Meanwhile, Russia is making efforts to persuade United States compliance with OPEC Plus, which will ultimately cut the US global energy supply share. Mr. Iak believes that it is the United States’ obligation to maintain supply control in order to prevent the formation of an oligopoly that can price gouge and push weaker industry players out of business. Depending on the progression of the current COVID-19 crisis, prices may remain under control or become incredibly unstable causing the market to potentially hit zero and, consequently, could push all high debt-bearing firms out of business.
Ryan Morfin: Welcome to Non-Beta Alpha. I’m Ryan Morfin, and in today’s episode, we’re going to discuss the war on supply, Putin versus Saudi Arabia with industry veteran Matthew Iak from US Energy Development Corporation. Matt’s here to talk to us today about what’s going on in the oil and gas space. This is Non-Beta Alpha. Matt, welcome to the show.
Matthew Iak: Thank you, Ryan. Glad to be here.
Ryan Morfin: So Matt, I know in a previous career you’ve managed a billion of client assets as a broker. And prior to joining US Energy, you were an advisor going through a lot of the same things people are going through today. And now as an executive at US Energy, can you maybe go into a little bit of what’s going on in the environment today and what brokers need to be thinking about when they’re talking to clients about the oil and gas space?
Matthew Iak: Yeah. Thanks Ryan. They’re both correct. Yes. I’ve been with you energy for almost 15 years now, probably just over and former life as an advisor. So I fully respect the angst and agna that many clients are having today, not just relevant to their investments in the energy sector, but probably across the whole spectrum. So I’d love to focus on the energy sector as much as I can provide some value and some guidance to hopefully give people an understanding of where things stands now, Saudi Arabia, Russia, the US overall pricing and how it affects the overall investment portfolio.
Ryan Morfin: So today we’d love to get your opinion just on some recent headlines on the oil and gas space, everyone’s really focused in covering the COVID and the virus pandemic, but a significant impact has been made across several industries. Oil and gas is no exception, but there’s something brewing that’s larger, that would probably be top news, if it wasn’t for all those other bad news that’s surrounding us today. Which is the war that’s going on between Saudi Arabia and Russia, and why it’s going on and how it’s impacting US Energy producers. I’d love if you could just go into that a little bit and share your insights.
Matthew Iak: Yeah. So the backdrop of all this is you’re right. If COVID wasn’t … Or Corona, wasn’t the top of everyone’s lips. I think that the number one news headline might in fact be the supply side war that has occurred once again in the oil industry and a backdrop Corona did obviously come to a head in February when the spread started and you started to see Russia and Arabia disagree, or as they call it OPEC plus start to disagree on future supply cuts in terms of stabilizing prices, what was then to be seen as significantly smaller impact than what we’re seeing now. And by both parties standing their ground, on essence doubling down by opting to flood the market with additional supply, that itself would be a major headline repeating the 2015 era of the Saudi playbook appears that the Russians are doing a very similar stand and Saudi Arabia is digging their heels in as well. So it’s a really unique headline, one that is actually almost being thrown out because the supply side …
If we talk about a normal equation, you’d have a denominator and a numerator, and we would be talking about one side of the equation, but now that the other side of the equation, the denominator in terms of actual demand is the biggest question mark, it almost makes some of the posturing less important than trying to figure out where demand will fall from over 102 million barrels a day of demand, down somewhere is at 90 years or is at 80. And then ultimately what levers are there to try to control that price decline with or without the stance of Saudi Arabia and Russia, that is occurring in that backdrop.
Ryan Morfin: And so the pricing of oil that we’re seeing today, could it possibly go lower? And how would that play into production levels that US producers are facing whether they want to produce or not?
Matthew Iak: Yeah. I’d love to tell everyone that this is the bottom of oil prices, but it definitely could go substantially lower. In fact, there’s conversations about below zero and in many aspects, oil is and will be below zero for many producers. And in fact, you’re probably less than 60 days away from being unable to store additional supply. And thus there’ll be parts of the supply chain that will be having negative arbitrage, is not 6 or 10 or $14 a barrel, but to the point where it’s a negative pricing, even if the actual market price didn’t drop further from here. But aside from regionality and storage issues, I think with ELGOS running the market now, and Hedge Funds really dominating money flows, you could absolutely see triggers that bring oil as down as low as $5 a barrel.
I don’t know if the conditions are there yet, but it’s an absolute possibility, that you don’t hit bottom yet because of the technical side. So you have the fundamental side, on one side of the equation, which I recently discussed, and then you have the technical side. And both are still at risk, which means that you could only dice for lower prices. And again, this is more of a short term than a long term conversation, but that risk is real.
Ryan Morfin: And some people talk about people being forced to pay others to drag oil away from the drilling sites. Is that a real possibility in today’s market or in the future market?
