Hard Assets Investor: The author of ‘Oil’s Endless Bid’ provides his insight on the recent gyrations in the oil market.
Mike Norman (Norman): Hello everybody, and welcome to HardAssetsInvestor.com. I’m Mike Norman, your host. My guest today is Dan Dicker, author of “Oil’s Endless Bid,” returning to the program. Dan, thanks a lot for coming back on.
Dan Dicker, author, “Oil’s Endless Bid” (Dicker): Well thanks for having me Mike.
Norman: I really wanted to have you on because of the gyrations we’ve seen recently in the oil markets. I think the last time you were back here we were up near recent multiyear highs, at, I think, around $114 a barrel.
Dicker: In WTI.
Norman: Right, in WTI.
Dicker: And Brent, it was $15 higher, $131 or $132.
Norman: Right. And then, we’ve seen a pretty decent pullback, back down to almost, I guess, in the low $90s on WTI. The market seems to be stabilizing. Now recently, we heard some talk out of Saudi Arabia. The Saudis threatened that they were going to raise their daily production up to 10 million barrels per day in July. Now that level—if they were to actually achieve that—we haven’t seen. You have to go back to the early 1980s. And I still think it was probably just a little bit under that. That would be a very high level of output for Saudi Arabia. Do you take that as a credible threat?
Dicker: Well first, let’s go back to the early 1980s. Remember that global demand was about 20 million barrels a day less then than it is now. So, in fact, getting to those levels, that 10-million-barrel-a-day threshold is not really as significant, for example, as what was being pumped by the Saudis in the ’80s. So that’s No. 1.
The second part of the question …
Norman: But it would represent probably an additional million and a half barrels a day to current production.
Dicker: Easily from the Saudis. The second part of your question refers to whether this is to be believed, or what the Saudis are actually planning. And to me, it’s all a load of hooey. I mean, the Kabuki theater that we saw in Vienna two weeks ago …
Norman: … at the OPEC meeting …
Dicker: … at the OPEC meetings, exactly, where there was a big story running around that was actually leaked before the meetings began, that all of the members were ready to agree to production quota increases. And then, in fact, you’ve got this wonderful little theater, a game, a parlor game that went on when Naimi kind of runs around Vienna, and the CNBC anchors kind of follow him around, and ask him questions. And he’s all cute and happy.
And then, as the meeting breaks up, the Iranian and the Venezuelan ministers come flying out of the room in anger. And they run into their cars, and they speed away. And Naimi comes out and describes the meeting as the worst they have ever had. Now, this is, to me …
Norman: …all predictable …
Dicker: … all entirely predictable. In fact, the markets predicted that they were rallying throughout the meeting, despite the fact they were talking about production quota increases.
Norman: But it was a good short to sell into that at the time.
Dicker: It was an excellent short, for the reason that, I think, this is the last time that OPEC may be able to get away with these kinds of theater productions on meetings where quotas, in fact, are never adhered to anyway.
Dicker: We have a demand picture of about 87 or 88 million barrels a day, depending on who you talk to. But, what is being pumped out, or at least what is being registered as pumped out, is about 81-82 million. Where’s the other stuff coming from?
Norman: But it’s always been the case …
Dicker: … always …
Norman: … that the other members of OPEC, outside of the Saudis, have always cheated and produced at their maximum capacity. And they’ve left it up to the Saudis to be the swing producer, to adjust production either up or down. I’ve heard that the Saudis have maybe an additional 4 million barrels a day of excess capacity.
Dicker: That’s about right, depending on who you talk to. Some oil analysts will tell you that the swing barrels— what they talk about as spare capacity inside OPEC, and specifically Saudi Arabia—is anywhere from 3 to 5 million barrels. Now, one of the things that came up over the last couple of months was this loss of production from Libya, and the specific promise from Saudi Arabia to replace that production into the global marketplace. Now, that didn’t happen.
Norman: No, not completely. OK.
Dicker: No. And, in fact, not even partially. And, from what we can tell, very little more Saudi increase came on the back of the Libyan disruption. In this case, where we had this OPEC kind of meeting fall apart, and then everybody screaming about how terrible everything is. And then the Saudis saying they’re going to increase production and take up the slack, in terms of global demand, again, I think it’s going to be one of those things where they promise much and deliver little.
This is, to me—as much as people want to guess about the OPEC cartel falling apart—part of the theater, the production that they continue to do, to try and keep prices as high as they possibly can, so their members stay as happy as they possibly can.
Norman: And you could look at it, I think, as really a battle going on between the Saudis on the one hand, and Iran. And I think the Saudis are very concerned and worried about Iranian influence in the region, perhaps Iran getting a nuke. And the Saudis maybe see it as that they have some ability to inflict some pain on Iran through the oil price, through an economic channel, if you will.
And we’ve heard talk of the Saudis wanting oil in the $70 to $80 a barrel range. If they want to, it’s feasible that they could put it there. They do set prices at the margin, by virtue of that spare capacity that they have.
