Andy Hall’s Take on Shale Oil and Orbital Insight on Bloomberg’s Commodities Edge (Part 2)
Andy Hall and Kevin O’Brien discuss the shale oil market and leveraging new data sources like Orbital Insight. Check out some of our findings on Bloomberg’s Commodities Edge with Alix Steel. This is part 2 of their discussion (Video above and transcript below.)
Alix Steel: I’m Alix Steel and this is Bloomberg Commodities Edge. This week we saw the first victim of lower oil prices. Parker Drilling, the company filed for Chapter 11 in Texas. Are we at that breaking point for U.S. shale producers? Andy Hall and Kevin O’Brien still with me here on set. So, the chart I want to bring up shows what you were just talking about Andy, which is the discrepancy between say, EIA forecasts for production in shale versus the reality. And there is a big difference. How does that, how do you follow that? And what does that wind up looking like going forward? What does that number look like going forward?
Kevin O’Brien: The big delta that you have here, Alix, is that you have the EIA come out with actual numbers and then they’ll do the initial release, then they’ll do a revision and do a second revision off of that. So, you immediately have up to a seven-day lag. Then you could have revisions coming out 30 days or even 45 days later. Imagine that if you were an equity trader. Trying to be able to kind of put your trades on and do your research, do your analysis, do your risk mitigation with latency like that. That’s what’s been happening in the oil market and you’re seeing that with shale as well.
Kevin O’Brien: So, what we think is going to be happening is that compression. To be able to say, you look at a release from EIA, you can also come in and look at some of the information that we’re releasing on a daily basis, to have just better decision making going off from what’s coming in. You don’t have so much guesswork going into, whether it’s in shale, whether it’s in oil, globally. Then you merge those two together to get a tighter thesis to actually put capital at risk. It’s one of the things we’ve had a number of clients come to us. Just say “I don’t have confidence in what I’m seeing coming from these government organizations. Zandi mentioned, the U.S. has pretty good disclosure, but it’s survey based. So, again, you have that natural latency effect and then it’s revised and then it’s revised again. Then, when you go outside of the other markets to see what that supply and demand will be coming from the OPEC or China, that’s where it gets really difficult to actually act upon.
Alix Steel: Also, what was interesting too, is that even the big banks and their forecasts. They were just blindsided by how much shale actually grew in August and September. Universally, all of them. First of all, Andy, how do you deal with that? How do you manage it and when you look at prices at 50 or even at 60, what’s your view for the production in the U.S.?
Andy Hall: Again, that’s one of the big imponderables.
Alix Steel: The second $64,000 question.
Andy Hall: Yeah. The range of forecasts of U.S. oil production is quite remarkable. I think everyone is groping. There are a lot of variables here that we don’t really have a good handle on. How do shale oil operators respond to lower prices? Are they going to drill within their cash flows? And then what are those cash flows going to be? They’re a function of well productivity, rig productivity, and again we don’t really have good handles on that. A lot of the data is either anecdotal or it’s only produced with very significant lags. The biggest producing state in America is Texas. Data from Texas is published by the Texas Railroad Commission, but it comes out with a lag of a month or two months, and then that data is subject to huge revisions going on for the next six to twelve months.
Andy Hall: So, we’re trying to forecast the future based on today’s data. But, actually, we don’t have today’s data. We’re basing our view of the future on data that actually is maybe six or twelve months out of date.
Alix Steel: So then using the data you get from Kevin, how do you make a longer-term view?
Andy Hall: Well that’s… that’s the thing. That’s what’s so, to me anyway, is so intriguing about what Orbital Insight is doing. Because they are looking at the world in real time and that allows one to make much more precise and confident predictions about the future. You’re not relying on data that’s already out of date.
Alix Steel: So what do you think the oil producers will then do?
Andy Hall: What do I? Well, talking about the shale oil producers, I think, they indicate that at $50 a barrel that’s where the brakes start going on. Even when oil prices were over $70 a barrel, they weren’t actually adding rigs. The rig count stayed pretty flat. When you look at the financial returns in the aggregate, they were nothing to write home about. The oil industry, as a whole, there was an article in the Financial Times, based on Bloomberg data, recently-
Alix Steel: Thank you for the plug.
Andy Hall: Yep. It showed that, in the aggregate, the oil industry had barely positive cash flow in the third quarter, and that’s with oil prices, you know, $75, $85 a barrel.
Alix Steel: So, Kevin, where do you sit?
