Why Cant Hedge Funds Make Up Their Minds About Oil Prices?

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This video was recorded on March 30, 2017.

Sean O'Reilly:Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. Today isThursday, March 30, 2017, so we're talking about energy, materials, and industrials. I'm your host, Sean O'Reilly,and joining me today in studio is Motley Fool Premium analyst Mr. Taylor Muckerman. How are you, sir?

Taylor Muckerman: I am great! Pizza Day today!

O'Reilly: It is Pizza Day today, on a Thursday! It's the first time in Fool history, what's going on here?

Muckerman: I don't know. It's madness.

O'Reilly: It is absolute madness. It might be anApril Fool's Day prank. We're going to find outin about 30 minutes.

Muckerman: I'm sure it has something to do with April Fool's. It's ournational holiday.

O'Reilly: To all our listeners,as you can imagine, we here at The Motley Fool takeApril Fool's very seriously. In fact, I'm not even talking to Taylor --I'm just kidding. Today, Taylor, we'retalking about the possibility that hedge funds are nowbetting on a renewed decline for crude oil below $50 a barrel. Actually, there's a rather large oil-sands asset sale,this time fromConocoPhillips. But first, I wantto get some quick thoughts from you on oil's recent pop. Couple percent. We've been harping on it so much lately, I wanted to bepositive for a bit.

Muckerman: I think, you know, a couple weeks ago, it hit a three-month low. So it popped a little bit.

O'Reilly: Becauseinventories kept going up. It was crazy. But I think,basically, you have the double whammy of,I think Libya shut down a pipeline that connected theirlargest field to some refineries.

Muckerman: So,temporary.

O'Reilly: Temporary,I don't know.To the bulls'credit, no bears talk about thepossibility that one of these countries just goes nuts again. Becauseit used to be good for $10 --

Muckerman: Just production? Or geopolitical?

O'Reilly: Fiveyears ago, the possibility of something crazy happening in Iraq or whatever, that was good for $5-$10 on a barrel of crude. Now,it's like, nobody cares.

Muckerman: I don't know. I think before OPEC shut it down inNovember of 2014,I think geopolitical risk was pushed aside, and I think,in hindsight for me, that was a warning sign, when you had some uprisings in a few major oilproducing countries in the Middle East andNorth Africa, and oil didn't really moveas much as it did traditionally. In hindsight,that was a red flag for me; we should have seen this coming.

O'Reilly: Butnobody cared.

Muckerman: Yeah,nobody cared because everybody had oil, oil was $100 a barrel, it was at its peak price.

O'Reilly: For sure. And then you had the gasoline inventory draw, which means there'll be an oil draw next week?

Muckerman: Hard to predict.

O'Reilly: Theconsistent thing is,I feel like everybody is grasping at straws.

Muckerman: Yeah,they're all looking for something as a reason to why it moves 1% or 2%. I don't look too deeply into it.

O'Reilly: Yeah.I don't know if you listened to the episode I did with [Tyler] Crowe, but he's like, everybody fixates on the U.S. because it has the best data, but it's not, it's just guys trading for the heck of it. Anyway. Speaking of guystrading for the heck of it --

Muckerman: Yeah,no kidding. Hedge funds.

O'Reilly: Hedge funds betting, I guess ...I thought it was just them selling their longs, but, anyway. Hedge fundsbetting on a renewed decline below $50 a barrel. What's up?

Muckerman: That's what theFinancial Times headlines said a week ago. This was after all the headlines are saying hedge funds have never bet this much on rising oil prices, in the history of oil trading. And nowthey have a historical decline in their long bets. I think it was 153 million barrels reduction in net long position across WTI --

O'Reilly: Just, for the layman, these are futures contracts.

Muckerman: Yeah, so, they'rebetting on the future price of oil.

O'Reilly: Right, and these are contracts to theoretically buy 153 million --that was the decrease? Or was that the total?

Muckerman: That was the combined decrease across WTI and Brent --

O'Reilly: So the net longs are way more than that?

Muckerman: Yeah, they are. It was the third straight week of sellingafter they hit a net long peak of 951 million barrelsat the end of February.

O'Reilly: That's the number I needed, OK.

Muckerman: So that's your relative number. It was a peak of 951 million. And last week, they sold off a combined 153 --

O'Reilly: And it dropped off to 800.

Muckerman: Well, that was the third week of declines, but that was the biggest decline in history. Because,I mean, you're starting from the biggest --

O'Reilly: Percentage-wise, you're starting from 16%-17%. So, for the layman, these guys and their ties on theNew York Mercantile Exchange,they have all these futures contracts to essentially take delivery of crude oil at a future date, at a set price, for 953 million barrels,which is actually a lot of oil.

Muckerman: That's aconsiderable amount.

O'Reilly: Then itdecreased to 800. And just so everybody knows,most of these never actually --nobody ever actually takes delivery of the oil; it's just a financial asset. But theoretically,you could take delivery if you wanted to. Butmost people don't. Isn't there $1-$2 per barrel that you pay in addition if you actually take delivery?

