Switching Horses on Oil Strategy

The WSJ reports on big oil's quandary...can't make new capital investment in exploration cause it just don't pay...

Thunder Horse, which started up in 2008, will provide 42% of BP's incremental upstream production over the next three years, according to analysts at J.P. Morgan Chase. Unfortunately, it is also one of BP's few discoveries of such scale in recent memory. Neil McMahon of Sanford C. Bernstein calculates that less than half of BP's additions to reserves over the past five years have come through its exploration efforts.

Malcolm Gladwell on Underdogs and Inliers

Malcom Gladwell is an author I enjoy greatly. And I recently found two pieces of his that are worth your time. One is about achieving success as an underdog. The next is about successful people who get missed by the media - "inliers" in his vernacular.

From the New Yorker:

Insurgents, though, operate in real time. Lawrence [of Arabia] hit the Turks, in that stretch in the spring of 1917, nearly every day, because he knew that the more he accelerated the pace of combat the more the war became a battle of endurance—and endurance battles favor the insurgent. “And it happened as the Philistine arose and was drawing near David that David hastened and ran out from the lines toward the Philistine,” the Bible says. “And he reached his hand into the pouch and took from there a stone and slung it and struck the Philistine in his forehead.” The second sentence—the slingshot part—is what made David famous. But the first sentence matters just as much. David broke the rhythm of the encounter. He speeded it up. “The sudden astonishment when David sprints forward must have frozen Goliath, making him a better target,” the poet and critic Robert Pinsky writes in “The Life of David.” Pinsky calls David a “point guard ready to flick the basketball here or there.” David pressed. That’s what Davids do when they want to beat Goliaths.

From Sports Illustrated:

Nick Faldo [is a golf inlier]. Think about it. He wins six majors. He's the dominant golfer of the late 1980s and early 1990s. But we don't mention him in the same breath as, say, Arnold Palmer, even though Palmer only won one more major than Faldo. And why? Because Palmer had Nicklaus and Faldo had, well, Scott Hoch, Mark McNulty and John Cook. Now imagine he comes along in the late '90s and goes toe-to-toe with Tiger Woods from the beginning. All of a sudden Faldo gets immeasurably magnified by the comparison. I'm not saying he'd beat Tiger. (Are you kidding?) But he's the perfect foil. I got a tape recently of the 1996 Masters, when Greg Norman had his epic collapse on the back nine. That tournament is always explained in terms of how Norman choked, as if there were something inside him that inevitably caused him to surrender a six-stroke lead. Nonsense. Surely the key to that whole collapse is that he's paired with Faldo, and Faldo in his prime was terrifying. He was surly and tough and charismatic and emotionally and psychologically bulletproof, and I feel like he'd do a better job of getting under Tiger's skin than anyone out there right now. What's the defining fact about Faldo? His ex-girlfriend once destroyed his Porsche with a 9-iron. The corresponding fact for Woods is that his favorite band is Hootie and the Blowfish. Hootie and the Blowfish? What's Faldo's favorite band? Joy Division? Or some kind of obscure Welsh thrash band too hard core for American radio?

Peak Oil Update

Here are three presentations by Matthew Simmons, the Twilight in the Desert guy.

Mr. Simmons is a big energy bull. The jury is still out as to whether he is full of bull. But his presentations are quite compelling.

60 Minutes on Clean Coal Technology

LTCM Guest Lecture at MIT

One of the Long Term Capital Management folks, talking about the implosion of this fund from back in the 90's.

* The first 1:05 of the talk is "facts and fictions about the LTCM meltdown"
* Lessons learned begins at 1 hour and 6 minutes.
* Q and A at about 1:10

Customer Programs in Electricity

The majority of postings on this site are related to commodity markets. Why? Because I find them interesting and dynamic, and because my readers feel the same way. Commodity markets are inherently interesting because they change so quickly. Also (and this is kind of a drag), we are exposed to commodity price in our businesses.

