The Price of Oil Is About to Blow a Hole in Corporate Accounting | Hacker News Reader

The Price of Oil Is About to Blow a Hole in Corporate Accounting

bloomberg.com

86 pointshotgoldminer72 comments

I bought some shares in an oil ETF a fews weeks ago my investment rationale was:

1. If the price stays low I win because my gas will be cheaper (essentially hedging my gas costs). If the price rises my cost at the pump will increase but will be offset some by gains on the ETF.

2. Geopolitical flares up typically drive oil prices higher. Low oil prices destabilize a lot of countries and increase the probability of these issues. It's almost like low oil prices will inevitably lead to high oil prices.

Of course, this is all speculative (mostly for fun for me although it is real money). I would never invest money I couldn't lose based on this loose reasoning. But now I get to call myself an "oil man."

Public service message from someone who went down this road before: it's worth studying up on the futures market. In particular, there's a nasty little thing called "contango" that effectively makes your investment worth less and less every month that you hold it and oil prices don't go up. Think of it as a rental fee for the tanks where they keep the oil held by investors.

The upshot is that you can lose money on oil futures even if prices don't go any lower, and you may lose money even if prices go up, if it takes a long time for that to happen.

tl;dr -- there's no clear way to make an investment that cleanly tracks the price of oil, like there is for the Dow or the S&P 500 or the Japanese Yen.

With all due respect, you're jumbling a bunch of parameters w.r.t. contango, and its implications. Contango structure can exceed cost of carry even if crude oil prices stay flat. There are lots of dynamics, which you allude to.

Fully agree -- it's more complicated than that, more than can be explained in a HN comment. I think you agree with my main point, which is that buying an oil ETF (or usually actually an ETN) doesn't mean your money will track the spot price of crude.

Is investing in a company like exxon a good proxy for oil price?

No, it's not.

An integrated oil company like Exxon has activities that lose money when the price of oil goes down (drilling, exploitation) and others that make more (refining, retail). The price of oil dropped by about half during the past few months; Exxon barely budged.

A better proxy for oil price could be drillers (Diamond Offshore Drilling for example) but they're very far from perfect either. In general, it is very hard to track an asset which price is expected to be mean-reverting like the price of oil.

Not really. A company is always way more complex.

1. If the price stays low you've lost because that money could have been better invested elsewhere. You would have been better off putting that money in your fuel tank, which you'll have to do anyway.

> It's almost like low oil prices will inevitably lead to high oil prices.

Well, historically yes. It's almost like markets exhibit some cyclical behaviour. Good luck picking where to get on and off.

You don't need to rationalise a gamble, just call it was it is: a gamble not an investment. And that's okay. As a perfectly spherical rational actor with zero information-friction I've placed a few bets too.

If the price stays low, he still has the insurance feature of his position (limited downside risk if the price goes up) -- which he wouldn't have otherwise.

The middle east is where the vast majority of geopolitical conflict happens these days and the middle eastern powerhouses (Saudis, Iran, etc) are the ones driving the price down. I doubt they'd do this if it created a security risk internally.

So I'm curious what ripple effect you expect might happen as a result of this decline? South American oil countries? Africa?

More like the Saudis are driving the price down partly in order to inflict damage on the Iranians, with whom they are engaged in something close to a cold war, but mostly to choke out the high cost producers in the US and make future investments in that sector look very risky.

There is definitely a strong destabilizing effect on Russia, Iran, and Venezuela at the very least.

Russia.

Pardon what may sound as a dumb question..

If I understand this correctly, as first quarter and 2nd quarter reports come out, oil-related firms will drop in share value assuming oil prices now are stagnant?

Well, if the stock market reacts by savaging the prices of these companies, sounds to me like a fantastic long-term investment opportunity will be opening up. However large this may be, it's still a transient price drop with a lot of politics in it, and in the long term prices are still only going to go back up. Most of that oil in the ground is still going to be pumped up at much higher prices, and not all that many years from now.

You should look at the graph [1: the article, 2: a hotlink] labeled "Welcome to the Terrordome..." showing the prices of various oil sources vs solar over time. If the fantastic decline in solar prices continue, many oil sources will soon be not economical. And yes, I know there's storage problems and energy density problems for mobile vehicles, but oil is still a riskier bet than I think you portray.

[1] http://www.bloomberg.com/news/articles/2014-10-29/while-you-...

[2] http://media.gotraffic.net/images/iQYuKSosjb3U/v16/-1x-1.jpg

This is pretty weak.

