have
been
trampled
down
by
concern
that
Iran
will
now
add
to
the
glut
of
oil
and
that
it
will
take
much
longer
for
the
market
to
balance.
These
fears
have
been
compounded
by
reports
that
Iraq
and
Saudi
Arabia
are
setting
new
production
records.
There
is
no
question
that
the
core
OPEC
producers
in
the
Middle
East
are
producing
oil
at
historically
high
rates.
But
lets
examine
this
more
closely.
First
Iran:
virtually
all
serious
analyses
suggest
that
sanctions
on
oil
exports
will
not
be
lifted
until
sometime
in
2016.
Moreover
these
analyses
indicate
that
Iran
will
not
be
able
to
increase
its
production
by
much
more
than
500
thousand
bpd
without
substantial
investment
and
the
involvement
of
the
international
oil
companies.
That
will
not
happen
quickly.
Also,
the
risk
that
the
oil
Iran
currently
has
in
floating
storage
will
flood
the
market
is
being
overstated.
In
all
there
are
about
within
this
group
for
which
data
are
available.
This
will
inevitably
result
in
an
acceleration
in
the
rate
of
production
decline
of
this
oil.
We
estimate
that
because
of
the
fall
in
rigs,
production
from
these
producers
will
on
current
trends
fall
by
about
3
million
bpd
by
2020.
Global
oil
demand
over
this
period
should
rise
by
at
least
7
million
bpd
and
probably
more
at
current
price
levels.
This
means
at
least
10
million
bpd
of
new
supplies
will
be
needed.
Iraq
and
Iran
can
possibly
add
3
million
bpd
provided
there
is
no
further
deterioration
in
the
political
climate
in
the
region.
Perhaps
the
other
Middle
East
OPEC
producers
can
add
another
million
bpd.
But
that
leaves
a
shortfall
of
at
least
6
million
bpd
and
it
cannot
CRUDE
OIL
PRODUCTION
EXCLUDING
NORTH
AMERICA
AND
MIDDLE
EAST
OPEC
(MILLION
BPD)
49
900
48
47
46
45
850
800
750
700
650
600
CRUDE
OIL
PRODUCTION
MILLION
BPD
-
LHS
RIG
COUNT
(DOES
NOT
INCLUDE
FSU
AND
CHINA
-
2015
ASSUMES
NO
FURTHER
DROP
FROM
JUNE)
-
RHS
44
550
500
43
450
42
400
Source:
BHI,
PIRA,
Astenbeck
Research
[2.2] [Investor Letter 7-15.pdf] [Page 4 of 7]
4
2014
2012
2010
2008
2006
2004
2002
2000
companies
turn
to
when
they
want
to
bring
back
rigs
in
quantity?
The
longer
prices
stay
depressed
and
the
more
that
non-shale
projects
are
postponed
or
cancelled
the
greater
the
risk
that
the
world
finds
itself
short
of
supply
and
prices
have
to
rise
to
a
level
to
once
again
ration
demand.
Long
term
projects
cannot
be
cranked
up
overnight.
A
recently
published
report
by
analysts
Wood
Mackenzie
estimated
that
$200
billion
worth
of
oil
and
gas
projects
have
now
been
shelved
globally.
That
is
up
from
$135
billion
in
May
and
this
during
a
period
when
deferred
futures
prices
were
20
percent
higher
than
they
are
now.
We
have
said
previously
that
price
cures
price
because
of
its
effect
on
supply
and
demand.
The
demand
side
of
the
equation
has
certainly
performed
with
year
over
year
demand
growth
running
at
close
to
2
million
bpd
so
far
this
year.
However,
as
yet,
there
is
little
evidence
of
a
slowdown
in
supply
above
all
in
the
U.S.
-
despite
the
massive
fall
in
rig
counts.
Because
of
this
there
is
much
debate
about
the
resiliency
of
U.S.
production
in
the
face
of
lower
prices.
The
fact
that
rig
counts
stopped
falling
and
even
rose
modestly
in
July
has
been
cited
as
evidence
that
the
industry
can
survive
and
even
prosper
in
a
low
price
environment.
We
think
that
the
results
being
announced
by
the
exploration
and
production
companies
for
Q2
are
hardly
reflective
of
an
industry
that
is
flourishing.
Prices
in
Q3
look
like
they
will
be
much
lower
than
they
were
in
Q2.
Meanwhile
hedges
set
at
much
higher
levels
are
rolling
off.
High
grading,
squeezing
suppliers
and
exploiting
efficiencies
can
help
but
they
are
strategies
for
survival
that
can
only
be
taken
so
far
and
are
not
a
recipe
for
sustained
growth.
