R-Oil-ler Coaster

I am not a roller coaster fan. When I was younger, my parents would take us on an annual trip to an amusement park for weekend getaways.  One of the main attractions was a wooden roller coaster with a drop of ~100 feet after an initial climb of the same distance. After a slow ascent up the incline, you would pause, or nearly pause, at the top for a brief second, then hurtle downward before coasting around several curves and small dips. I really enjoyed the smooth ride around the curves after the fall, but the drop was more drama than 13-year-old me was up for. According to Goldman Sachs, the oil industry moves in phases that remind me of that roller coaster.

In April of 2018, Goldman Sachs released a research report describing the oil and gas industry as moving through 3 distinct phases in an ~30 year cycle.  Those phases were the Expansion, Contraction, and Restraint phases.  In the Expansion phase, there is a real or perceived shortage of capacity to produce more oil. New entrants are drawn to production of the hydrocarbon and prices rise, with plentiful money for the ventures available through debt and equity financing.  The Contraction phase sees a drop in commodity prices as sufficient supplies are brought online to reduce the need for further investment.  A confluence of long-term capacity to produce, transport, and store oil along with a reduction of the inventory overbuild, moves the industry into the Restraint phase. The Restraint phase sees further industry consolidation, as large operators with tightly controlled and integrated operations and low capital costs come to control more of the industry’s assets and production.

The roller coaster template is easy to see as the long incline, Expansion, is followed by a rapid plunge, Contraction, and the less volatile coast to the end, Restraint. Examining annual oil prices provided by BP going to back to 1861, shows prices spiking to over $100/Bbl (adjusted to 2018 dollars) only three times since it’s discovery.  Each spike follows the roller coaster pattern.

It is my belief that the Contraction phase of this ride has not fully completed yet.  The average price going back to 1861, using the data referenced above, is $36/Bbl.  Average prices going back to OPEC’s initiation in 1960 is $50/Bbl. The post-OPEC average price calculation includes 2 of the 3 $100/Bbl price spikes, however, and which could point to a run-rate price much closer to the long-term average.

Price has stayed consistently higher than both of these price levels after bottoming in 2015-2016.  Price action over the past 4-5 years shows WTI oil prices with support around $45/Bbl and resistance in the $60/Bbl range, although pricing was greater than $60 for much of 2018.  I believe that until price returns to longer-term averages, another leg of the Contraction phase will likely complete on the way to the Expansion phase.

Disclaimer: I own put options on SOXX, which are expected to go up in value if a market correction occurs, and expect to sell or add to the position at any point in time.

I am not a financial services professional.  All information on this site should be regarded as informational or for entertainment only, and not as actual investment advice.