MAX WIETHE: All right. Welcome to Real Vision Live. I'm Max Wiethe for Real Vision. This is a special edition that's going to be free for all of our Essential Members as well as Plus and Pro Members. We have Warren Pies from Ned Davis Research here. He's the chief Energy Strategist for Ned Davis.
And we had him on Monday for what we thought was going to be a timely update of the oil and energy markets. But we got a wrench thrown in that by the Saudis and the Russians starting a price war over the weekend. So we decided we'd bring Warren back, make it available to everybody so that we could get a true, timely update for all of our viewers. With that being said, Warren, thank you so much for coming back so soon.
WARREN PIES: Thanks for having me. Yeah. So I was pretty happy with our conversation on Friday. But obviously-- or last week-- but a lot's happened. So the main message from that conversation remains, though. And that was, we're going through a massive demand shock. You wanted to avoid energy, have liquidity to put in place come the end of this crisis.
Well, then what happens, obviously, is in the midst of this demand shock, we have OPEC plus dissension. And that's kind of thrown us into a world that is uncharted territory for the oil market. I don't think you've ever seen OPEC moving into this kind of dissention at the same time that you have demand falling apart.
It's usually kind of like the Federal Reserve. If you think of the Fed in times of financial stress, it would be the Fed hiking rates during a period of financial stress. It's really unprecedented. So basically, it's gotten worse for the oil energy sector.
But the main point I would say before we get into the details is that this level of oil price, $30, if we go down to $20, it doesn't work for any of the major producers. So the major players that we have in the current drama is Saudi Arabia, Russia, and the United States. And that's roughly 30% of global crude oil supply. And a $30 world just doesn't work for any of those major producers.
So this is going to be a temporary phenomenon. The key is going to be-- and we'll talk about it more through the conversation-- how do you know it's OK to go back into energy? And when you do go back into energy, what are you going to buy?
So the bottom line for now, though, is the Saudis can't withstand this pricing. Russians are probably in the strongest position, and they can hold out for a bit. But they ultimately can't sustain it, either. And, of course, US shale won't be able to either without a massive recapitalization, which is probably going to happen, as we discussed in our last conversation, anyways, of the entire industry.
MAX WIETHE: Yes. So I would like to talk a little bit about that, that price war. Who's the aggressor in this battle between the Russians and the Saudis? The Russians came out and said that they could withstand this price war for years. I would just like to get your take on how long do you think that this can actually go on, and what you think the probability is that this is resolved sooner rather than later?
WARREN PIES: Well, I mean, I'll speculate. But the bottom line is no one knows, really. The people who say they know, they're really just guessing, to. But an educated guess is that we can look-- first, let's look at the Saudis. So I believe the Russians were, like you said, the aggressor here. The Saudis were ready to cut and stabilize the market. The Russians didn't want to cut.
And so then the Saudis kind of responded. And I think their response has been an overreaction, or at least bluster at this point. Their response is, OK. If you're not going to cut and be of assistance here, then we're going to flood the market. We're going to go max capacity on our production, and we're flooding the market.
They then moved to undercut on all their official selling prices at key hubs globally by $8 to $10 a barrel, which is why we saw a 30% drop overnight when we went into Monday's open for crude oil markets. And so the question is, how long can this go on? The Russians have been asserting that they're the strongest player here in this drama.
And they've been adding to their forex reserves over the last 5 years. They've been recycling forex reserves into gold. And it kind of looks like they've been preparing themselves for this kind of a moment. And so they probably have the most resolve in time to get through this.
If we look over a good chart here. If we look over the Saudis, though, last time we had a price war, 2014 to 2016, Saudi Arabia burned through 1/3 of their forex reserves. So if you think of this, like, this is like your savings account. They're burning through savings to do a price war. And really, they can't afford to go through another one of these kinds of protracted price wars. They're on shaky ground.
When you get into their budget, Russia's budget, the budget breakeven is about $50 a barrel for crude oil. That means no deficit. What would you need in crude oil to run no deficit? The Saudis need about $84, $85 barrel oil in order to balance their budget. So you can imagine what $30 oil does to their budget and how quickly those reserves drain.
There's a compounding effect with the Saudis, because they want to, it seems, plug some of their financing holes and economic holes by selling off parts of Aramco, a state-owned oil company. And Aramco prices have gotten destroyed during this process. So they're getting hit from a flows perspective and from an asset perspective.