Kevin O’Brien: Just listening to what Andy said, which is fascinating, if you think about, we’ve talked about oil, we talked about OPEC, we talked about the U.S., but if you’re a Shell operator in Odessa or Midland, you also want to know what’s going on inside of OPEC and these other markets, because that’s going to impact some of your decisions. How much you’re going to be drilling, how much you’re not going to be drilling, what do you think the actual price is going to be? We do feel again this discovery aspect of looking at different parts of the marketplace, it’s going to benefit a lot of different folks. For us, we’re actually going deeper now into the supply chain, that we’re looking at both oil storage but then going into fracking monitoring as well.
Alix Steel: What does that mean?
Kevin O’Brien: Well, to be able to go into look at different fracking locations across west Texas, in the Bakken, in North Dakota, to look at, has this ground actually been disturbed? Is it being prepped for drilling? Are we seeing an increase of activity on those actual locations to indicate drilling is actually happening or is completing? But to be able to do that at scale, synthesize that into more distilled data that can be delivered down directly next to some of the oil storage data.
Alix Steel: First of all, that’s pretty amazing. Second of all, what are you noticing? What’s the takeaway? Are they drilling more? Are they drilling less? Are they keeping the same? What do you see?
Kevin O’Brien: We’re seeing a slowdown in terms of the actual activity on new rigs going up. So you’ve got the actual leases have been taken, the locations are there, but you’re not… the land is ready, the locations are ready, but you’re not seeing the highest level increase that you’ve seen previously.
Alix Steel: Interesting.
Kevin O’Brien: There may be a temporary situation. But again, do you take that situation to go ahead and hit that drill and go, it’s going to be based on some of these other market factors. And again, when we think we can make that full circle, you’re going to have tighter decision making going on.
Alix Steel: Which is a, like, a totally different world, Andy, that you basically traded in for thirty years. Now, it’s OPEC cuts, prices go higher, shale production goes up, prices go down.
Kevin O’Brien: It’s all connected.
Alix Steel: It’s all connected. It’s very different than when you were trading.
Andy Hall: Yeah. Well what’s changed, I think, in the past five or ten years is both oil supply and oil demand have become more price elastic. It used to be on the supply side of the equation, you could predict, with some confidence, what future supply was going to be, outside of global political events. Oil projects were planned five, or even ten years, in the future. And once the decision had been made to go ahead with that investment, it was going to go ahead, it was a sunk cost, it was not going to change as a consequence of changing prices.
Andy Hall: Today, the vast majority of growth in oil production is coming from shale oil and that is price responsive. It’s a result of thousands of smaller decisions to drill or not to drill another well. We don’t really know what that functionality is. What that decision-making process is. How sensitive drilling operators are to changes in prices. It’s much harder to model.
Andy Hall: And then on the demand side of the equation, many markets that used to be insulated from changes in prices because of government price controls, that’s no longer the case. Those price controls have been removed. As a consequence of that, demand is more price elastic. So, for example, we’ve seen prices fall over the past couple of months by 30% and undoubtedly, there will be a response in demand, because of that fall in prices. Because of end-user consumption, but also, as Kevin noted earlier, the Chinese in particular stockpile opportunistically. As prices fall, they tend to accelerate purchases for their strategic oil reserve. So all of those things come into play. They make it much harder to gauge what the future supply/demand balance is going to be. Whether we’re going to have a deficit or a surplus. Whether inventories are going to rise, or whether they’re going to fall.
Alix Steel: Just to recap here, we are here with Andy Hall, legend oil investor, and Kevin O’Brien of Orbital Insights. Basically, provides real-time data for inventories across the globe.
Alix Steel: In theory, that creates a whippy market. As a trader, did you like a whippy market?
Andy Hall: No, not so much. I knew the sort of generally received wisdom is that volatility is great for trading. I’m not sure that’s really true. Traders, at least in my experience and maybe this shows my age-
Alix Steel: You can say experience.
Andy Hall: Whatever. But I think traders, like me anyway, prefer trending markets, you know, troughy, noisy markets. When all is said and done, I don’t know whether people really make money in them.
Alix Steel: So using that data to… what I hear is A) We’re going to continue to see bottlenecks in the U.S., there’s going to be rolling bottlenecks. Then the bottlenecks going to move maybe a little bit to Eagle Ford because we had more production coming out. Maybe then also to U.S. gulf coast for exports. Are you noticing any other types of bottleneck issues and inventory increases in specific basins as of now?
Kevin O’Brien: We’re not specifically getting down to that level yet. We are looking at advancing some of our research down into exports specifically. We’re also doing some early work at looking at refinery activity. Which is another, what Andy was saying, which is spot on, is that when you get visibility into supply, if you can get visibility into demand, then you’re really bridging that gap and reducing volatility and uncertainty and being able to deploy CAPEX faster. So, we’re looking at, basically, looking at refineries all the United States and the world to see, are their disruptions at that refinery. Because you’ve actually seen markets have wild swings, like you said, from the volatility, because of lack of visibility into that part of the supply chain.
