Andurand's brave bet on a $100 oil price

Earlier this year hedge fund manager Pierre Andurand bet that oil will return to $100 a barrel. The bet caught the industry and runs against the conventional wisdom that the energy industry must prepare to survive with prices at half that level.

It is a call that pitches the French-born trader against some of the biggest trends that have come to dominate the oil market outlook, from the US shale oil revolution to the rise of electric cars which have led the majority of investors to believe oil prices will be capped near $50 for the foreseeable future.

To date, Mr Andurand is nursing losses, with his fund having dropped 15 percent. But his record of bold bets paying off” Andurand has returned investors in his eponymous $1.1bn fund a cumulative 560 percent since 2008’ means it could be foolish to dismiss outright his call of $100 oil by 2020. To understand if such a radical price change is possible one needs to look at the market trends.

Drop in M&A activity

While general global M&A activity has dropped off, the debate around oil price has diverted global M&A Oil and Gas sector activity. In the first eight months of 2017, this sits just shy of record activity, with 611 deals worth a total of $194.9bn.

The activity is clearly led by the US, where 250 transactions worth $113.9bn have been agreed, according to data from Dealogic. This month there was significant activity in Europe where Total bought $7.45bn of oil assets from Maersk. 

The areas to track and focus upon are in production technology, debt reduction by NOCS and mid-size companies and increased investor focus on purchasing key assets. This activity is betting on price increases within 16 months. M&A activity is important to monitor as it is a subtle indicator of sector direction, shift between upstream and downstream which in time will trickle into the whole market.

Just before prices fell from their highs at over $110 per barrel in the middle of 2014, energy giants have been looking to gas, renewables and alternatives to adjust to the new market realities. The common wisdom among the same experts was that prices were expected to stay high for a while. But almost three years later, they are still in a relatively low range of the upper $40s to the lower $50s per barrel.

Low earnings from upstream exploration due to falling oil prices have led to a renewed focus on downstream activities for oil and gas companies.

Exploration and Production (E&P) companies in the upstream sector invested capital in both human talent and physical facilities in order to maximise growth in these areas, based on the assumption that the oil price would remain at approximately $100 per barrel.

Since the fall in oil prices from 2014 onwards, companies began to streamline their upstream operations, by downsizing or exploring their M&A options and seeking cost synergies.

The USA so-called shale boom in recent years, coupled with the fall in the global oil price, has led to significant downstream activity. Lower costs for energy inputs have spurred big increases in the manufacture of plastics and chemicals. This has resulted in capital investment into petrochemicals and a hope that earnings from the downstream segment will offset some of the declines from the upstream segment.

The LNG Train

Supplies of LNG are on course to increase by 50 percent between 2014 and 2021. That implies the opening of a new LNG train” the facilities that condense gas into liquid form to allow it to be transported long distances by ship” every two to three months.

The $14bn Prelude project, led by Royal Dutch Shell, is the latest in a surge of new LNG capacity which promises to reshape the oil and gas industry” and with it, the energy markets they serve. Chevron Wheatstone LNG development in Australia is due to start producing this month, on the heels of its nearby Gorgon project last year, after a combined $88bn of investment. ExxonMobil, BP, Total, and Eni have also made big commitments.

Will demand outpace supply?

According to BP, the world economy is expected to almost double over the next 20 years, with growth averaging 3.4% p.a. (at Purchasing Power Parity exchange rates). Growth is largely driven by increases in productivity (i.e. GDP per person), which account for three-quarters of the growth.

In turn, this economic growth requires more energy, although the extent of the increase is mitigated by falls in energy intensity (energy used per unit of GDP): global GDP doubles whereas energy demand increases by only 30%.

Energy consumption is expected to grow less quickly than in the past: 1.3% p.a. over the Outlook versus 2.2% p.a. in 1995-2015. A significant part of the global economic growth said to be occurring in the next two decades will be driven by emerging economies, with BP estimating that China and India will account for +-50% of the increase.

However, as China focuses on improved environmental standards and rebalancing its economy, it is likely that it will seek less intense primary energy consumption. This could have a profound effect on demand.

Where does that leave Pierre Andurand?

The oil industry, after all, has always moved in cycles. More than anything else his view is based on the assumption that the impact of the US shale industry, while important, is in danger of overshadowing every other source of oil supply.

The transition to electric vehicles is going to take time. Even then the prediction is that logistics, shipping and air transport will increase demand for oil. So maybe although an outlier, Pierre Andurand could be on to something. This is a conflicted market which is moving every quarter. One would be brave to bet him, but braver to bet against him.