So the Saudis can not handle this like they did from 2014, '16 into-- it's really bluster, in my opinion, the way they're approaching the last week. And so I would expect at some point a resolution of this. I don't think we're just going to keep pumping oil in breach storage. But I think that the Saudis are going to have to give as they have been more than the Russians are going to give.
And then moving to the third big player in the drama would be the US shale and US production. The thing here is we're going to see a reduction in US production, for sure. And we're going to see bankruptcies, as we talked about in the last conversation. That was more of the main points in the conversation. We're going to see more shale bankruptcy come over and say, it's safe to get back into the space.
But ultimately, you're just recapitalizing the industry. The assets, the minerals are still there. So you're going to just eliminate a lot of the debt and bloat that's come along with the shale revolution.
And at the end of the day, you'll come back, and the US production, it's still going to be there. It's stabilized. It's not going away. There's no way to make-- the call on shale is too great to move forward without producing a significant amount of oil from US onshore.
MAX WIETHE: Yeah. So while we're talking about bankruptcies, I know we said we get into some questions at the end. But there was 1 question that we got that specifically related to bankruptcies. So Edward was asking, he says he owns some CHK bonds. I think that's Chesapeake Energy, which are being around $0.33, and are now around par.
So these 2020 bonds are due in November. It looks like the market is pricing in almost certain bankruptcy, or is there something more going on? At this point, he said he's going to hold until maturity, as it doesn't make much sense to sell at this point.
Is there anything more going on from a liquidity event in terms of Chesapeake? So I think I had that backwards. They're now around $0.33, and just a few months ago, they were at par. Do you have any insight into specific companies?
WARREN PIES: No, I would definitely not have advice on individual bonds of individual companies. But I can say, just knowing what I know about Chesapeake, is they're primarily a natural gas producer. I don't have any idea what the bonds are. As you can imagine, I've got to deal with everything else.
But natural gas, there's a small silver lining in all this for domestic US production. So we're going to slam the brakes on US crude oil production. Along with that, we're going to slam the brakes or at least slow down associated gas production, which has really been the big problem for gas, natural gas producers. And Chesapeake is a huge natural gas producer.
So to the extent that you eliminate associated gas production, which is just the natural gas that comes up when you're drilling for oil as a byproduct of drilling for oil, really, when you eliminate that out of the supply picture, the fundamentals get incrementally better for the more traditional natural gas producers like Chesapeake, or some of the players up in the Marcellus.
And so we had a day the other day where the only energy stock, major energy stock I saw that was up was Cabot Oil and Gas, which is just a pure natural gas producer in the Northeastern United States. And so you've seen the market start to make a small distinction there between natural gas producing equities and oil. I wouldn't jump to crazy on that.
One of the points I would make is in this period, everything's being sold. So there's no reason to own marginal or crappy assets. You can buy the highest quality names and assets in the North American energy space at a major discount. So I would be careful.
If you're asking yourself about a bond trading at $30 on the dollar for Chesapeake, that's not something I would want to own, personally. But, again, I haven't dug into that exact issue in that exact company enough to say too much intelligently about it.
MAX WIETHE: All right. Thanks, Warren. Sorry to derail you there.
WARREN PIES: No, no worries. Whatever people--
MAX WIETHE: --what we were talking about. So with all that being said, is this looking like a time to maybe start considering buying? I know in our last talk, you were saying it's time to have a shopping list. Are we kind of through the shopping list stage and getting more towards the going to market?
WARREN PIES: Yeah. I mean, I'll give you the traditional caveats, which is everyone has to know what their holding period is, their time horizon, and their liquidity conditions are. So I'm not saying you don't want to go out on margin and do any of this. And anything you're buying today, you're doing it with 3 to 5-year time horizon.
With that said, yes, it's time to start buying high-quality names out there in the energy space. Specifically, Williams Company is one of the names I mentioned last time. It's a midstream company. It's not an MLP anymore. It's a midstream corporation. Primarily, vast majority of the volumes are natural gas volumes.
And they own probably the most essential pipeline system in the United States, Transco, which accounts for roughly 35%, 40% of the company EBITDA. So with the decline we've had, you're getting what is one of the most essential pipelines in the United States at a reasonable multiple. And then the rest of the company is almost getting thrown in for free.
