The Bottom of the Barrel

For the past several years, OPEC producers have continued to cut their own production in order to maintain reasonable Oil prices.  OPEC countries depend on this revenue to balance their own fiscal budgets.  However, this price stability gave a green light to U.S. Shale producers to grow their own production – which in turn forced OPEC to reduce production even more.  This was an unsustainable situation but was manageable as long as global economies were growing.
 
Covid-19 brought the entire world to its knees and created a massive demand shock for the oil market.  The magnitude of the shock and the resulting excess oil supply meant market forces would dictate prices.   At the same time, the disagreement among members themselves came to a bubble.  To continue the strategy of reducing market share via production cuts while letting Shale-players enjoy the upside became untenable.  There was only one way out of this dilemma.
 
The Saudis finally decided to play long-ball.  The only long-term solution to let the market balance would be for U.S. Shale-players to cut their supply.  They (we) are swing producers after all.  The only way to do that would be for prices to stay low for an extended period of time.  By raising its production at a time of global demand shock, the Saudi’s accomplished that.
 
The energy ‘Bear Market’ that started in the summer of 2014 is now in its final innings.  These are also likely to be the most painful of innings.  The Saudi’s rescued the U.S. shale industry by balancing the market in 2016.  This time we are on our own.  In 2016, there was an overwhelming amount of private capital waiting to scoop up bargains.  Four years later, there is no one.  Equity investors, private equity investors, as well as bond investors, are all running scared.
 
There is a good reason for investors to turn their backs on the energy sector.  Most businesses did not generate an acceptable return on invested capital over this cycle.  They threw good money after bad deals and aggressive investment plans.  If they didn’t make money in boom times, what are their chances during the bust?
 
Now only the fittest will survive.  There are two ways out 1) Either the Saudi’s blink (stop over-producing) or 2) we endure a wave of painful bankruptcies and restructurings.  While the former will only provide temporary relief, the latter will bring a lot of pain to all, and a lot of gain to the ones who survive. 
 
We have reached the Bottom of the Barrel.

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This material contains certain forward-looking statements and projections regarding the future performance and asset allocation of the Fund.  These projections are included for illustrative purposes only, are inherently speculative as they relate to future events, and may not be realized as described.  These forward-looking statements will not be updated in future.