The reason solar-power generation will increasingly dominate: it’s a technology, not a fuel. As such, efficiency increases and prices fall as time goes on.

That's true of shale oil extraction as well.

The corresponding chart conflates all natural gas extraction under the "Henry Hub" label, and all crude extraction under "Brent". Meanwhile, it tries to show an exponential price decline in solar by starting the time series for solar energy costs in 2007. What are we meant to be comparing here?

"That's true of shale oil extraction as well."

If you're arguing that the price of shale-oil extraction can and will only fall, you're almost certainly in error.

Yes, there's some room for improvement in any technical process, initially, but in virtually all (IT and IC design specifically being the notable exception), diminishing returns set in.

For oil, the challenges are twofold.

One is accessing ever more difficult to extract resources -- further offshore, more remote, tighter shale, etc. US EIA's own estimates call for a peak in US shale / tight-oil extraction likely before 2020. http://www.eia.gov/pressroom/presentations/sieminski_0521201... (p. 11, "reference case")

Per-well extraction rates fall off tremendously in 18-24 months, and constant new exploration and drilling (both expensive) are required. Contrast with First Oil Well, Bahrain, completed in 1931, and still providing 35,000 bbl/day nearly 85 years later: https://en.wikipedia.org/wiki/First_Oil_Well,_Bahrain

They don't make 'em like they used to.

The other is the increasing likelihood that fossil carbon assets will be stranded -- prohibited from access until climate and environmental impacts are addressed. Almost certainly a process of a century or centuries.

Solar costs (direct PV) have been falling consistently, though other associated costs (labour, installation, structures, inverters, interconnects) haven't declined as much. The relatively fixed costs then become a larger

> it’s a technology, not a fuel

Maybe! But nothing has an infinite lifetime, so while solar is a technology, the actual solar panels that get made aren't, they're a durable good or an asset, depending on your point of view.

Right now, in a lot of ways a solar panel is simply a way to burn a fossil fuel to make more fuel. Since the lifetime isn't infinite you can compute the amplification factor. Depending on how you calculate it might be a factor of a couple up (just based on price) to a couple dozen (joules to joules). But it's not infinite.

http://www.scientificamerican.com/article/solar-cells-prove-...

This finite lifetime and substantial capex is one of the reasons people criticize basically any kind of ocean power; the environment is so harsh that it's hard to do a lot of energy amplification. If your maintenance costs aren't completely trivial then you're opening yourself up to a sensitivity failure. The difference between 2% and 4% per year doesn't seem huge but over 20-30 years is big.

1.02 ^ 30 = 1.8

1.04 ^ 30 = 3.2

That's one of the reasons that people like fossil fuels so much. The amplification factor is huge and it's well known. It might take two weeks to drill a well (on land) and during that time you might use 3000 horsepower continuously (about 2MW). But if you do the math, that's only 672 MWh. A BOE is about 1.7MWh so you only need to produce 400 barrels to get ahead on the well. Add in another couple of thousand for everything else (pumps, piping, etc) and you've still got a very low bar to net energy gain.

Here's solar back further:

http://io9.com/solar-powers-epic-price-drop-visualized-51044...

What we're meant to be comparing -- and I don't think that chart mean to lump all lng or all oil in together -- is that solar is now comparable to oil and/or lng in certain locations.

Oh, and I don't think anyone anticipates efficiency gains in shale oil extraction comparable to the ongoing efficiency increases in anything silicon related.

Current P/Book values for oil companies now seem to reflect that the market is pricing them with oil reserves at current prices, not reported prices. If it bumps lower around Q1 and Q2 as actual oil price filters into the books then that would be pretty irrational, and likely reflects opportunity.

Right? The whole article seems to be based on the premise that the markets are too stupid to have done the maths, and will need to have it spelled out to them, but somehow this Bloomberg journalist has discovered a huge secret

the markets are too stupid to have done the maths

Lucky for us, the markets are made up entirely of perfectly-informed, perfectly-rational, perfectly-self-interested frictionless spherical humanoids in uniform harmonic motion.

That's a straw man. If you think the markets are as predictable as you're suggesting they are, put your money where your mouth is. Otherwise, best to assume the information has already been priced in.

It seems satire is lost on you.

You mean sarcasm, and you should read more carefully. The post was implying that markets are irrational, through sarcasm, and that in fact it was possible to predict this irrationality. HTH HAND.

> Current P/Book values for oil companies now seem to reflect that the market is pricing them with oil reserves at current prices, not reported prices.

One would hope so. The efficient market hypothesis may not be 100% true, but I'd be surprised if it were that far from true.

