When one considers the impact of the price decline on regional Russian crudes such as the East Siberian Pacific Ocean oil8, when coupled with the currency arbitrage of a falling ruble, it is clear the Russians aren’t the intended victim in this Saudi murder mystery. In fact, at the quoted exchange rates and a price of $69.32 for this type of crude at the time of writing, Russian producers are actually realizing a ruble price today that is only 4.5-5% less than what they were receiving in early June of this year.9 Yes, over the longer term a falling ruble will have far wider reaching impacts on the Russian economy and purchasing power, but one still has to ask the question of whether it is logical to think that making the whole world suffer just to show Putin he can’t misbehave is realistic?
Marginal production out of high cost sources like shale are clearly the easiest and most logical target of the Kingdom’s recent decision not to cut production. By killing off some of the shale production it’s a win for nearly everyone but the U.S. Eventually, we’d expect formerly displaced light oil imports will return to the U.S. and market share competition in places such as Asia will ease up.
At Peritus we have long been of the opinion that many shale producer business models are flawed and unsustainable, and now that oil has fallen so precipitously, cracks in already stretched balance sheets are starting to appear. Energy represents 18% of the U.S. high yield market.10 Capital expenditures commonly exceeded cash flows of many shale producers at $100/bbl. How do you think they will they fare at $70 with wells that decline by 90-95% every two years?
While calm waters are a ways off for the oil markets and along the way there will undoubtedly continue to be unexpected supply disruptions out of the Middle East and Africa that will add volatility to prices, we expect the medium to longer term supply and demand dynamics will lead to a rebound in oil prices, benefiting those that are able to withstand these shorter-term price dynamics.
1 Source: U.S. Energy Information Administration, Weekly Petroleum Status Report, week ending 11/28/14 (November 2008). 2 Source: U.S. Energy Information Administration, Weekly Petroleum Status Report, week ending 11/28/14 (November 2008). 3 Data based on expectations from Bloomberg. 4 Determination based on Peritus’ research. 5 Prices and exchange rates as of 12/3/14. 6 Prices and exchange rates as of 12/3/14. 7 Data sourced from Bloomberg, covers the period 3/31/14 to 12/3/14. 8 Data sourced from Bloomberg, covers the period 3/31/14 to 12/4/14. 9 Prices and currency rate as of 12/3/14. 10 This statistic for the J.P. Morgan High Yield Index, constrained. Acciavatti, Peter, Tony Linares, Nelson R. Jantzen, CFA, Rahul Sharma, and Chuanxin Li. “Credit Strategy Weekly Update,” J.P. Morgan North American High Yield and Leveraged Loan Research, November 21, 2014, p. 6 This article was written by Doug Holt, Energy Analyst for Peritus Asset Management, the sub-advisor to the AdvisorShares Peritus High Yield ETF (HYLD).