However,
with
the
current
sour
mood
in
the
oil
market,
it
will
take
hard
evidence
that
supply
is
rolling
over
for
prices
to
stage
a
recovery
and,
as
noted
above,
it
hasnt
happened
yet.
One
of
the
problems
is
data
availability.
Here
in
America
we
still
dont
really
know
how
much
oil
was
produced
six
months
ago.
Final
data
for
May
was
released
at
the
end
of
July
but
will
be
subject
to
revision
for
months
(if
not
years)
to
come.
The
much
vaunted
weekly
production
data
published
by
the
EIA
is
simply
a
projection
based
on
the
most
recent
monthly
data
now
May
-
which
itself
is
likely
to
change
over
time.
Data
5
connoisseurs
prefer
to
look
at
the
adjusted
or
implied
weekly
production
for
guidance
this
is
the
sum
of
the
(projected)
production
and
the
balancing
item
that
the
EIA
calculates
to
equate
their
projection
of
production
with
observed
changes
in
inventories,
refinery
runs
and
net
crude
oil
imports.
Although
it
has
recently
been
very
volatile,
adjusted
production
does
appear
to
be
rolling
over.
Pessimism
in
the
oil
market
is
currently
at
extreme
levels
as
reflected
by
speculative
positioning.
The
ratio
of
longs
to
shorts
is
at
a
historically
low
level.
Producers
cannot
hedge
profitably
at
current
prices
so
they
will
not
be
selling.
Indeed
they
should
be
persistent
buyers
as
they
buy
back
existing
hedges
as
production
is
sold.
Furthermore,
if
we
are
right
about
crude
oil
inventories
falling
through
the
balance
of
the
year,
inventory
hedges
will
also
have
to
be
bought
back.
But
for
a
sustained
recovery
the
market
will
need
to
see
evidence
that
low
prices
really
are
impacting
supply
and
that
physical
oil
balances
are
beginning
to
improve.
We
believe
that
is
coming.
There
could
be
other
catalysts
obviously
any
sort
of
supply
disruption
would
bring
in
buyers.
Its
also
not
beyond
the
realm
of
reason
that
core
OPEC
could
revisit
their
current
policy.
Saudi
Arabia
and
Kuwait
both
recently
announced
bond
issues
to
cover
expenditure
deficits
and
the
UAE
is
eliminating
fuel
subsidies
as
it
tries
to
staunch
the
burn
of
its
foreign
currency
reserves
reportedly
down
by
almost
half
since
the
start
of
the
year.
The
hint
of
an
OPEC
policy
change
in
August
of
1986
was
sufficient
to
cause
prices
to
rally
50
percent
in
24
hours.
The
recent
fall
in
oil
prices
was
preceded
by
a
fall
in
oil
equity
prices
which
have
now
made
new
lows
for
this
cycle.
Valuations
for
the
oil
majors
relative
to
the
broader
market
are
at
35
year
lows.
Prices
for
the
equities
of
the
E
and
P
companies
have
fallen
30
percent
on
average
from
the
recent
high
in
May.
The
market
has
abandoned
its
expectation
of
a
V-
shaped
recovery
to
$70+
WTI
and
reflects
an
expectation
of
lower
prices
for
longer
in
line
with
the
futures
strip
which
is
below
$60
all
the
way
to
2018.
It
is
certainly
the
case
that
companies
are
hurting
at
current
prices
especially
those
with
weaker
balance
sheets,
less
good
acreage
or
low
levels
of
hedges
in
place.
Chesapeakes
suspension
of
its
dividend
speaks
to
the
stress
being
experienced
across
the
sector.
There
has
already
been
a
flurry
of
recently
announced
bankruptcies
among
smaller
producers
and
more
will
likely
follow.
It
is
hard
to
reconcile
the
distress
in
the
sector
with
predictions
that
shale
production
can
be
maintained
and
even
grown
at
current
prices.
Turning
now
to
metals
these
have
been
hit
by
the
growing
expectation
of
a
rate
rise
by
the
Fed
in
September.
Gold
has
broken
through
key
support
levels
and
dragged
the
PGMs
with
it.
However,
there
has
been
no
change
in
the
supply
and
demand
fundamentals
which
remain
in
prolonged
deficit.
Current
prices
are
deep
into
the
cost
curve
for
the
South
African
producers
with
much
production
uneconomic.
Short
positioning
in
PGMs
is
at
an
extreme
which
raises
the
potential
for
a
sharp
recovery
in
prices.
Best
regards
Andrew
J.
Hall
Chairman
and
CEO
6
*
It
is
also
worth
noting
that
of
the
current
total
oil
surplus
inventory