The efficient market hypothesis wants to have a word with you.

You don't know that.

The world is really on the way of getting rid of oil.

Electric cars, bioplastics, solar panels getting exponentially cheap.

From my point of view the only thing that stops us all from switching to electric cars is the battery technology.

When it comes to the industrial use of solar energy, we already have the technology of storing energy - flywheel (google Beacon Power).

Even if a perfect battery was introduced tomorrow it would still take at least 10 years before it made a serious dent in the car market. The Prius was introduced in the US in 2000 and it took about 11 years for them to sell the first million.[1]

The vast majority of people don't buy a brand new car more than once or twice in their life. They simply don't have the money. The rest of the people buy a car used and drive it until they sell it to someone else to buy another used car. Cars can last 200+k miles which is often 15-20 years in the life of most vehicles.

[1] - http://en.wikipedia.org/wiki/Toyota_Prius

> The vast majority of people don't buy a brand new car more than once or twice in their life.

The adage has been that "Americans buy, on average, a new car or truck every 3 or 4 years."[1] That's like a dozen new cars in a lifetime.

I was going to call bravo sierra on your assertion, but I decided to try a back-of-the-envelope calculation to check the plausibility:

Roughly 10 million cars are sold each year in the U.S., the U.S. has 230 million adults, and they'd likely buy their cars between ages 18 and 65 (a span of 47 years). That means each adult has a 1 in 23 chance (230M/10M) of buying a new car each year, so over a 47-year span they'd buy 47/23 = 2 new cars.

There could be all sorts of ways my calculation could be wrong, but it agrees surprisingly well with your claim.

I'm wondering now if the "new car every 3-4 years" is a myth propagated by auto makers.

[1] http://www.cnbc.com/id/49504504

If you look at fleet life then you'll find it's markedly more than 3-4 years. It stood at 10.8 years as of 2011.

http://usatoday30.usatoday.com/money/autos/story/2012-01-17/...

33.8% of cars were older than 10 years as of 2001: https://en.wikipedia.org/wiki/Passenger_vehicles_in_the_Unit... http://www.nada.org/Content/NavigationMenu/MediaCenter/NADAD...

If you run the statistics as median number of lifetime purchases by person (rather than average), you'll likely get a lower count as well. High-volume purchasing is likely concentrated among wealthy (or exceptionally unlucky) drivers.

Thanks for the backup. :)

I think the numbers are heavily skewed by people who do buy those new cars every few years.

Also, I think the car rental companies - who would have massive annual turnover of vehicles - further skews the average[1]. The top 4 companies have ~2M vehicles and if they never have a car more than 3 years old (probably more like 2 years), then they buy ~700k/year or 7% of that 10M in annual new car sales.

1 - http://www.fool.com/investing/general/2012/07/13/surprising-...

2nd hand cars? The 10m is just new cars right?

I do mean 10 million new cars are sold yearly in the U.S.[1][2]

Without doing a lot of research, I couldn't decide how to deal with questions of:

- Including or excluding light trucks

- Including or excluding cars that are new but being leased rather than sold

- Large year-to-year variations in sales (esp. of low sales during the recession)

But I think 10 million is reasonable rough estimate.

[1] http://en.wikipedia.org/wiki/Passenger_vehicles_in_the_Unite... [2] http://online.wsj.com/mdc/public/page/2_3022-autosales.html

I would switch to an electric car immediately if I had some place to plug it in. That's a bigger problem for me than the number of miles I can get on one charge. I need about 25 miles a day from my car. More than that is gravy.

It's common on Hacker News for every mention of electric cars to have a complaint from people who can't charge at home. That's not an actual problem: if only the people who could charge at home bought them, that's still a huge % of the market.

> exponentially cheap

Solar is following an exponential fall, but the tail has long been wagged

http://io9.com/solar-powers-epic-price-drop-visualized-51044...

It's funny how the amount of FUD has shot up as the price has precipitously dropped:

* They're unreliable.

* The intermittency makes it impossible to use.

* It's unfair on the monopolistic power companies.

That last one is particularly egregious. They could have been reaping the benefits themselves but they, like incumbents everywhere, sat on their hands and watched the cash roll past.

The largest impediment to everyone switching over to electric cars, is grid and supply, not storage.

We can do the battery storage right now, it's just not as great as what we'd like.

If you switched all cars over to electric tomorrow, the grid would melt down in every country that attempted it. There is not even remotely enough power available to handle it. Most first world countries are running their national power grids with a very modest buffer (and for countries sub first world, forget about it, they're still dealing with routine rolling blackouts).