Muckerman: I'm not 100% sure how these future contracts work.I know how they can impact prices,but I've never personally bought a futures contract.

O'Reilly: We should pool our money and buy one future.

Muckerman: One barrel of oil? Yeah.

O'Reilly: "We want to buy a future for three months from now."

Muckerman: We'll look into it. We'lladvertise it. If listeners want to chip in, we'll start our own hedge fund.

O'Reilly: Weboth live in Arlington. Which of our places could we keep this barrel when we take delivery?

Muckerman: I have a garage.

O'Reilly: How would your wife feel about that? Oh, you have a garage! We'llput the barrel of the oil in your garage!

Muckerman: It's acommunal garage. People might siphon it.

O'Reilly: Theycouldn't refine that.

Muckerman: It's likethe episode of It's Always Sunny in Philadelphiaseveral years back, when they were filling theirLand Rover onbarrels of gasoline because gasoline prices were rising through the roof.

O'Reilly: Oh, man. You knowDylan from the Tech show loves Always Sunny, right?

Muckerman: I hope more than just Dylan loves it.

O'Reilly: No,so do I, and I'm so glad you brought that up. Anyway. Itseems to me like they're not necessarily betting on oil being below $50. They're just being a little less bullish.

Muckerman: Being a little less bullish, but also, because they still have such high long betsif oil starts to fall a little bit more and they get a little nervous and they sell, that could just be added pressure to the downside for oil prices.

O'Reilly: You couldget a cascade.

Muckerman: A cascade, yeah, that's a good word.

O'Reilly: Well,you know, I'm a bit of a poet. Do you care about any of this? For our listeners who are, obviously, long-term Foolish investors?

Muckerman: It's justfunny to see how whimsical these hedge funds really are, to go from record longs one day to,the very next week, record selling.

O'Reilly: I think it's algorithms.

Muckerman: It very well could be.

O'Reilly: There was one hedge fund that was analgorithmictrading firm; the name escapes me.

Muckerman: There'smore than one.

O'Reilly: Bottom line, 90% of the trades on theNew York Stock Exchange, it's justalgorithms going nuts.

Muckerman: I would imagine it's very high,I don't want to call out a number, but it's very high. It'shigher than 50%.

O'Reilly: I think of an algorithm that could flipinstantly and it would be hilarious.

Muckerman: Maybewe just need to start making a lot of tweets about bullish oil,because apparently some algorithms readTwitter.

O'Reilly: They do read Twitter, you're right. So, Mr. Muckerman!

Muckerman: Yes?

O'Reilly: Shell Oil a couple months ago.

Muckerman: Yeah,Royal Dutch Shell.

O'Reilly: They sold off their oil-sands assetsup there in the Canadian North.

Muckerman: Notevery last barrel of exposure, but yeah, they sold off $7.25 billion worth.

O'Reilly: So,naturally, you're like,that's a lot of money.

Muckerman: Yeah,they sold it toCanadian Natural Resources.

O'Reilly: All of a sudden,ConocoPhillips announces this week --

Muckerman: A dealnearly double that at $13.3 billion,and that's also on the tales ofMarathon Oilselling $2.5 billion --

O'Reilly: Whatdid they pay for these assets?

Muckerman: ThatI haven't really taken a dive into.

O'Reilly: For an oil company, $1 billion is like ... butthis is a chunk of change for even these guys.

Muckerman: Sure, $13 billion is definitely a chunk of change. They had to cut their dividend recently, so they'retrimming some debt, they'rebuying back shares,doubling their share buyback from $3 billion to $6 billion using some of this money. Butthey're not losing all of their exposure to the oil sands, because what equates to $2.7 billion of that $13.3 billion total isbeing paid to them inCenovus Energy shares, which is who's buying these assets from them. So another Canadian oil-sands specialistbuying these assets, but they're getting share, so they still haveexposure to the success or failure of these assets. They also have a five-yearcontingency in this deal where for every dollar that Western Canadian Select oil --

O'Reilly: This is way more complicated than I thought.

Muckerman: -- is above $52, which is a little ways away, to be fair. They're going to get $6 million every quarter for the next five years if, for every dollar Western Canadian Select is over $52 a barrel.

O'Reilly: So if it's at $62, they get $60 million?

Muckerman: They get $60 million that quarter.

O'Reilly: Oh, boy.

Muckerman: So they have a lot of upside.

O'Reilly: Kudos toConocoPhillips; that actually feels a little bit better. I thought that was just, they bought these assets when oil was at $100and now they're cutting their losses. But this is actually ...

Muckerman: They'rebasically trimming theirexposure from the $13.3 billion that this price suggests theassets were worth down to $10.6 billion with upside.

O'Reilly: It'sbeen a while since we talked about this,but throughout even the downturn, oil frackers,domestic onshore in the United States,they've gotten even better at what they do. Ithink I saw a headline the other day,there was something in the Permian Basin,they're talking about profitable, that $20-$25,it's like, oh my gosh. Do you hearany kind of efficiency rumblings coming out of the oil sands?