And these are the types of liquidations that you want to be buying, if you're talking about a yield at this point that's 12%, 13%, depending on where we're at in this crazy market. So a company like Williams, which I mentioned already, a company like Enterprise Products, these midstream companies that are in the best of the best.
Because like I said, there's no reason to have to go buy anything that's not the best or the highest quality names right now. You're talking about integrated companies like Chevron, which, again, you're going to be exposed to oil. But at the end of the day, if the carnage that I believe is going to take place in the shale patch takes place, these large integrated players are going to have an opportunity to really consolidate.
And, again, 3 to 5-year time horizon. Remember what we said at the beginning. Oil cannot stay here because it doesn't make sense for any of the major oil producers in the world. Capex everywhere globally will just grind to a halt. It's impossible [AUDIO OUT] for oil to stay where we're at right now. So highest quality companies, start picking your spots. yeah, absolutely.
MAX WIETHE: And we actually got a question from Bruce asking whether you think there's any potential for protectionary tariffs from the US to try and protect some of those shale producers here.
WARREN PIES: I mean, you never know what's going to happen. Right now, we're in a crazy world. And so I saw Harold Hamm on, like, Fox Business the other day. Harold Hamm, a Continental guy-- Continental is an oil producer in the Bakken. And they're in a lot of trouble, and they've been in a lot of trouble for a long time.
And Harold Hamm looked shell-shocked on TV, and he was asking for the US to essentially look into an illegal dumping scam by the Saudis and the Russians. Yeah, it was kind of a crybaby move. But he has a line to the important people in the government. And to the extent that they're willing to throw anything at the problems that we're having right now, that's a possibility.
At this point, it doesn't make any sense to be short basically anything, because we can have a policy response that rips your face off the next day if you're short any of these guys, which they might ultimately be zeros. But you just don't want to touch it. You're at this stage of these things are toxic. Don't touch.
As far as protectionism, that's been something that's happened before. But at the end of the day, I hope they don't do it, because it would ultimately do more harm than good, and the market will balance itself out. And the distress within the OPEC-Plus group is going to ultimately work through the system as well, and they'll know come to the table and then figure it out.
There's not going to be an easy way through, even with before we had supply things. I mean, coronavirus is a massive-- like I said you, shut down the Chinese economy, you shut down the American economy, I mean it kills everything from a demand perspective. And so we're not going to see high oil prices for a little while. But protectionism and things like that, that's not going to solve the problems. Hopefully it'll do it.
MAX WIETHE: Yeah. So speaking of oil prices, you did bring some charts with you today. I think now's a good time to get into some of those. Where do you want to start?
WARREN PIES: Yeah. I mean, so if you remember from the conversation we had on the previous one, I talked about the contango that we were currently in. So let's start there. And that's the second chart, I believe, in the pack. And we're going to skip between that one and the first one. So this is the--
MAX WIETHE: OK. We're looking at elongated, the longer-term contango chart?
WARREN PIES: Correct. So this is the chart that we looked at in the previous conversation. And I reference it as a reason for being bearish, and that we had saw-- I explained the indicator somewhat. It's more or less a ratio between spot and 12-month strip crude to indicate whether we're in contango or backwardation. I explained that in the last conversation, what contango is, what backwardation is.
How contango is a sign of a market, a symptom of a market that's oversupplied. And that's what we were seeing as the coronavirus went out, spread into the globe. And so we're now in what I would call a condition that's super contango. And we haven't picked it up on this indicator yet. This indicator gets smooth and is slower moving. But we're firmly in contango. And now, we're in super contango.
If we flip over to page 1, this is that indicator we just looked at. But to add the full history, but we're just zooming in the last year or so here. And so you can see closer where we came from. Backwardation is below that dashed line, means that the spot prices, front month prices are higher than longer-dated prices.
And when you get above that dash line, it means that your front month and spot prices are going lower than your outdated prices. And the reason you're doing that is because you're trying to incentivize oil going into storage. So as the contango is kind of flat at first, you're incentivizing traditional storage, your tank storage.
And then as we get into steep contango, you're going to start filling up crude carriers, ships, tankers, with crude, and doing what we call floating storage.
And so we're at this point now where contango is really starting to ramp up. You don't quite see it in this chart, because like I said, I smoothed it out. But if you flip over to, I think it would be the sixth page, you can see the raw guts of this chart.
MAX WIETHE: Yeah. What's