Monday, June 8, 2015

Review of Twilight in the Desert by Matt Simmons

It's interesting to take a book that made a bold prediction ten years ago - Matt Simmons' Twilight in the Desert in 2005 - and see how it performed, and whether it holds any lessons for us today.

When it was published, WTI crude oil was at about $50/bbl. Now it's $60, only a 20 percent increase over a decade - and adjusted for CPI inflation, real oil prices are the same as a decade ago!

Probably the most embarrassing miss by Simmons - which isn't in Twilight but in his other public comments - was on natural gas supply and prices. Despite attempting to know the world's supply curve for oil and natural gas, he was not able to know the area that shale oil and gas occupied on the supply curve. But who can blame him? Aubrey McClendon didn't foresee it either!

What Simmons got right was the increasing complexity and cost required to produce Saudi oil. From the original vertical wells that were gushers, the Saudis have had to turn to much longer and more complicated horizontal wells and water injection wells. This is true for the world at large; capital expenditures by oil producers grew significantly (~3x) over the decade since the book was written.

And oil has averaged significantly above $60 over the past decade. In fact, there have only eight months (12/08-4/09 and 1/15-3/15) during the decade since the book was published that oil has been below the $50 price from the time of publication.

So, conservative oil investments made at the time that Simmons published the book would have done well. Two things that come to mind are royalty interests (which would not have a bankruptcy risk during periods of falling prices) and oil service companies (thanks to the tripling of capital expenditure). My hunch is that the royalties would have done the best, thanks to the dividends, but probably would have underperformed a 30 year treasury.

What Simmons got wrong was overheated commodity bullishness, and not cashing out once he'd gotten everyone else to buy in to his bullish story. The December 2013 oil expo was a third chance for everyone to cash out of the ancient (15 year old) oil bull market, the first being the blowoff top in July 2008 and the second the commodity blowoff in April 2011. Nobody took the opportunity.

3/5

8 comments:

whydibuy said...

I don't think he was so wrong. What he miscalculated, as did M. King Hubbard did, is underestimate the balance between price and production. Higher prices spur more innovation in the extraction area and make more of that remaining 50% of oil in a mature field accessible. Remember, a field is considered depleted when 50% of the oil is produced.

As for oil discovery and the ensuing bell curve, that has not moved. Fields are still peaking out and oil would be much higher except for the time buying innovations in extracting oil.

One big screwup Simmons made just before his passing was a big short bet on BP. He thought the well accident would ruin BP. Like cp, his permabear mode led him to wrongly think a one time event would kill a great company like BP. It was madness.

Anonymous said...

CP in 2010:

Bought Some British Petroleum (BP) Notes
http://www.creditbubblestocks.com/2010/06/bought-some-british-petroleum-bp-notes.html?m=0

Still Like British Petroleum (BP) Debt
http://www.creditbubblestocks.com/2010/06/still-like-british-petroleum-bp-debt.html?m=0

Mr. Gotham said...

@whydibuy Doesn't seem like you have considered that higher prices spurring innovation in extracting oil will be a continuous process that will likely flatten the decline rate over an extended period. In the same way that rising prices destroy demand and insure that we will never run out of oil, higher prices will support production longer than a typical static analysis assumes. The cure for high prices is high prices.

James said...

Two things that come to mind are royalty interests (which would not have a bankruptcy risk during periods of falling prices) and oil service companies (thanks to the tripling of capital expenditure).

Oil service companies like RIG and TDW have been terrible investments over time. TDW trades at the same price today as in 1980. IMO oil services is the stereotypical cyclical industry where awful capital allocation and lack of any barrier to entry keep returns close to nil.

CP said...

A couple people have pointed out that oil service stocks have lagged the S&P since the book was published. I was surprised that they haven't been able to generate value for shareholders despite industry revenues tripling.

Selling shovels and pickaxes to miners, after all.

Maybe this is telling us too things: the book actually came out far enough into the oil bull market that it was tough to make money on the information, and the oil and gas industry managements are remarkably poor at capital allocation.

Without oil services, that leaves just the royalty trusts. And what sets royalty trusts apart from the E&P and services companies? No reinvestment of cash flows!

CP said...

Also, it is amazing that Aubrey was (one of) the first to lease a major position in every shale play, and yet generated this little value:

http://www.barchart.com/chart.php?sym=CHK&t=BAR&size=M&v=1&g=1&p=MO&d=X&qb=1&style=technical&template=

The company has paid $3.52 in cumulative dividends. (Plus the Seventy Seven spinoff that's in the process of going to zero.) Probably some people have owned this for 10 or 20 years and lost money!

Never give money to a landman!

CP said...

Now oil is 20 percent lower than when Simmons wrote the book a decade ago!

What do you think he would have paid for 2015 $50 oil calls?

And yet they've expired worthless.

CP said...

What Simmons got wrong was overheated commodity bullishness, and not cashing out once he'd gotten everyone else to buy in to his bullish story. The December 2013 oil expo was a third chance for everyone to cash out of the ancient (15 year old) oil bull market, the first being the blowoff top in July 2008 and the second the commodity blowoff in April 2011. Nobody took the opportunity.

I should've posted a chart of this:
http://www.barchart.com/chart.php?sym=CLY00&t=BAR&size=M&v=0&g=1&p=MN&d=X&qb=1&style=technical&template=

In July 2008, you have the high of 145. Then in April 2011 you have the much lower high of 114. Then oil stalled three more times on rallies into the 105-110 range before collapsing.

A series of lower and lower highs!

But most investors these days can't read a chart!