Crude Oil Alert: This Time May be Different

March 26, 2014

Is your P98 (low case revenue) adequate for 2015? At R^2, we quantify risk as the difference between P50 (base case revenue) and P98 (low case revenue). Our patented process updates these risk estimates each month (“RRHR”) by refreshing objective observations of price and volatility used as inputs for modeling price risk. Our model, like all models, is only as good as the data and assumptions it uses.

Here in 2014, there are many macro items that are destabilizing the markets and increasing risk. We suspect that markets may not be accounting for the following risk factors;

                      5 year bull market in stocks

                      New Federal Reserve Chairman

                      Bear Market in world commodities such as Copper

                      China (emerging market) client credit issues

                      Rising real estate costs despite declining employment participation
                      Record long crude oil speculation

                      Low levels of client oil percent hedged

If we are right, then our low case estimates may be underestimating the downside risk. By way of example, you may remember that in the summer of 2008 oil prices collapsed after peaking near $140*. In 2008, R^2 pointed out the change in trend on July 18 when the market was trading $129. The trend would not reverse for another 33 weeks, resulting in a $96 fall in spot prices to $33. At that time, our analysis risked 2009 prices to $65, which was close to the mark. The average settlement price for 2009 was $62. But this does not adequately reflect how difficult this period was for our industry. The average price during the first quarter of 2009 was $43. This presented many firms with significant challenges.

In our most recent report, we have risked Cal 2015 WTI down $25 to about $65. Given the time remaining, I would normally expect our model to risk Cal 2015 down by $35-$40. Please review your P98 estimate for 2015 to determine if you are adequately hedged. If not, then you should consider adding hedges to your Cal 2015 portfolio or develop a contingency plan for the possibility of sharply lower revenues. We are not saying this will happen, but we want you to be prepared in the event that it does. Please call to review your hedge portfolio with us.


*All prices are quoted in $US per barrel throughout this alert notice.

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