So if the majority of postings are on the drivers of commodity prices, would it surprise you to know that I feel that commodity price fundamentals are not the most important thing that this site communicates? It is true...most of my postings are interesting and important (arguably) - but not crucial to business success.

The following post IS crucial to business success. It deals with providing customers choice and certainty. I have posted previously about how developing customer programs like budget billing, fixed price offerings, and not-to-exceed (cap) price offerings - and how these programs are integral to a business's success. Why do I feel this way? They create customer freedom to choose. Customer certainty. Customer flexibility. Customers can be offered program entry points at multiple times during the year and customers have the ability to spread their costs evenly over a number of months are the happiest customers. Per Gallon Price becomes less of a hurdle. Value is added above the delivery of the molecule into the customer tank.

Here is more proof, via Yahoo Finance:

DALLAS (AP) -- At TXU Energy, the biggest electric company in Texas, the fastest-growing billing plan is one that lets customers lock in the price of power for one or two years.

"It's easier to plan that way, and I think you're saving money," says Brian Bell, an advertising salesman who signed a 2-year, fixed-price contract for electricity at the 1,500-square-foot Dallas town house he bought last year.

Other homeowners across the country are locking in prices now on electricity for summer cooling and heating oil for next winter. Heating oil prices are nearly 60 percent lower than they were at this time last year, according to Energy Department figures.

Natural gas prices have fallen as well, which not only affects the price homeowners pay for gas but the price of electricity produced by power plants that run on gas.

Our deregulated competition is beginning to offer flexible payment terms - not selling price but selling value to the consumer. Will our industry be early adopters of this customer service, or will our competitors build a competitive beachhead and some momentum in this regard?

Embracing these programs satisfy a customer need. They allow the local propane company to offer piece of mind to the customer, and make paying the heat bill feel like paying the cell phone bill, or the water bill.

In grad school, I learned that businesses should "make it easy for their customers to give them money." The more flexible our businesses become to our customers' desires, the more customers will embrace us as their supplier - regardless of price.

The Curve of Forward Prices

An article containing some good explanation about what the forward price curve represents can be found at DownstreamToday.com. Here is an excerpt:

Looking at the prices of long-dated oil futures can be useful as they provide the best tradable indication of the future expected price of the commodity. While long-dated futures contracts are traded less frequently than their near-month counterparts, the December contract is an exception as speculators and producers attempt to lock in or hedge oil exposure for year-end.

Oil producers use the futures prices as a key benchmark for domestic production, using the contracts to hedge current inventory or using the price to evaluate potential exploration projects.

"The forward price of crude oil is a combination of the need to fund existing stock levels and trading flows, which in turn embody price expectations," said Lawrence Eagles, global head of commodities research at JPMorgan.

While long-dated futures contracts are still much higher than the near month, a situation described as contango, the forward curve has been flattening out recently as traders have adjusted expectations after weeks worth of data from the Energy Information Administration, an Organization of Petroleum Exporting Countries meeting and bulk shipping statistics. As the curve flattens, the long-dated contracts fall at a faster rate than the near-month contract, or the near-month contract rises faster than those further out. A year-end rally could be thwarted by continued weak demand and burgeoning supplies. Oil demand is forecast to fall to the lowest level in five years, according to the Energy Information Administration. U.S. crude oil inventories are at 18-year highs.

A Fantasticly Entertaining Waste of Time

The Washington Post held its third annual Peep-Art Competition recently.

HERE are the 20 top reader diorama submissions.

Oil Futures Market Primer

Here is a lecture by Robert Shiller of Yale on the uses of stock and commodities futures. It spends a great amount of time focusing on oil market fundamentals. It takes an hour to get through - but if you are a propane of heating oil marketer this is a solid and easy to understand primer on a key market and how it works.

OPEC Oil Market Report for March

Monthly Oil Market Highlights in an audio podcast, as OPEC sees them...