By the time all autos are switched to electric in 30 years, hopefully self-driving cars have wiped out at least half of all vehicles in the first world.

"If you switched all cars over to electric tomorrow" is not a useful scenario. In reality, the shift will take decades, and that's enough time for changes in the grid to happen.

Of course. The parent said this however:

"From my point of view the only thing that stops us all from switching to electric cars is the battery technology."

My obvious point was that, in fact, that is not even remotely the only thing stopping us from switching to electric cars. My scenario was extremely useful in highlighting the fact that we do not have the capacity to switch to an all-electric car approach, and not primarily due to batteries.

We can do the battery tech and manufacturing in the present, to build very effective electric vehicles. Building up the grid to support ~500 million cars in the first world would cost tens of trillions of dollars and take decades. It makes the battery challenge look hilariously minuscule by comparison.

If building up the grid to support 500 million electric cars only costs trillions, it sounds like an order of magnitude easier than the batteries.

Emphasis on tens of trillions and decades (not merely a few trillion).

Batteries are not a $30 trillion and 30 year problem, not even remotely close. Batteries are an order of a magnitude smaller of a problem.

We can build the Tesla S already. Musk is going to spend $5 billion building a plant that can produce 500,000+ car battery systems. We can already make effective battery systems for mainstream electric cars, the challenge now is to make them better and scale up manufacturing (which has already begun).

It costs $5 billion in the US just to build one major nuclear power plant.

I rarely see anybody discussing where the trillions of dollars in new spending is going to come from to boost energy supply and grid to handle 100 million electric cars in the US. It'll cost trillions just to maintain what we already have now over that time.

Right now, batteries for a realistic replacement car (not a compromise EV like a Leaf) cost about $20,000 per vehicle. That's $10 trillion for 500 million cars. It doesn't look an order of magnitude smaller to me.

As for where the money comes from, doesn't that just fall out of supply and demand? As demand for electricity increases, prices will go up, funding the infrastructure improvements needed to accommodate the increased demand.

The solution may not even lie in the grid. Batteries can solve the grid problem as well as the battery problem. Give every electric car customer enough solar to cover his charging needs and a fixed storage installation to keep the power for when the car comes home, and the grid won't even know the cars are there.

I'm sure this will all be wonderfully challenging for those involved, but it doesn't look like something to worry about from the outside.

> As for where the money comes from, doesn't that just fall out of supply and demand? As demand for electricity increases, prices will go up, funding the infrastructure improvements needed to accommodate the increased demand.

Looking forward to oil-shareholders claiming how expensive electric cars for the elites are making electricity unaffordable for the poor.

Huh. Well, the only thing I can suggest is that if you want to say that, that you say that, instead of what you said. Because no, that's not obvious from what you said, and no, people don't agree with your cost estimate. No "of course" involved.

I did in fact say just that, in the comment you replied to I said:

"By the time all autos are switched to electric in 30 years"

You ignored what I said, and proceeded to tell me how the shift will take decades.

What the heck? That was in a different part of your comment ("tomorrow" instead of "in 30 years"), logically unconnected to what I responded to! If you meant it to be connected, then you could have made it clear.

As soon as we have good cheap batteries, you don't need the grid. You have batteries charging from solar during the day, your car is charging at night.

Unfortunately I don't think that Beacon is doing all that well. They recently had some layoffs.

In case anyone forgets that it can go too far in the opposite direction: http://en.wikipedia.org/wiki/Enron_scandal#Mark-to-market_ac...

Isn't the price being held at an unsustainably low price by OPEC? If so, then any accounting problems would be short lived. Once OPEC cuts supply, the prices will bounce back to ~$100/barrel, I would expect.

There's a lot of speculation on OPEC's motives and power. They could be trying to shut down exploration in the US. The Saudis could be doing the US a favour by trying to destabilise russia. They could be trying to sabotage green energy for a while. Their coalition might just be powerless because everyone needs to pump out as much oil as possible, especially at these price levels.

Regarding future price levels the efficient market hypothesis probably holds: nobody without inside information knows which way the oil price is going.

The reasons I've heard were to kill US oil exploration, and also to teach the high-cost producers (Venezuela, etc) in OPEC a lesson. It's common for these countries to "accidentally" pump over quota to make some extra cash. So Saudi just refused to cut the quota this time around. The Saudis could also be interested in messing with Iran, which has much higher production costs.

I read a lot about the subject and couldn't come up with a satisfying answer as to why the Saudis are doing that. All I know is they are playing a very dangerous game and Washington is letting them do it.