Matthew Iak: It is. I mean, I just … People don’t really recognize that in parts of the world, is the supply side fight. Russia and Saudi Arabia having a fight for the control of the supply chain, which I will hold the whole separate argument of why I think that’s a useless and silly fight because buyers aren’t really stuck with any one seller. They’re not really loyal to anyone, but the lowest price. So to have a supply side fight is somewhat of a silly fight, but Saudi Arabia is already selling oil at 12 to $13 a barrel below market price to Europe. To try to supplant Russian supply, which means at $20 a barrel you are down to 8 or $7 a barrel that they’re selling oil to their lifting costs, and it is … Might be 5 or $6 a barrel, but at the end of the day … So, and the answer is yes, there is absolutely as prices drop, and even in current markets, as storage fills and custody is, or people might have to pay to take oil or even natural gas away.
And ultimately when you have … The US has significant legal ramifications for not producing oils that are already in production. So to not lose leases to land owners, to not have certain conditions applying in terms of contracts with midstream companies that you’re guaranteed takeaway capacity, you have significant issues where people could be in in fact, losing money per barrel.
Ryan Morfin: One question I had is I know in the last call at five or six years, a lot of these marginal producers have been ramping up leverage. And now they’re in a position where oil prices and their revenues are served really curtailed. What’s your view on the outlook of those companies that are over leveraged today and how is that going to play out in the market?
Matthew Iak: Yeah, so markets usually have a natural level of capitulation and companies are going through bankruptcy and restarting. And I think the last downturn really was almost unnatural in that there’s very little capitulation. There’s a lot of zombie companies that are overlevered, have been able to kick the can in one way or another. Most of the bankruptcies were chapter 11 and were really were nothing more than financial re-engineering in 15, 16 and 17. So what you had is debt holders taking the equity holders out, taking possession of the companies and the assets, but never actually going to market. And we’ve really never had the free market takeover in that force capitulation. And I think you’re finally going to see a mass exodus and wipe out of companies really even here at 20, but especially if there is any even technical move down because of algorithms in the market or fundamental move down because Saudi Arabia and Russia refuse to or keep their heels hammered in.
There’s a lot of other global fallout for the other OPEC members, Algeria, Nigeria, Iraq, there’s significant fallout everywhere, but in the US specifically, I think those zombie companies, and there are a lot of them will ultimately now be out of business. And I’ll come to my conclusion, which I’ll reiterate multiple times probably on this call. Anyone who is long cash and short on debt is probably in the largest generational opportunity in the energy space. They’re just going to have to be very patient and wait for those opportunities to come to them. But there is going to be hundreds of billions or trillions of dollars of loss, unless there’s someone who steps in and interferes with the capitalistic process here in the US which could happen. State regulators are already starting to get involved as is comments from the white house. So there could be a backstop to all of this, but ultimately in the free market system, which is the healthiest system, there’s going to be more pain before those gain.
Ryan Morfin: So going back, so where did all this start? I mean, did Putin really want to take aim at the US fracking and marginal production market or and the Saudis were basically stepping up to protect our market for a period of time. And now they’re saying they’re finished, or is this something that’s a personal riff between these two countries because of Syria? What’s your thoughts on what’s really playing out this pricing war between these two superpowers in the oil space?
Matthew Iak: Yeah, so Russia has always wanted … And has really been frustrated by the US coming out of the last applied side war and for team with a lion’s share of the market. So there has been … The United States has increased production by 600 barrels a day. It’s an utterly frustrating process for them. Saudi Arabia attempted this move once and failed miserably, and actually lost a significant amount of supply side control in the last price war. And that tends to happen with capitalism, right? You drop prices, people get more efficient, they can operate at a lower cost. The reality is the US is still a higher cost producer than both Saudi Arabia and Russia, and will remain scale as a more expensive production level. But the reality is the world doesn’t want two oligarchs and despots in control of pricing. It really wants the US, it’s almost an American obligation for the US to become independent and stay independent and keep our supply side control.
Because ultimately, I think what it does is it keeps us in a world where we’re not going through Corona and also paying $80 oil. And I think ultimately the US is a godsend in so many ways. For the revolution we’ve had and not allowing these countries to have the ability to produce oil at 90 to a $100 a barrel and force everyone in the market. I also think the supply side war is silly in the sense that even if you close every US oil and gas business, including the majors as oil prices rise, a new company will come in and other companies will come in and fractured at efficient low costs. You can get production to market so quickly, thirties, forties and fifties and sixties, the US will once again supply the world with … and will wash the world with oil to keep prices from staying higher or lower than Saudi Arabia and Russia war.