* Outlook is Bearish as world GDP is being revised downward.
* World GDP is contracting by about 1%

* Supply growth is slowing, too
* Days of forward supply (at 60 days) are the highest they have been in 15 years

Southwest Reports that Fuel Hedging Program Creates More Losses

From Southwest's 10Q, released today.

“We benefited from significantly lower year-over-year economic jet fuel costs in first quarter 2009. Even with $65 million in unfavorable cash settlements from derivative contracts, our first quarter 2009 economic jet fuel costs decreased 16.2 percent to $1.76 per gallon. With oil prices rising, we have begun to rebuild our 2009 and 2010 hedge positions, using purchased call options, to provide protection against significant fuel price spikes. These new positions present no additional exposure to cash collateral requirements. Furthermore, we have modified our major fuel hedge counterparty agreements to allow us to use collateral other than cash to limit our cash collateral exposure to comfortable levels. Based on our second quarter derivative position and market energy prices as of April 14, 2009, we currently anticipate our second quarter 2009 economic jet fuel costs, including taxes, to be in line with first quarter 2009 (or the $1.75 per gallon range).”

The Company has derivative contracts in place for approximately 50 percent of its second quarter 2009 estimated fuel consumption, capped at a weighted average crude-equivalent price of approximately $66 per barrel; approximately 40 percent for the remainder of 2009 capped at a weighted average crude-equivalent price of approximately $71 per barrel; and approximately 30 percent in 2010 capped at a weighted average crude-equivalent price of approximately $77 per barrel. The Company has modest fuel hedge positions in 2011 through 2013. The current market value (as of April 14, 2009) of its net fuel derivative contracts for 2009 through 2013 reflects a net liability of approximately $950 million.

I am partial to the SWA business model and corporate culture. It has proven its competitive advantage in the best of times and the worst of times. Its team members are friendly and motivated, and its management is aggressive in attacking opportunity. Plus...they are active fuel price speculators. Their hedging program has earned them kudos from the national media, and has been written about on this site several times. But unless your fuel price speculation program is run by Bernie Madoff (pre-ponzi), even the best traders and economists are going to lose once in a while.

More importantly for propane and heating oil marketers, though, check out that they bought long dated CALLS to protect their position. They weren't afraid to spend the premium for the insurance that the calls provide. Also, they view their fuel risk position as a portfolio - and seem to be willing to enter into a number of strategies to achieve their goal. Finally, they have a model that they use that can help them plan what costs will be due to the hedging tools they hold in their portfolio. These are the things that every propane and heating oil marketer should be doing to manage their risk and fine tune their business.

If SWA management needs a post 10q pick-me-up, I am sure that they could step on board one of their planes with this industrious and talented flight attendant.

Barton Biggs on Charlie Rose

This interview is about a month old - but this morning is the first time I had a chance to watch it. Good stuff.

Natural Gas Basics

This is a 4-page analysis of simple supply and demand in the natural gas sector. It was released by the EIA last week, and is a good basic overview.

Climate Change Doubters Unite

Behind a new website.  

www.climatedepot.com

Causes of the Oil Shock

This article is from Econbrowser, a blog from Dr. James Hamilton - a professor from the University of San Diego.

It discusses a paper he wrote on the causes of the oil price rally of 2007-2008. It is formal and academic, and there are charts and formulas. But here is the bottom line: Dr. Hamilton agrees with my thesis regarding the rally. Dr Hamilton states:

"Growth in world income was the primary cause behind an increase in world petroleum consumption of 5 million barrels per day between 2003 and 2005, a 6% increase over the two years. The next two years (2006 and 2007) saw even faster economic growth (10.1% cumulative two-year growth), with Chinese oil consumption alone increasing 870,000 barrels per day. Yet between 2005 and 2007, global oil production stagnated.

My article (from early January) is here.

The cool thing is that Dr. Hamilton and I agree on the causes. He builds better looking models, though.