People say,there will be no consequences for USA,but oil prices will go up again sooner or later. What then ? I don't believe shale oil is an explanation.

You don't believe shale oil is an explanation... why? Have you looked at the barrels/day production figures for shale oil? They are gargantuan.

Current oil storage is nearing full. With present condition, they will be full sometime in April. It will take some months, maybe a year for storage to empty out enough to support high prices.

http://blogs.wsj.com/moneybeat/2015/03/05/the-newest-commodi...

http://www.forbes.com/sites/christopherhelman/2015/03/04/u-s...

It isn't only OPEC.

The US dollar shaved at least 20%+ off the price of oil, and likely instigated this crash (the world was swimming in oversupply of oil for quite some time before the crash).

The US dollar began skyrocketing, due to the end of QE, at exactly the same time oil began crashing. Not a coincidence, given oil is priced in dollars and the US dollar is on its greatest one year run in decades.

Look at July 1st

USD http://finviz.com/futures_charts.ashx?t=DX

Oil http://finviz.com/futures_charts.ashx?t=CL

Can you help me get my head around the USD chart? In my head it only makes sense to value one currency vs another (i.e. the USD to GBP exchange rate) so seeing one chart which simply plots "USD" over time is a bit tough to wrap my head around.

that chart most likely comes from this calculation: http://en.wikipedia.org/wiki/U.S._Dollar_Index

Thanks. So a weighted index of USD vs a handful of other currencies - that's a useful measurement I never really knew existed.

It looks like the reverse; OPEC stopped holding prices up.

Indeed. The theory here is that besides a demand drop due to the general world economy, and the US swimming in oil, the Saudis have decided to stop playing the swing producer game because they've noticed when they tighten the spigot, they permanently lose market share.

The current US inventory issue is akin to this, because it exists in part because refineries are tuned to the types of oil they use, and we've spent quite a bit making a lot of them take heavy, sour crude, and fracking tends to produce light, sweet crude. Which is good stuff, and in high world wide demand, but due to another one of those insane '70s energy policies, no one is allowed to export crude (with I think one exception, to refineries that immediately return the distillates to the US).

E.g. we should have exported a lot of Alaskan oil to Japan, when California was not set up to take all of it, and it would have cost less to transport it to Japan and equivalent oil to the US.

It's held at an unsustainly low price by OPEC, but not for OPEC... Saudis can sell oil at $20 per barrel if they feel like it. The pain they're causing Iran right now is probably not coincidental to the nearing of a nuclear deal that would lift the current sanctions and give the regime a lot of wings.

Its more like Saudi Arabia is not reducing production and certain countries such as Russia and Venezuela cannot survive at that price. I think they're trying to force closure of US fracking sites, but they can go down lower than a lot of countries.

I take it no serious investor makes any decision based on that arbitrary number, do they? So then, why require it?

Most serious investors consider this number very important when making decisions. By this number i mean the amount of reserves. Yes, some of the methods of calculating it are a little arbitrary but it is the best information investors have as to the value of a company's reserves. Thus, it is very important.

And it is not completely arbitrary. For example the rules are the same for all oil companies at the same time. So the number is by no means random. And while the results depend on the price of oil on particular days, everyone knows the price of oil and what the key days are. So if some investors believe oil will climb back up, they can do some math and arrive with a number that better suits their view of the future.

Investors, suppliers, the taxman: everybody makes decisions on a company's balance sheet. Accounting like this is done for everything. Oil, cars, computers, cash, bonds, buildings etc. No analyst has the resources to hunt down all these numbers and even if they would, it's often quite hard to decide what a 'fair' value for a given asset should be. A lot of that information probably isn't even public.

It's also done for legal and tax reasons. If your assets lose value, you may run into insolvency (net assets < debt). Your balance sheet should reflect reality and the result can be that you have to shut down the business even though you have money in the bank.

The article's a bit melodramatic about what is everyday accounting. The price of oil always fluctuates so accountants have to use some historical price for calculating reserves so the figure will always be off at a later date when the price has moved. Pretty much anyone capable of reading and understanding the accounts of oil companies will know that.

Its useful to point out that although the standard accounting method was used for the official numbers, at least one of the drilling companies in this article also included the impact of current prices on their reserves. Investors care about this, know about it, and at least some of the the companies give them information so it can be properly priced in.

Accounting usually tends to trail events. That's not a bad thing. More problems come from valuations of future events.

Oil may go up tomorrow. The short-term price is driven more by political events than drilling activity.

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