Specious Argument

Have oil prices hit bottom? While I don’t know the answer, I have a hunch that we might have bottomed or might be close to bottoming. In a Financial Times article “Opec chief says oil prices could soon rebound” (subscription might be required) on January 26, 2015, Abdalla El-Badri indicated that prices might have bottomed.

Oil prices may have hit a floor and could soon rebound, said the secretary-general of Opec, the oil producing cartel, on Monday.

After hovering in the $45-$50 a barrel range, Abdalla El-Badri said, “maybe prices have reached a bottom”.

Speaking on the sidelines of a Chatham House conference in London, Mr El-Badri said to the Financial Times: “How long will it last? I don’t know … but I am sure the price will rebound.”

In a New York Times article “Oil Prices Surge 8% After Long Slide Down” (subscription might be required), there were a few factors contributing to a sudden rise in prices this past Friday. The decreased rig count, however, seems to suggest that oil production will decrease and that a bottom should not be too far away.

The rally came shortly after the Baker Hughes service company reported that the nation’s rig count had dropped by 94, or 7 percent, in the last week, the largest single-week drop since the late 1980s. That leaves 1,223 rigs in operation, the lowest number in three years, and energy executives say another 300 rigs could be decommissioned in the next few months as service contracts expire.

A drop in oil production normally happens several months after rigs are decommissioned, but the Baker Hughes report was another sign that oil companies were responding fast to the global oil glut by cutting their spending.

…

“My gut says the oil price has been artificially low, and I think this is a logical correction from that overreaction,” said Joel Moser, the chief executive at Aquamarine Investment Partners. “It would not surprise me at all that this may reflect a bottom.”

While I am not positive that oil prices have bottomed, I think we are at least close. Perhaps oil prices touch the high $30s. But I doubt that oil prices could stay in the $30s for an extended period of more than two months. I believe the pain being endured by the oil industry is intense, as evidenced by the dropping rig count. Thus, I expect that oil prices have either bottomed or will soon bottom.

Reports that say that something hasn’t happened are always interesting to me, because as we know, there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns—the ones we don’t know we don’t know. And if one looks throughout the history of our country and other free countries, it is the latter category that tend to be the difficult ones.

As we prepare to enter 2015, financial pundits aplenty will be giving you their forecasts for the upcoming year. People have a tendency to overestimate their confidence when working with ambiguity or uncertainty.

Rather than anchor myself to any pundit, I want to look at what the market is expressing through options. On Friday, December 27, 2014, the SPX closed at 2088.77. Looking at the SPX December 2015 Options (those that expire on December 18, 2015) and using thinkorswim’s platform for options, I note the following:

• about a 90 percent probability that SPX closes above 1400;
• about a 90 percent probability that SPX closes below 2400.

Alternatively, we can state that there is an 80 percent (equals 100 minus 10 minus 10) probability that SPX is between 1400 and 2400. We note the skew to the downside.

Now, let’s look at 80%:

• about a 80 percent probability that SPX closes above 1650;
• about a 80 percent probability that SPX closes below 2300.

Alternatively, we can state that there is a 60% (equals 100 minus 20 minus 20) probability that SPX is between 1650 and 2300. Note again the skew to the downside.

Incidentally, the approximate volatility across different strikes for next December’s SPX options is about 20.4%.

Looking at the first series of numbers, we note that low value of 1400 is about 67 percent of today’s value and the high value of 2400 is about 15 percent greater than today’s value. Looking at the next series of numbers, that low value of 1650 is about 79 percent of today’s value and the high value of 2300 is about 10 percent greater than today’s value. The downward skew is clearly evident.

If these numbers seem way out there—way too far to even be considered—one can always sell the puts or calls and pocket the “risk-free” money. Me, nothing surprises me anymore, so I don’t consider any potential profits to be risk-free. Put differently, there is no “risk-free” money. While these values might seem far away from today’s values, there can always be surprises that warrant lower or higher values.

How many of us predicted some of today’s geopolitical concerns or the plummet in oil prices? The unknown unknowns can and will surprise us.

How accurate or reliable are these option generated percentages? These percentages are simply based on an option’s pricing model. As prices move throughout the year, the values will change. At present, however, these values represent the market’s view. That view will change. If you disagree, you can always take the other side. But I do find looking at an option pricing model’s values helpful because it reminds me how much volatility and uncertainty exists. It’s too easy to get lulled into thinking into a pessimistic or rosy forecast.