Dicker: Look, they haven’t touched quotas since 2008, when, obviously, we had the enormous deleveraging in the oil market, and oil fell into the $30s. And that’s when they readjusted, obviously, down the quotas in terms of what’s being pumped.
Again, these quotas are nothing. They’re really just a theater trick. They’re a parlor game in order to give some idea to some of the analysts of what exactly is going to come out. Now the Saudis, I think … you’re right: They have a desire to be a little more conservative, a little more Western-thinking, in terms of the oil market, in terms of providing the kind of supply that might keep the price from rocketing again into the $140-$150 …
Now, the Saudis, obviously, don’t want to see that happen all so fast, even if they think it’s inevitable. And one of the things that will make that obviously move with some acceleration is with oil prices at $150 a barrel, as opposed to hovering around $95 or even better, for the Saudis, around $85.
Norman: You and I were discussing how the benchmark in crude had always been WTI, the U.S. contract. But now we’re starting to see a shift towards Brent. And you were mentioning that a lot of the big Wall Street firms, now, if they put out a recommendation on oil, it’s based on the Brent price. We’re starting to see more trading move towards Brent. And, in fact, the Brent WTI spread now has really been blowing out. Is this a temporary thing? Is this like something we should come to expect?
Dicker: People should first understand how ridiculous, from a physical point of view, it is for the Brent benchmark that’s traded on the ICE and cleared in London, compared to our WTI, which is traded at the NYMEX part of the CME and cleared here and comes out of Cushing, Oklahoma.
Norman: Ridiculous in what aspect?
Dicker: Here is the point. The grade of WTI is what’s called a sweet grade of crude. So is Brent. But the West Texas Intermediate sweet grade is a lot easier to be refined than the Brent product is. And, therefore, it’s usually more expensive, because it’s an easier product to use for refineries to turn into gasoline and heating oil, jet fuel and all the other byproducts that we get from crude oil.
Now, to see a price of Brent go over WTI, even a little bit, is usually a financial disconnect that we used to see when we were trading it very, very infrequently. But it used to happen: Somebody got stuck on a position or spreads; there could have been a physical problem in one of the markets that could cause something like that.
To see a long-term trend of Brent $10, $15, $20 over West Texas intermediate, is more than just a run-of-the-mill financial disconnect. This is, to me, one of the most striking examples of where all the speculative money, and all the interest in crude oil, is going, and what it is, and how it’s feeding into Brent and out of WTI.
Now the reconnaissance on that, if I can go back for a second, is with Goldman Sachs at the start of this year, in 2011, deciding that they were going to take their benchmark product for crude, crude index speculation, called the GSCI, and move it from WTI, and move it into the Brent contract.
So they call that a rebalancing. I call it shifting where all the speculative money goes. So there is a rebalancing of the largest commodity index in the world, from WTI into Brent, No. 1. And then you find that, over the course of the last several months, when recommendations come out from Paribas, from Goldman Sachs, from Morgan Stanley, from JP Morgan—from everybody, basically, who trades oil for a living and gives out recommendations to clients—is in that Brent contract in the long run, WTI.
Now, there are some physical constraints on WTI on the pushing side, there is no doubt about it. But those physical constraints do not equate to a $20 differential between something that should be cheap.
Norman: Let me ask you, could it also have anything to do with regulation or expected regulation that U.S. contracts coming under the regulatory of the CFTC … ?
Dicker: Absolutely. That’s one of the reasons that Goldman moves to rebalance into Brent, because they know, from their own experiences, with Dodd-Frank and some of the prop trading in other desks, how regulation might impact their trading in this. And they are trying to avoid that kind of problem down the road, although it’s not there yet, obviously, for their clients and for themselves, in terms of crude oil trading. And so, they’re moving into a contract cleared in London, outside the United States, where there might be less effect on regulation down the road.
Norman: Oh, I just want to get, quickly, your outlook for oil for the rest of this year. Where do you think we’ll hit?
Dicker: Well, I think we’re on the bottom. We’re on the back end of one of the mini booms that we saw, up to, you know, $113 in WTI, $130-whatever in the Brent. I think that the summer is going to require a little settling back. But, what happens is that we create a higher low than we had in 2010. In 2010, we got down to $68. This low—I see it somewhere between $82 and $87. And that’s going to be the silver lining of this soft patch that we’re going …
Norman: Yeah, they said an oil price collapse. And we’re talking $90.
Dicker: But we’re talking about a higher low again. And again, what you have is you make one of these higher lows, then when the next leg up comes … which I believe doesn’t start until the fourth quarter in ’11 and into ’12 … that next spike up doesn’t go to $130, it goes to $150 or $160.
Dicker: And we’re back where we started.
Norman: All right, good stuff, but probably scary stuff for the economy.
Norman: Dan Dicker, thank you very much. Dan Dicker, author of “Oil’s Endless Bid.” This is Mike Norman. That’s it for now. We’ll see you next time. Take care. Bye-bye.
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