Muckerman: Notto that degree. But they are slightly more efficientjust because they have to be, because they're on the higher end of the cost curve. But if you listen to the IEA [International Energy Agency],they still expect Canada to be a significant contributor to global oil supply. That'snot going to come without the oil sands. So what you're seeing here is global oil companiesselling these assets, the buyers, who happened to be oil-sands specialists. So,Cenovus Energy,Canadian oil producer--

O'Reilly: So, this is the efficiency thing I'm talking about.

Muckerman: Yeah. So,these companies think, "We'reprobably better at this than ConocoPhillips or Shell orMarathon Oil." So, you have Canadian Natural Resources and Cenovus being buyers of this oil sandsproject,some of which they've already had stakes in with these companies,they're just buying the remainder of the stake. But also they're getting into some newer projects that they were previously a part of.

O'Reilly: I wonder if [Suncor Energy] up there, I know it was a Buffettholding for a while, I think he sold --

Muckerman: It was, they're thevertically integrated, they're the [ExxonMobil] of Canada.

O'Reilly: I wonder if they'll start,because they're good at getting oilout of the oil sands.

Muckerman: Yeah,that's also a part of their bread and butter.

O'Reilly: I wonder if they'll do anything.I always liked that company.

Muckerman: I don't know,because they're right along the lines with Canadian Natural Resources and Cenovus Energies of the world, where they understand oil sands. So it's not like they bought into it thinking, "This will be part of our portfolio." That's what they do.

O'Reilly: Theyhave those giant trucks that you put the tar in.

Muckerman: Yeah. So I don't know if they'll be sellers. Maybe they had some bids out there for these last -- I don't know, I didn't see that. But if somebody else sells, maybe it's their turn.

O'Reilly: That'd be fun. So,this sounds like a good deal for everybody,because ConocoPhillips is getting some incentive if this works out --

Muckerman: And they're paying down debt.

O'Reilly: -- andpeople who are good at this are working the assets. There you go.

Muckerman: We'llfollow it for a little while, because where oil prices are at today, it's probably not as lucrative to continue to develop these assets, but if oil demand continues to rise, Canada, like the IEA said, shouldplay an important role.

O'Reilly: Cool. Beforewe head out, you get the last word. Anything else on your mind?

Muckerman: Just, there's --

O'Reilly: How's your bracket doing?

Muckerman: I think I still have UNC in there. I got that going for me.

O'Reilly: David Gardner loves you right now.

Muckerman: I was raised there my whole life, so I have to at least support the home team. But, just, some joint venturesgoing on out there if you want to pay attention to the North American drilling market.SchlumbergerandWeatherford,they have a target onHalliburton'sback on theNorth American fracking market. Halliburton is the leader in the industry, and North America.

O'Reilly: Service companies throwing down.

Muckerman: If you don't have a target on your back,maybe your competition isn't doing something right.Weatherford getting thrown a bone here bySchlumberger; they were the fourth player in the market; Schlumberger was No. 2 inNorth America, right around there. Now they have about3 million hydraulic horsepower ofcompetitive fracking capabilities here inNorth America.Weatherford recently poachedHalliburton's CFO to runWeatherford.

O'Reilly: That's how you get a promotion, folks.

Muckerman: Yeah. That was earlier this month. I mean, I'minterested to see how this works out. Halliburton wasplanning on hiring by the end of this quarter,by the end of this month.

O'Reilly: Thisisn't the first time you've talked about those drillers,because now it's time for them to reap the harvest, because they're like, "We were giving you guys a break for two years, now it's time for us to get some day rates up here."

Muckerman: Yeah,if you look at Dave Lesar,Halliburton CEO, in their last call, he "loves the outlook for North American unconventional oil." Theyplan on doubling the equipment that they're going to bring back online this year thanwhat they originally thought. Like I mentioned, they'rebasically hiring 2,000 more --

O'Reilly: This is why oil is staying below $50, people.

Muckerman: I know! They'refocusing on North America,which is where you can produce it for cheaper than $50.

O'Reilly: Unbelievable. Thank you for your thoughts, sir.

Muckerman: Yeah, cheers.

O'Reilly: Have a good one. Let's go get some pizza!

Muckerman: I'm right on board.

O'Reilly: That is it for us, folks. Besure to tune in tomorrow for the Technology show with Always Sunny in Philadelphia enthusiastic and technology hostDylan Lewis.If you're a loyal listenerand have questions or comments, we would love to hear from you. Just email us at industryfocus@fool.com. As always,people on this program may have interestsin the stocks that they talk about,and The Motley Fool may have formal recommendations for or against those stocks, so don't buy or sell anything basedsolely on what you hear on this program. For Taylor Muckerman,I am Sean O'Reilly. Thanks for listening, and Fool on!

Sean O'Reilly has no position in any stocks mentioned. Taylor Muckerman owns shares of Halliburton and Twitter. The Motley Fool owns shares of and recommends Twitter. The Motley Fool owns shares of ExxonMobil. The Motley Fool has a disclosure policy.