The joint monthly web chat for subscribers of The Energy Strategist (TES) and MLP Profits (MLPP) took place last week. The chat is conducted by Igor Greenwald, who is managing editor for TES and chief investment strategist for MLPP, and myself. Given the rapidly changing dynamics in the energy market, it wasn’t surprising that we received nearly 90 questions/comments during the course of the chat. While we addressed about two-thirds of them during the chat, there were a number of questions remaining at the end. Many people asked about the bottom for oil prices, so I want to address that as the topic of today’s column. In this week’s MLP Investing Insider, I address some of the remaining MLP questions from the chat. 

There were at least 10 questions related to the drop in the price of oil, but most were some variation of the following. I did answer this question during the chat, but I would like to elaborate today because there is a very common misconception about the supply/demand picture for oil.

Q: Many have suggested that the drop in oil prices in due to a drop in demand more than an oversupply. With oil at less than half of its peak, has demand dropped by half? Seems ridiculous. What is the actual amount of oversupply, and the actual amount of demand destruction?

I have been asked numerous times about the role of a “drop in demand” in the oil price decline. Many stories in the media have referenced a drop in demand.

There are two primary reasons given for this so-called demand drop. One is that years of high oil prices have resulted in reductions in consumption through conservation and improvements in vehicle fleet efficiency. The second reason is that, due to the strengthening dollar, oil has become more expensive for many countries since oil is generally priced in dollars.

There are elements of truth behind both reasons. There has indeed been reduced oil consumption in recent years in most developed regions of the world. It is also true that the dollar has strengthened against many currencies. But despite the rationale that explains this drop in oil consumption, ultimately the data must support the narrative.

We have to keep in mind that the developed regions of the world aren’t the entire world. Despite this oft-repeated mantra about falling oil demand, there is no evidence that this is actually true. Last October, the International Energy Agency (IEA) reduced its forecast for 2014 global oil demand growth by 200,000 barrels per day (bpd). The revised forecast was that global oil demand would only increase by 700,000 bpd from 2013.

Last week, as reported by CNBC, the IEA forecast that “global growth in the demand for oil could modestly accelerate in 2015 to 910,000 barrels a day.” However, the article also noted that the World Bank had reduced its forecast for growth in the global economy for this year to 3%, down from the prior forecast of 3.4%.   

What has happened is that these reductions in the forecast for oil demand growth or economic growth get mistranslated into forecasts of declining demand. I think we can all agree that if I gained five pounds a year in each of the past five years, but this year I only project that I will gain three pounds, I did not lose weight.

Consider that in the five-year period of 2008-2013, the price of West Texas Intermediate (WTI) crude averaged $88/bbl. The price of Brent crude was even higher at $95/bbl over this period. These prices were much higher than the average oil price over the previous five-year period, therefore we might expect that this had a negative impact on oil demand. This was in fact the case in the U.S. and E.U., but global demand increased, driven by increases in every developing region of the world:


Despite much higher oil prices, global demand for oil increased by more than 5 million bpd in the past five years. In fact, global oil consumption has increased in 18 of the past 20 years.

Now, look at where most of the world’s oil production growth took place during that time period:

This is why I maintain that oil below $50/bbl is simply not sustainable for very long. If global demand were actually declining, it would be a different story. But with demand continuing to grow, and with the majority of the oil production added in the past five years coming from the shale oil fields in the U.S., there is simply not enough $50/bbl crude to meet demand. 

Oil will not — as I have seen some predict — sink to $40/bbl and stay there. There may be a new norm for oil relative to what we have seen in the past five years, but it will be closer to $70/bbl than to $40/bbl.

(Follow Robert Rapier on Twitter, LinkedIn, or Facebook.)

Portfolio Update

Kinder Morgan Goes Shopping

Kinder Morgan (NYSE: KMI) marked its first report since the recent consummation of its merger with affiliated MLPs in the expected way on Wednesday, announcing a multi-billion dollar acquisition.

The rationale is similar: the more businesses Kinder Morgan buys, the bigger its depreciation tax deduction in future years, leaving more cash flow for dividends and interest payments on the debt financing the acquisitions.

The amuse-bouche it swallowed this week was interesting because the seller was none other than Continental Resources (NYSE: CLR) Chairman and CEO Harold Hamm. The $3 billion (including $1 billion in assumed debt) to be paid by Kinder Morgan for privately owned Hiland Partners, a Bakken crude gatherer, gas processor and oil pipeline operator, should help Hamm reliquify his personal balance sheet after recently paying nearly $1 billion in a divorce judgement.

The timing of the deal is curious, coming with crude at $46 a barrel, or roughly $40 more than where it stood when Hamm sold all of Continental’s oil hedges. Kinder Morgan is now making its own bet on a recovery, and it’s not getting Hiland cheap despite the deeply discounted oil.

It’s claiming a 10x EBITDA multiple based on its projections for Hiland in 2018 but saying only that the deal will be “modestly accretive” to its cash available to pay dividends this year, which implies a multiple as high as 18x.

CEO Richard Kinder said the high price tag is justified by Hiland’s footprint in one of the Bakken’s lowest-cost “sweet spots” and by the growth potential of its Double H pipeline shipping crude south to Wyoming and ultimately down to Cushing, Oklahoma and the Gulf via connecting pipelines.

Hiland has long-term acreage commitments from top customer Continental for crude gathering, and also serves Oasis Petroleum, XTO Energy, Whiting Petroleum and Hess.

In other news, Kinder Morgan declared a fourth-quarter dividend of 45 cents a share representing 10% growth year-over-year, out of cash available for distribution of 60 cents a share. The company aims to pay out $2 per share representing 15% annual growth over the coming year, with $654 million of excess coverage based on its forecasts of an average $70 per barrel price for crude and $3.80 per million British thermal units of natural gas.

At $50/bbl crude and $3.20/mmBTU natural gas, the excess coverage would shrink to $436 million. Every $10 off the price of a barrel of crude costs the company $100 million.

CEO Kinder also confirmed that he will hand over that title to Chief Operating Officer Steve Kean in June, but stay on as executive chairman.

Kinder Morgan’s share price held its ground on news of the acquisition, suggesting shareholders continue to prioritize dividend growth. Beyond the 15% increase this year, the company has committed to 10% annual growth in the payout through 2020, without increasing its already high debt leverage. It is highly likely to keep acquiring and selling stock to get there. KMI remains a Hold.             

 — Igor Greenwald