So when you hear or read about some pundit providing a rosy forecast, think back to our exercise. How many pundits are expressing that the market could have a significant retracement? My guess is that most pundits are going to express an opinion of a market rise of somewhere between five and 10%, largely because we’ve enjoyed two strong years. Yet, from the options model’s values we noted the skew to the downside.

The key point from this discussion is to keep an open mind to next year’s potential outcomes.

I have no clue where oil prices are headed. Like everyone else, I have been confounded by recent developments.

Leading up to the November 27 OPEC meeting, I expected that OPEC would not cut its production to support higher prices. I got that part correct. I thought, however, with the recent drop or fall in oil prices that most of the damage had already occurred. I did not anticipate a precipitous further drop in price following the OPEC meeting on Thursday and Friday.

I have been reading everything I can in an attempt to anticipate future developments. After all my reading, I have come to believe that the near future is highly uncertain. Some forecasters seem to suggest that we have likely already overreacted. While others, including Murray Edwards of Canadian Natural Resources who stated in a Financial Post article “Canadian Natural Resources chairman sees oil touching US$30 a barrel,” believe that oil prices might fall as low as US$30 per barrel.

My only expectation is that the next few months will be unsettling times for the oil industry. Eventually, oil prices will find a new normal and the industry will adapt. I further expect that there will be changes in Alberta and in Calgary, more specifically, with decreased oil revenues in the short term. Looking further afield, watch Venezuela. It was encountering severe stresses prior to the collapse in oil prices. Unfortunately this recent change might hasten further adverse changes.

The year 2015 promises to be one of change for the oil industry.

On October 27, 2014 I went to photograph Lake Louise in Banff, Alberta. While I have been there countless times, I am always hoping to capture a better image than I have before.

I arrived early in the morning, before sunrise, and the temperature was near 0C or 32F. At about 8:15 a.m., the sun finally began to appear over the mountains. After I captured this photograph, I waited for a while longer hoping to get better or more even light. When I felt that was not likely to happen anytime soon, I headed toward the other end of the lake, closer to the base of the glacier.

When looking back toward Chateau Lake Louise, the Chateau was partially in shadow. Consulting apps on my iPhone, I knew that the sun would not swing around for a couple more hours. So, I headed up to the top of Beehive to capture my next photograph looking down at the Chateau.

I typically carry too much stuff. In this instance, I carried my camera gear, including my tripod and its case. I felt like a pack mule going up the mountain. By the time I finally reached the top, I was exhausted. A key lesson when hiking in the mountains is to keep your stuff to an absolute minimum.

After capturing my shot from the top of Beehive, I returned the same way I came so that I could take my photograph of the Chateau from the end of the lake near the base of the glacier. On my way down, I noticed gathering clouds above. When I initially got myself into position for my final photograph, the Chateau was hidden in shadow. So I waited for a few minutes for the sun to move from behind the clouds and light up the Chateau.

Behind the Chateau is the Lake Louise Ski Resort. Although it appears to be located directly behind the Chateau, it is actually across a valley through which the Trans-Canada highway is routed. The base for the ski runs is nearly 5 kilometers or 3 miles behind the Chateau.

Looking at these photographs, you’ll notice that the color of the lake changes considerably. Although I am sure that there is some scientific explanation as to why the color varies from photograph to photograph, I don’t know what it is. I know that lakes in the Rockies usually have a turquoise color because of the dissolved rock silt from glaciers. In the last photograph, however, the color is closer to a traditional blue lake color. I have a hunch that photographing from behind the sun on a cloudy day affected its color.

Here’s a link to a photograph shot by my Flickr friend Bernie. You’ll note that he is even higher up the mountain than I was, and from his photograph, you can see Lake Louise and Lake Agnes. Notice the difference in color between the two lakes. And, from Bernie’s photograph, you can see Chateau Lake Louise, the valley, and the ski trails.

In reviewing these photographs, I know there is room for improvement. When I get home and review my pictures, I compare what I recall seeing in my mind to what I see on the computer screen. It’s a tough challenge, because the immense grandeur of Banff is difficult to capture. Yet, it’s a valuable exercise because I discover where my photographs fall short. Sometimes it is something as simple as lighting. That can only be fixed by being at a location at a different time, or a different time in a different season. Other times, I see that my lens selection is poor. Perhaps a wider or narrower lens would be more appropriate. Perhaps some photographs would be better captured from a different location or angle. And at other times, Mother Nature wasn’t cooperating. In the last photograph, for example, the water was too rough. In that instance, it simply means that I have to try it again on some other day. Even with all the shortcomings, the trip was a valuable exercise because it is only through experience that one learns to become better.