Sui Generis Lays Out Bearish Oil Price Thesis

Although industry fundamentals have markedly improved and crude prices have soared since February, there are still some energy bears. Given that it’s always good to hear what the other side is thinking, let’s analyze the long term bearish thesis for crude by the fund Sui Generis, which was up 9.38% year-to-date net of fees and expenses as of August 31.

Given that the fund’s thesis is also relevant to integrated oil giants such as BP plc (ADR) (NYSE:BP), Exxon Mobil Corporation (NYSE:XOM), Chevron Corporation (NYSE:CVX), Petroleo Brasileiro SA Petrobras (ADR) (NYSE:PBR), and Total SA (ADR) (NYSE:TOT), let’s take a closer look at Sui Generis’ comments and assess what other investors think about these companies. For those of you interested in more oil related research, check out this interesting article on the 11 countries that consume the most oil in the world.

Hedge fund sentiment is an important metric for assessing the long-term profitability. At Insider Monkey, we track over 745 hedge funds, whose quarterly 13F filings we analyze and determine their collective sentiment towards several thousand stocks. However, our research has shown that the best strategy is to follow hedge funds into their small-cap picks. This approach can allow monthly returns of nearly 95 basis points above the market, as we determined through extensive backtests covering the period between 1999 and 2012 (see more details).

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According to its October letter to investors, Sui Generis is rather long term bearish/cautious on oil due to both supply and demand reasons. In terms of supply, Sui Generis thinks that any progress made by OPEC in terms of reigning in production could likely be taken up by North American unconventional producers. This is due to the fact that many North American shale producers are rather competitive in the $50-$55 per barrel range due to their years of experience and their various acreage across promising plays. The fund also thinks that production costs could continue to stay low as the shale players take advantage of data analytics and other technologies to increase efficiency. Furthermore, in contrast to the traditional long lead time of product development for traditional fields, North American shale producers can go from spud to production rather quickly, and thus dampen any sort of major oil price spike.

In terms of long-term demand, Sui Generis thinks that concerns over global warming will prompt more adoption of greener transport alternatives, particularly in countries such as China where pollution is currently a big problem. The fund also notes that many millennials aren’t super enthused about working for companies such as BP plc (ADR) (NYSE:BP), and thus logic reasons that many might not want to invest in oil company stocks either. That could cause some multiple condensation.

On the next page, we will look more into Sui Generis’ thesis on crude and will examine the hedge fund sentiment towards the five oil giants mentioned earlier.

Due to those factors, Sui Generis considers:

“As it relates to oil, start discounting anyone who tells you their long asset life is worth a premium. If the demand side of this conversation is even half right, having a 50 year asset is going to become a liability.”

Given that Exxon, Chevron, BP, Petrobras, and Total each have major projects listed as assets on their books, Sui Generis’ stance suggests that the fund is rather cautious on investing in all five names. In terms of elite fund ownership, the smart money liked Exxon Mobil Corporation (NYSE:XOM) the most, as 60 funds from our database held its shares at the end of the second quarter. Given that Chevron Corporation (NYSE:CVX) is the second-largest market cap stock on our list, it’s not surprising that it ranked as the second most popular with 47 investors reporting stakes as of the end of June.

In terms of international companies, BP plc (ADR) (NYSE:BP) came in third as 40 funds were bullish on the stock at the end of the second quarter, up 6 funds from the previous quarter. Meanwhile, Petroleo Brasileiro SA Petrobras (ADR) (NYSE:PBR) and Total SA (ADR) (NYSE:TOT) rounded out the top five, as 23 and 16 funds tracked by Insider Monkey were long the two integrated giants on June 30, respectively.

While the fund is rather cautious on oil in the long run, Sui Generis does acknowledge that Saudi Arabia and OPEC wants higher prices:

“OPEC clearly wants a $50 floor and will do what they can to maintain it (or at least Saudi Arabia will). Saudi Minister HE Al-Falih seemed very open and serious about wanting higher prices, though since the conclusion of that conference OPEC’s 2nd largest producer (Iraq) has publicly stated that they do not plan to cap production.”

If crude does find a floor at $50 and the price of the commodity trends higher, the fund is more bullish on oilfield consumables (such as fracking sand, frack fluid companies) and specifically those that service competitive North American unconventional basins. Of course the preceding info is just one side of the coin, and there is always the other side such as whether all of Sui Generis’ beliefs have already been priced in.

Disclosure: None