One year ago, when oil was trading in the mid-$50s, and when MarketWatch released an article saying "Now’s time to consider energy stocks: Goldman Sachs, Morgan Stanley" (from December 15), we took the other side and on January 29 we explained why "Either Oil Soars Back To $88, Or Energy Stocks Have To Tumble By Over 40%."
Oil stocks did indeed slide, if not as much as we expected, although out other forecast was virtually spot on: we said that the implied price of oil one year out would tumble by over $14 to just $36/barrel. This is precisely where oil closed the year: at the lows (and at $36/barrel), despite the daily protests of hundreds of so-called experts who took every opportunity to tell the world they are using other people's money to BTFD, and daily called for "imminent bounce" in oil prices. Simply said, dogmatism at its worst.
One person who admits their "dogmatic views" cost them dearly, was Hayman Capital's Kyle Bass, who in an interview to be aired tomorrow on Wall Street Week, says that "this has been one of the worst years in the last ten."
And yet, even though his expectations for a rebound in energy prices in 2015 did not materialize, Bass is doubling down and told Gary Kaminsky that there is a "massive opportunity in energy." He explains his optimism as follows:
The margin of safety for the globe is the smallest it's ever been in energy: global demand is 96 million barrels per day, the highest it's ever been, and incremental supply capacity, or swing capacity, is at the lowest point of that, about a million and a half barrels a day.
He notes that very little marginal production has come offline, with US production declining by just 400k barrels per day from 9.6 million bpd to 9.2 million bpd. Of course, the wildcard in Bass' forecast is that demand will remain in an uptrend based on his assumption that "global GDP will still be positive."
Alas, that is only the case when denominating GDP in local currencies, something which for a USD-denominated asset (which is where the collapsing price problem stems from in the first place) like oil, and energy in general, is meaningless. As we have shown before, in USD terms the global economy shrank by just about $3 trillion in 2015, and as Deutsche Bank added, this was the worst dollar-denominated GDP recession in 50 years!
Macroeconomics aside, Bass' thesis about the virtually non-existent margin of error at the, well, margin is the following:
"The U.S. added a million barrels a day five years in a row, but it took $100 crude for us to do that. We were the marginal swing producer for the world. And now we're going to go down a million barrels a day, I think, in the next 12 months. So, we're going to go from a glut to all of a sudden a deficit. And the world's not ready for a deficit."
Once again correct, but once again incomplete: recall "I Know Of No One Who Predicted This": Russian Oil Production Hits Record As Saudi Gambit Fails", in which we showed how as US shale became less important as the world's marginal source of oil, it was none other than Russia who is aggressively stepping in to fill the US shale void.
This morning Reuters reminds us of just that: "Oil output in Russia, one of the world's largest producers, hit a post-Soviet high last month and in 2015 as small- and medium-sized energy companies cranked up the pumps despite falling crude prices, Energy Ministry data showed on Saturday. The rise shows producers are taking advantage of lower costs due to rouble devaluation and signals Moscow's resolve not to give in to producer group OPEC's request to curb oil output to support prices."
In other words, anyone hoping that there is a small margin of error when it comes to incremental supply will likely be very unpleasantly surprised in 2015.
Which brings us to Kyle Bass' best investment idea for the medium-term: "If you are going to allocate capital for the next three to five years, you should do it now" into the energy space over the next 6 months.
Bass is agnostic as to what subsector of energy one should invest in: whether it is infrastructure, pipelines, producers, upstream, downstream, he believes that there are places in the cap structure of each of these where once can put new capital and generate substantial returns.
Bass' summary is that the energy rebound, when it happens, will be comparable to the housing rebound post 2009... which, we would like to remind readers, has not nearly as "strong" as many wish to make it appear, and was driven by three core pillars: a shortage of inventory (due to the foreclosure scandal of 2010 which plugged the REO pipeline for years), foreign capital and Wall Street investment in distressed properties. For everyone else it has been largely a wash.
As to whether Bass will be correct this year, or whether he will suffer another "worst in ten years" performance over the next 12 months, tune in in one year to find out.
Excerpted interview below: