Understanding Volatility in Oil Prices

In this episode of Industry Focus: Energy, Nick Sciple and energy investor Tracy Shuchart (@chigrl on Twitter) do a deep dive into the oil and gas industry. Their conversation covers a wide swath of the oil and gas market, from an impending wall of debt facing shale producers, to how the ongoing coronavirus epidemic could affect oil demand, and more.

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This video was recorded on Feb. 5, 2020.

Nick Sciple: Welcome to Industry Focus. I'm Nick Sciple. We've got a great show for you today. Last week, I sat down with Tracy Shuchart to chat about the current state of the oil and gas market. Tracy manages an energy portfolio for The Family Office and has built a large following through her @chigrl account on Twitter, where I first encountered her work. Our conversation covers a wide swath of the oil and gas market, from an impending wall of debt facing shale producers, to how the ongoing coronavirus epidemic could impact oil demand and more. We hope you'll enjoy our conversation.

Tracy, welcome to the podcast!

Tracy Shuchart: Well, thank you for having me!

Sciple: Thanks for coming on! Just before we dive into the oil markets and in energy markets more broadly, I'd just like to talk about you and your background. You've kind of had an unconventional path to the oil markets and energy markets, can you talk about that.

Shuchart: Yeah. This is actually my second career. I actually started in medical device industry and I didn't like my job anymore and I literally quit. I moved to Chicago to get into this industry and I started at the Board of Trade. And literally, at the time there weren't a lot of women in the industry. So, I just went knocking on doors until I got a job in a boiler room hawking energy or hawking options on futures, literally calling 400 people a day. And kind of just work my way up from there. Then from there, I moved on to the floor, then I moved into private equity, and then to my current position at The Family Office.

Sciple: Yeah. And what drew you to oil specifically as the market that you really wanted to focus on and dive into?

Shuchart: I had studied Middle East politics in college and it always had interest me. And to be honest, my very first winning trade was in oil. So, it just kind of stuck.

Sciple: I hear you. That kind of happened with me, when it came to getting into stocks, found The Motley Fool, and here's where I am today. When you talk about trading oil and that sort of thing, you're kind of in the business of predicting changes in oil prices. So, just from a high-level, why do oil prices move up-and-down, why do they change?

Shuchart: There's so many factors that go into the oil industry in itself. There's obviously the commercials that are playing the market that are generally hedging themselves, there's the fund managers that have a position in the oil market. So, the players within the oil market are obviously changing. Which is also separate from supply and demand, of course, we have supply and demand issues, right. We have, whether OPEC is cutting or not, how much U.S. is producing? And then you also have this geopolitical aspect of it. Is there a war in the Middle East? Is there a tanker on fire? Is somebody shooting at Aramco facilities? So, there's all kinds of things that happen on a daily basis that are moving this market around.

Sciple: Yeah. And I think when you lay out all those different factors affecting the market geopolitical, supply and demand, as somebody who pays attention to this market, how do you decide what's important to pay attention to and what to ignore? You know we looked at those attacks in Saudi Arabia, four, five months ago and the price spiked up quickly but then really fizzled out after a couple of weeks. How do you decide what matters and what doesn't?

Shuchart: Up here, I'm not a day trader, I'm a positions trader or a swing trader. So, kind of an intraday move. So, if there's a tanker fire or something like that and the market goes bust, that doesn't really change my perspective on direction. When things happen -- that are big news, like, $10. When Aramco happened, you know, you just have to start gathering information. I just started gathering information, what's offline, what's online, where are people positioned? Are people [...] going to reshort? We just have to go through all of those questions and all of those things and wait for more information to come out, so that you can make a decision on whether, do I think oil prices are going to continue moving higher or do I think that this is just an overreaction to something that happened in the market.

Sciple: Yeah, so you just have suss out those factors at play?

Shuchart: Unfortunately, there's no equation for doing it. It's really about gathering information and deciding where you already think the market is headed.

Sciple: Sure. And as we talk about where the market is headed and gathering information, let's talk about some subsectors of the energy market. I think the big one everybody talks about today is shale. Obviously, this huge technological evolution in the oil and gas industry in North America has rocketed the USA to the number one oil producer in the world. As you look back over this decade, how has the market changed with the onset of shale and what should we be paying attention to there?

Shuchart: Well, there are several factors in that involved. You have to realize that there's different kinds of crude qualities, which people tend to forget. Yes, we can be energy independent, no we can't be energy independent, why? Because all of our crude is light crude. Basically, all you can get out of a barrel of light crude is gasoline. Well, you need other products too. So, we're always going to have to be an importer. With the onset of shales, it's great for the U.S. but at some point, you're going to have too much WTI in the market, because you're going to oversaturate the market. We're not the only country with light oil. Light oil comes from Nigeria, etc. It's a good boon for the United States, but again, you're going to have saturation level at some point.

Sciple: Absolutely. And I think if you look back at the history of this industry, there's been this explosion in production, but we have seen very little free cash flow, at least sustainable free cash flow over time. And I think we're starting to see that and you've written some on this, of some of those bills coming due, the debt that was taken out to grow production in the middle of the 2010 are starting to come due here in 2020. With this debt coming due, how is this going to affect these businesses, should we expect bankruptcies, insolvency in the industry?

Shuchart: Absolutely. I think you're going to see a lot more mergers and acquisitions, I think you're going to see a lot more bankruptcies. Since 2015 to 2019, there's been over 200 bankruptcies in the shale industry, in the giant growth years of this market. And that was before this debt wall is coming due, in 2020 and start tapering off again in, I would say, 2024, and then really start tapering off in 2027.

So, I definitely think that we're going to see a lot more pain right now in this industry as far as where companies are headed. We're still overproducing, no matter how you look at it. It's still kind of a wild cat industry. The problem is now that you just don't have -- first you had all the banks throwing money at them, right, that was like the initial shale boom. And then when we had the bust in 2014, banks said, "Forget it, we don't want to loan to you anymore." And the private equity guys were like, "Okay, we'll loan to you."

So, now all the private equity guys loaned to these people and they're still not able to pay their debt. And now they're facing this debt wall. So, they've kind of run out of options for people to throw money at them right now. So, that's also another reason why I think we should expect more bankruptcies and more mergers and acquisitions.

On the flipside, the good thing about it is, now we have Chevron and Exxon who have moved into the shale industry, so we kind of have some adults in the room now that can kind of handle the booms and busts of the shale industry, rather than these young guns that just came in there and started drilling. So, there is an upside. I think there's more pain ahead definitely for the industry but after that I think there will be a lot of opportunity.

Sciple: Sure. I think when we look at, at least the willingness to loan to these companies or to buy equity issuances from these companies, it's really starting to play out. And we're seeing that in companies starting to be more focused on delivering free cash flow, which puts pressure on CapEx. And when you look at the shale industry with the decline rates on these wells, the need to constantly pump additional CapEx into the business to continue growing production. As you see these bankruptcies, this wall of debt coming due in early 2020s, less willingness to lend to these companies. What effect do you think that's going to have on production in the shale oil patch in the next several years?

Shuchart: Well, exactly I think that we're going to see a decline, which is what we need to see, right. I think we'll see a decline in production which will then increase prices. Because really at these prices right now -- I mean, last year we were basically in a narrow $10 range all year, from $50 to $60 basically. And within that range, most of these guys are not making any money. And a couple of these guys are making money, and then there's a middle part that's barely breaking even. So, even at these prices, these guys aren't making money, so eventually it will play out that production will slow down, prices will move up, same cycle happens over again.

Sciple: Sure. And we're talking about, I think, predominantly so far, the E&P folks who are getting this oil and gas out of the ground. When you look at these bankruptcies that are coming down the line, how do you think about the impact on the midstream folks? I think we just saw this past week, one of the first bankruptcies, a private equity bankruptcy. And one of the primary drivers was getting out of these minimum volume commitments to midstream folks. So, when you look at the producers starting to have financial issues, what do you think about the contagion as it goes down the supply chain to the midstream and even the downstream refinery folks?

Shuchart: In the downstream. Yeah. Everything moves down, right? Downhill. So, it definitely will. Like I said, I just don't think that upstream, downstream, midstream, I think where it just -- as much as everything is sold off, you know all these -- there's just so many companies that are like at their low and everybody this year was like, "It's the year for oil, it's the year for oil." We kind of saw a lot of companies get a bit up at the beginning of the year, oil prices... After Aramco's announcement in November started creeping up, it was the reflation trade. Prices started going up, people are like, "Oh, yeah, let's invest in oil." And all that has reversed rather quickly. So, I think that was pre-emptive or a little early to get into some of these companies. I mean, there are companies out there that are worth bottom fishing, but you just kind of have to be careful on what you're choosing right now because I just don't see the bottom in yet.

Sciple: Yeah. When you say, the companies to look at, I think the independence obviously folks view is very threatened, you mentioned private equity is in trouble, these big integrated folks, would that be the place that you'd be looking to go if you had to jump in right now?

Shuchart: Yeah, I would. I would want something -- a major figure integrated, like, GXC, or any of the majors; except for XOM it doesn't look really great right now.

Sciple: Another question I had for you as you talk about the oversupply problems in the market; shale not being able to make money. This has been an environment where you look at Venezuela's production has come off the market really markedly, there's been issues in North Africa. And we've seen Russia and other folks start to get involved in Venezuela up their production back. As we see these other producers sort of come on the market, do you foresee that affecting shale in a meaningful way. How should we think about these other producers that have just been kind of under-producing the past several years for geopolitical and other reasons?

Shuchart: Right. So, Venezuela is very heavy crude. So, it's not really in the same category, it's not the same competition level. They're not competing for the same market is another word. And, of course, that's another thing, that's another good point, kind of veering off the question a little bit. But you have to look at the fact that oil prices are still depressed and we have Venezuela off the market, basically we have Iran -- a lot of its off the market, granted there's some on the black market. You have Libya now that just came off -- I mean there's a lot of places, right, there are a lot of reasons to be long oil here, but, what it looks like on the geopolitical level. But if you look closer into it, we've got a glut going on. And it's not a crude glut, it's the products glut. And that's the problem I think people are overlooking right now.

Sciple: Yeah. And for someone who isn't deeply familiar with this industry, can you unpack that distinction between a crude glut and a product glut and what it means?

Shuchart: So, you have crude oil, so we are producing crude oil. Now, generally what happens, China does this a lot, basically you overproduce. So, you overproduce and you have all this product on the market. And it looks like oil inventories are going down, they are going down, but then the products market is flooded, which means that eventually it becomes so flooded that the opposite happens, you can't refine anymore, right? And then that leads back to a crude glut. But you'll see that often. So, right now we have too much product swishing around that you need to get rid of that to be able to start refining again.

Sciple: And so, sooner or later that needs to move out on the market and then it affects the entire industry?

Shuchart: Yeah. I mean, it's all cyclical, you know.

Sciple: Again, on the geopolitical side, I think, we mentioned that prices have been kind of in this range for the past several years, during that time we've seen OPEC cut and cut and cut. It seems to me that OPEC's influence on the market is not the way it's been in the past. How do you assess the way OPEC's been able to influence the market and their influence as it is today?

Shuchart: Well, I think obviously their influence is a little bit less. I mean, you're always going to have Saudi Arabia as a strong producer, but with the onset of Russia production is way up, even though they are part of the OPEC pact, they have never hit quota. So, they say, "Yeah, yeah, we'll hit quota, we'll be OK." But they never do. So, you have as Saudi Arabia scale back, Russia is at a post-Soviet high right now; almost over 11 million barrels a day. And then you have the United States that went from, in 2008, 5 million barrels a day to 13 million barrels a day in 2019. So, we've had a rush of oil on the market. And OPEC itself can only cut back so much, right?

Sciple: Right. I mean, yeah, these were economies that are fundamentally dependent on oil and gas. You mentioned Saudi Arabia. It's another kind of a question geopolitically, how things are going to change. Last year the Saudi Aramco IPO, as you look at that company coming on to the market, do you expect that will change Saudi Arabia's policy when it comes to the oil market at all?

Shuchart: Not at all. What Saudi Arabia is now trying to do with their Vision 2020 plan is basically they want to transition their domestic market over to renewables, so that they can sell more of their oil. Which kind of gives you a hint that if they see that the world is maybe pulling away within the next 20, 30 years from the oil market, you kind of have to watch what they do now, what they say; if that makes sense. So, they're trying to transition their own domestic economy away from the oil markets, so they can sell more oil in the market, because they are predominantly oil dependent. That's another reason why they're trying to bring in tourism and things like that, because they know that they need to get money from somewhere else than just the oil industry.

Sciple: Sure. Changing topics again, I'm just kind of jumping around in different oil topics. Another topic that's been big over the last year, has been IMO 2020. This was built up as, where they're just changing the marine fuel standards for shipping tankers. Over time folks really expected this to show significant waves in the oil markets, as the calendar turned over though, what are we seeing as far as the effects of IMO 2020 on the energy market?

Shuchart: The surprise place where IMO 2020 is adding pressure to is the shipping industry because -- and for people that don't know -- IMO 2020 basically means that the entire marine shipping sector has to reduce sulfur emissions. And there are three ways that you can do this: You can install a new motor, which is very expensive for one to handle low sulfur fuel oil; you can install a motor that runs LNG over oil, which again is very expensive; or you can install a scrubber, which is again still expensive. So, all of these options have been very costly.

And rising fuel prices of low sulfur fuel, now are forcing shippers to pass this on to customers. So, that's creating a drag on world trade, basically. Because shipping costs are going up while trade is going down. So, really the effect that we're seeing right now is in the shipping industry more so than in the oil industry.

Sciple: Right. And these vessels need to retrofit their vessel to be able to maintain the current standards. Those tankers over time, if I'm not mistaken, had been burning this high sulfur fuel oil, were the only real source of demand for that substance in existence. How does that -- now that we have that oil that was being burned by these tankers, what happens to that high sulfur fuel oil, how does it get distributed around the market?

Shuchart: I mean, people started producing a lot earlier. Like everybody thought that there was going to be this huge shortage and we were going to have this huge glut of high sulfur fuel oil cover, but really the transition went much smoother than most people anticipated. And the port has it available, not all of them. I mean, there are some ports that are lacking. You know you have some outrageous oil prices, like in Australia, because they have that heavy oil that you need to make light sulfur fuel oil, but it's true. So, you have grades, like, Pyrenees in Australia that are going for like $100 a barrel right now. So, you are seeing that in some markets, but not the market that we're trading. And those definitely are not -- those are very niche markets.

Sciple: Right. So, overall would you say that IMO 2020, at least so far, has been a much more tepid of a response than expected?

Shuchart: I think shipping is scaling at more than anything, or shipping customers, because they're having these costs tagged on to your shipping. Merck just came out and they said, they are adding $50 to $200 per container to their customer's bill. So that's where I think it's being felt the most.

Sciple: Right. Just international trade more broadly. On that topic, I wanted to talk about China. You mentioned earlier the glut in products that's somewhat related to China. I guess the big news in China right now though is the coronavirus and the effect that that might have on global oil demand. As you're following this -- obviously, it's very early days and there's lots of fear mongering and that sort of thing -- but how are you assessing what this outbreak could do for energy markets?

Shuchart: Right. So, first, I'm looking at, right now we are starting to see airlines cancel flights. So, I'm looking to see any kind of port closures, airline closures, things that would affect jet fuel, even marine fuel, any kind of fuel demand, that's what I'm watching really closely. Today we have the announcement -- I don't know, we've had, what, 12, 13 airlines all cancel flights to China. So, it's going to depend on how long are they canceling their flights for? Because, for example, if you're going to travel, say, 10, 11 hours, that flight on a big plane, like a big 777, that's 700 barrels of oil just on the way there, right? So, then multiply that by how many flights and then roundtrip it. So, it starts getting up there. So, those are the kinds of things that I'm watching. Also, if they have any port closures, meaning that, can they not import oil, can they not export their products? Those are really things we need to see what happens. So far, things kind of look pretty shut down until February 9th. So, we'll have to see if that continues on to March, on to April, how long is this going to last?

Sciple: Yeah. And when you think about the supply being off the market. Obviously, any amount of time where these flights are canceled, that's oil and gas that aren't being used. But when you think about this thing stretching on, when does it really become super-significant and start affecting the producers, they have to change their business plans? How long before this really becomes a major service disruption?

Shuchart: You would need six months, generally six months is the time for something to filter through down to the production level, as far as anything happening on the market or with oil prices. Today, really until producers really start to feel it, that's why when markets fluctuate $5, producers are freaking out that much, right, because it really takes six months for them to start really feeling the crunch.

Sciple: Sure. Last thing on China, when you look at China's economy, obviously, there's been the trade war going on. And that slowed production there. We saw the past couple of years, their auto sales have declined for the first time in a better part of a decade, I believe. So, as you look at China outside of the epidemic issues, you look at their economy, how do you view their role in global oil demand and how that's changing going forward?

Shuchart: Well, I think that that's something that we definitely need to keep an eye on, because China has been sort of the buyer of last resort, right? The U.S. consumes the most energy, the most oil in the world, but China has, by far, been the fastest growing. So, any kind of decline in manufacturing or any kind of decline in their growth is going to affect the global market. In addition, they started ramping up because they wanted 90 days to cover in their SPR [Strategic Petroleum Reserve,] so they are near around 82 days or so. So, we also are looking at when their SPR is full, is that going to significantly curtail their oil purchases or are they going to expand beyond that? So, there's a lot of angles to look at on the China front. And we are seeing them slow down a little bit. So, that does put a little bit of fear in the demand issues globally.

Sciple: Sure. When you say SPR, for folks that are not familiar with that acronym, that's just their oil reserves correct?

Shuchart: Correct.

Sciple: Correct. Okay. Moving on from oil, I wanted to talk briefly about natural gas. We talked about shale earlier. Obviously, with a lot of these shale oil wells, just a massive amount of associated natural gas coming out of the ground, that's really put a lot of pressure on prices in that market. When you look at natural gas, how should we be viewing that market today?

Shuchart: I mean, natural gas is sad all around. I'm not going to sugarcoat this one. And the problem is that, with natural gas, it's just simply overproduction. I mean these guys are just they're overproducing and they're trying to get to the oil and the byproduct of a lot of its natural gas, so we're seeing flaring, outrageous flaring, right, we're just burning it off. Because they're just really trying to get to the oil. So, the business models are bad. And if you look at some of the companies, like, Chesapeake, they're kind of they're frightening, right? And we had just last year, we had Chesapeake, Chevron, EQT all have writedowns on their shale gas assets. And it doesn't look like it's getting any better, because we actually have a global glut -- another glut of natural gas all around.

So, if you look at global prices, you know, as far as Henry Hub, Korea -- Japan and Korea, I mean everybody -- Europe -- everybody's prices are down. We are close to the lowest. Well, Canada is lower than the U.S. But in some places, even like Waha -- which is not the contract that most people are trading, but that traded negative this last year. So, these guys need to stop drilling with reckless abandon, and otherwise, this is what happens, right? Stock prices go down, they're oversupplying the market, nobody is making any money. And it's a big disaster. But again, eventually these companies get weeded out, production slows down, prices move up, the cycle starts all over again.

Sciple: Yeah, I think a lot of people talk about these LNG export terminals getting built up to maybe allow oil shale gas producers to realize higher prices outside of the U.S. market. When you look at those opportunities there, can that save this market or help this market?

Shuchart: The LNG market cycle is so slow, so it gets really magnified on booms and busts. So, export terminals that are coming online -- that came online in 2019 or coming online in the next couple of years, were part of investment that was almost a decade earlier when prices were much higher. So, in the backend you have to factor in that spot prices really only account for 25% of the market. Most cargos are locked up in long-term contracts. So, really, we're going to need to see a little more bust in this market, I think, for it to pick up again.

Sciple: Okay. I want to transition now -- talk more about looking forward. We talked earlier about that we're hitting this wall, this debt wall in shale. Really expecting there to be some bankruptcies, some consolidation. As you look out three to five years past this kind of debt wall period, how do you view the world market playing out, what's it going to look like?

Shuchart: I think that we'll be in a healthier position. I think oil companies will look healthier. And oil as a sector has gone from 20% of the S&P 500 to 4.5% in the waiting. So, you know, this industry is due for a little relief, it's just we're going to have to go through a little bit of pain first. So, in four to five years. And maybe not even that long; I'm kind of looking out in the three-year horizon, I think we'll be able to see kind of a healthier industry. I know that people bring up electric vehicles and renewable transitions, and I agree that that's a great way to go, but I don't foresee that really making a dent in any kind of oil demand within the next ten years.

Sciple: Sure. Another thing we talk about hitting this debt wall, bankruptcies in shale; do you think the United States, ten years from now, will still be the world's largest crude oil producer and why or why not?

Shuchart: Hopefully it'll be a little bit more balanced. I think it will depend on what the supply and demand theme looks like at that point, right? But I don't think that production is going away here anytime soon. And I don't think we're going to drill through our reserves within the next five years by any means. So, if we can level off a little bit, I think it's again going to be beneficial to the market, but U.S. is going to maintain being a strong producer.

Sciple: You're an incredibly active Twitter user. How do you use Twitter on a day-to-day basis?

Shuchart: I mean I use Twitter for research for one thing. I mean I get a lot of research reports on a daily basis, and whatnot. But I use it for news curator, I follow a lot of reporters and things like that. And a lot of things I just tweet out, it's kind of like a diary, right? So, I tweet out charts or things that I'm currently looking at. But it really is good for up-to-the-minute news. I mean, usually you get something off Twitter -- and I have a wire service too. But Twitter is just as fast as the wire service. So, I think it's great for people who maybe don't have a wire service or don't have Refinitiv or Bloomberg or -- I think you can kind of curate your Twitter experience in the investment world for that; no matter what your sector is, what you're trading.

Sciple: Sure. And then, if someone wanted to learn about the oil markets, was new to this industry, is there any place you would point them as a good resource to get up-to-date and learn what matters in this industry?

Shuchart: I would get the book by Morgan Downey -- Oil 101, if you're really just starting in this industry and you really kind of want to get a grasp of what it all entails in a big way. There are some parts that are a little scientific when they go into oil grades, but overall, it's a really good book to kind of get a grasp of everything that's involved in the industry. And then go-to websites like OPEC and EIA and IEA. I mean, EIA is a gift because the United States is one of the only countries that tracks, literally tracks everything, it has a government agency that literally tracks import-exports between [...] in-depth detail. And all that information is free. So, it's a great resource.

Sciple: Yeah, I can echo that as well. I mean just their charts are super valuable for me as I'm trying to put together information for these podcasts or just run research. Where can people find your work, if they want to stay in touch with what you're doing and the things that you tweet out on a day-to-day basis, where can they find you?

Shuchart: So, I'm @chigrl C-H-I-G-R-Like; because somebody had G-I-R-L. So, I didn't get it. And they haven't tweeted once since 2009, and I want that handle. I didn't get it. So, I'm there. I do have a website chigrl.com. I don't really keep it up to date as much as I should, but there is a bunch of information on there if you want to go take a look at it.

Sciple: Well, awesome! Thanks so much for coming on the show and we hope to have you on again sometime soon.

Shuchart: Yeah, absolutely. Thank you!

Sciple: As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against the stocks discussed, so don't buy or sell anything based solely on what you hear.

Thanks to Austin Morgan for his work behind the glass. For Tracy Shuchart, I'm Nick Sciple. Thanks for listening and Fool on!