Kevin O’Brien: And then also we’re looking at going deeper into the demand side by looking at things like monitoring 136 thousand gas stations across the United States, to see, are you having an uptick or decline in activity at those locations.
Kevin O’Brien: So it’s just more of the pieces of the puzzle when pulling them together from both supply and then getting into demand. We think it’s just going to, again, reduce that lack of transparency and visibility and provide more confidence for people to either trade or invest, hedge their risk and those areas.
Alix Steel: I want to end on kind of how the world has changed in terms of actual trading, but before I get there, I just want to get your, just one sentence on the Permian. Like, how transformative is it going to be? How do you look at something like the Permian?
Andy Hall: Well, I think it’s already been transformative. I said earlier how production growth here in the U.S. has exceeded virtually everybody’s expectations this year. You know, running year over year, 2 million barrels a day and a big chunk of that is obviously the Permian. It’s a huge resource. It’s like this layer cake of benches of potential production. It is a unique natural resource.
Alix Steel: Do you think that’s going to continue? That ability?
Andy Hall: Again, the third $64,000 question.
Alix Steel: So what are we now? You’re good at math past 28 to 30.
Andy Hall: But, you know, that’s what everyone keeps asking. And one of the key variables, for me, is well productivity and rig productivity. These have continued to grow and the question is how long can they continue to grow? It’s a big resource, but it’s not limitless.
Alix Steel: So, let’s move to the change in trading. I have a great chart that comes with CFTC that shows the change in trading on a person to person basis versus automation to automation basis. The man to man is the blue line and the white line is automated trading systems services and if you just look at the end of there, you’ve seen a real uptick in automation. Algos. Quants. I feel like that’s the easy thing to blame when prices get out of bed. Andy, how does that change your world?
Andy Hall: Well, it obviously changes it in a big way. There’s a lot of money that obviously is being invested in the market, based on algorithms. A lot of these things tend to be self-fulfilling. A lot of the models use the same underlying equations or ideas, so there’s a certain self-replication or self-fulfilling nature to these things. Then that can continue for a long time until reality catches up and, ultimately, I remain a fundamentalist. I mean, ultimately oil prices are determined by fundamentals. But in the shorter term, the can detach because of money flows which are being driven by anything other than fundamentals. I think it was Caine’s who once said, or someone once said, that the market can stay irrational longer than you can stay liquid, or solvent. And that is one of the problems you have to face these days.
Alix Steel: Do you ever regret having to shut down the fund? Close it up?
Andy Hall: No. I mean, I think, I didn’t want to go to my grave trading oil.
Alix Steel: But you’re still doing it!
Andy Hall: Yeah, but it’s, it’s not the same responsibility or the same pressure, doing it for yourself as doing it when you’re investing other people’s money. There are other things to do in life, then worry about the price of oil.
Alix Steel: So, Kevin, as you go forward, what do you think going to be the biggest thing that you’re looking at in your business that’s going to be the biggest provider of stabilization oil prices? Product storage? Refinery automation like you mentioned? What’s going to be the thing that people are going to need to have?
Kevin O’Brien: So I think that just going back to Andy’s point, in terms of some of the quantitative aspects was that I’ve been selling to quant asset managers for years, and the way that I look at this is, even some of the data we’re providing are new fundamental factors. I think the more that you can have. The more accurate, precise, transparent fundamental factors that may go into different types of Standard models or Risk Guard models, that’ll lower some of the volatility in those particular areas of trading. I think that, in regards to what we plan to do. Again, if only to simplify things, of connecting those dots. I think the further that we can provide better transparency to the Andy Halls of the world. Whether it’s base oil supply, whether it’s refined product supply, refinery activity, demand activity and then tightly link that together to provide whether it’s an operator in Midland, TX or a trader here on Wall Street, or someone in an overseas market, that same type of data, the same time of precision, the same type of accuracy and timeliness. I just think it’s going to lead to less volatility and better decision making across the board. Whether it’s coming out of OPEC, out of China, out of the United States. But I think there’s a lot of upside and a lot of opportunities to gain from that and to hedge an exposure that folks may not see.
Alix Steel: Such a pleasure. We tackled $192,000 questions. That’s how high. I did the calculations when you were talking. It was really great to spend time with both of you. Thank you very much.
Alix Steel: Andy Hall and Kevin O’Brien, Chief Business Officer at Orbital Insight. Great conversation.
Alix Steel: That does it for Bloomberg Commodities Edge, catch up every week on Thursday at one.