So I think all of this is very interesting. So yes, you have the Russia side that would like this, but people don’t recognize that Russia’s conditions of producing oil aren’t exactly easy to ratchet up and ratchet down production. A lot of them are extreme conditions. And ultimately they really don’t have the same levers. They want to produce and they’re going to continue to produce. They have smaller levers than Saudi Arabia does. So they weren’t really in the position to continue to cut without it having a major cost to them. Now, they also can’t afford this $20 oil really, $30 oil and below puts them in a complete recessionary scenario. So although they have the balance sheet to afford this for a couple of years, Putin has an awful lot of political [inaudible 00:13:22] who wants to stay [inaudible 00:13:25], going through a massive sums of tariffs of you name it that’ll probably come hurt them.
So they want lower, probably not this low. Saudi Arabia on the other hand, did always want to keep prices modest, but has now stuck its heels in, in this battle, trying to fight with Russia, not really against the US, but it’s also not working with the US, it would like US to take a significant part of this pain. Unfortunately, it doesn’t work as quickly in the US as shutting things down or slowing these down, but they do want us to take a significant amount of this pain and go away from 13 million barrels a day, maybe down to 10 or a longterm.
Ryan Morfin: So who do you think blinks first? You think it’s going to be Saudi Arabia or Putin?
Matthew Iak: I don’t think it would be Russia. I think Russia believes they have the strongest hand. I believe if Russia can get what it’s wants, which is really difficult, because what it wants is the US to come into compliance and to jump into this negotiation with OPEC plus and cut supplies. The problem is that violates US antitrust laws. The Texas railroad commission is already in negotiations, but it can’t really act as a country to, in essence stop capitalism. So I think the more likely scenario is you’re going to have a lot of short term pain, you’re going to have a slight insignificant long term production decline in the US, which is going to be lower prices than people want them. A lot of bankruptcies, a lot of retooling of the industry in the US. But also Saudi Arabia and Russia not getting what they want longterm, which has any type of control where it can’t just be turned back on in the next high price.
So I think all of the above. Short term pain and longterm gain. That could all be put to bed very quickly if Russia and Saudi Arabia do decide to get together, and there are some levers pulled by the US in terms of it opening up its strategic reserves and buying some of the reserves along with a bunch of other measures, like the Texas railroad commission. Doing what it did in the seventies, and ultimately limiting production from the state. There could be some, all of the above that doesn’t seem likely, because you have capitalism in the mix against a bunch of oligarchs who are very stubborn in their way.` And it basically means everyone has to lose. And I’m not sure everyone has that, and the reality is, Ryan, as you and I were talking offline before, it depends on how long cov had six round, because if you have a demand side destruction of 20% of the market, there’s not enough leverage to pull. You’re going to have a substantial reduction in price for that period of time.
Now, as soon as that goes away and the global production goes back to a norm, obviously you’ll have a massive pendulum swing. But until that point in time, there’s really no control in where the prices go from a fundamental or a technical standpoint, which means wall street algorithms are going to run a while and have massive volatility in price.
Ryan Morfin: Well, Putin has recently also leveled the playing field during this coronavirus. He’s made himself president for life by changing the Russian constitution. So he’s now on par with the King of Saudi Arabia to not have a local domestic politics interfere with his time horizon. Well, I got one more important question for you. Who do you think wins in a bar fight Putin or MBS?
Matthew Iak: It’s a phenomenal question. I think the US wins in a bar fight.
Ryan Morfin: The US wins in a bar fight. All right.
Matthew Iak: We win in a bar fight, but hey, listen. At the end of the day, there’s a ton of optimums in the space Ryan, there’s going to be a lot of pain. There’s going to be a lot of EMP companies that aren’t there five months from now, but there’s going to be an awful lot of gain as well. The US will come out just as resilient. The energy market will be just as technically sound. My only concern truthfully is something I don’t have the bandwidth to measure. And that’s if the oil and gas market as a whole takes a substantial hit for three months, five months, six months, and there is a retooling of the whole industry. It unfortunately is what led the US thought of the last recession. And I’m unsure as to without that industry, the US is V-shape recovery versus U-shape, right?
Because I don’t want to speak for others, but I truly believe that you now with the passing of this bill have a more likely scenario of a V-shape, if this Corona can be contained. But the oil industry could be the one question mark. It was the leader of the last time. And without it, I do wonder where that major inflection point comes to move the market higher, faster.
Ryan Morfin: All right. Well, that’s all the time we have for today, Matt. I wanted to thank you for coming to the show today. We appreciate your time and your insights, and we hope to revisit this conversation. I assure it will continue to be a timely conversation going forward. So thank you so much for your time. I know you guys are very busy right now.
Matthew Iak: Thank you, Ryan.
Ryan Morfin: Thanks for listening to Non-Beta Alpha. And before we go, don’t forget to subscribe and leave us a review on Apple podcast or our YouTube channel. Our next episode, we’ll speak with a Shanghai native that will tell his story on the first few weeks in China, during the COVID crisis, give us some perspective of what they’ve been going through since they’ve been in a few weeks out of the US. Until then this is Ryan Morfin signing off from Non-Beta Alpha. Thanks for joining us. And now you know.
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