I've read all the Super-Spiked posts, watched all the videos, and I keep coming back to this post. I think volatility is the critical question for us as investors during these supervol years.
I have a question from the perspective of 'upcycle/supervol cycle investors', meaning those investors looking to invest at the beginning of the long upcycle to provide capital, hold throughout the volatility, and hopefully benefit from the structurally higher ROCE through the duration of the upcycle/supervol cycle. If you could address this specifically from the perspective of longer-term individual investors that would be very helpful.
Let's agree with the supervol framework, and let's assume that there is a "volatility trap" developing which is driving away even long term investors and making the ROCE secondary to the extreme short term price fluctuations, reducing liquidity and making the volatility worse. The only two practical approaches I can think of for investors in this environment are:
1. Compare one's estimate of the likelihood of various oil prices to the market's estimate of that likelihood, the way you describe in the "What is a more practical example of how to embrace volatility?" paragraph;
or
2. Sell/sell short only at what appears to be the very top (in practical terms this is WTI somewhere well above $100 and we're seeing demand destroyed/recession triggered), or buy only at what appears to be the very bottom (in practical terms WTI is $30, $40, etc. and we're seeing shut ins/bankruptcies). This approach gives investors a buffer of protection because we know these scenarios are fairly close to the historical high/low extremes. I know these are rough estimates and people will object, but this is the best approach I can think of - any method more complicated than this I think many investors will feel is too complicated and has too many unknowns.
Question:
Are these the two basic approaches? Or is there another way longer-term investors can operate in this supervol environment? Any thoughts are appreciated.
Your #2 approach is definitely one of the ways a long-term investors can think about trading around a core position. I think for your #1 approach, I might phrase it differently which would be to have an estimate of various long-term earnings/cash flow/ROCE scencarios for various companies and then compare to what it appears the market is assuming. There likely still would be a preference to buy/add on the pullbacks as you describe in #2.
I think the bigger point, which I think you are getting at, is that the super vol macro backdrop will cause continuous fear and doubt cycles that "its over" for traditional energy. Through the ups and downs, does the sum of those earnings/cash flow/dividends justify what you are paying today (or whatever price you find attractive)?
Thanks for another excellent column. The 1970s was a pre-NYMEX decade. So the data for calculating volatility such as that shown in the three charts are presumably hard to obtain. Can you offer any qualitative comparisons and contrasts in volatility between the 1968-1980 cycle and the 2002-2014 cycle?
Thank you Tonyforever. I would recommend Bob McNally's outstanding book "Crude Volatility" for an excellent history on volatility in crude oil. In the earlier era, we certainly had jarring moves in crude oil. The difference really is you don't have the day-to-day noise that comes with NYMEX. But it's an excellent point to raise: the existence of NYMEX is not what creates volatility. It is supply/demand/geopolitical fundamentals that do. Without NYMEX you simply don't have the daily trading noise that comes with an exchange.
Limited geographic potential. Unfortunately no one informed Zak Effron during his visit to Iceland (though I enjoyed the episode and it’s focus on geothermal prospects as an alternative to traditional fuels/sources)
Iceland has about 0.1% of the U.S. population, not 1%. Does that change your views on renewables potential?
seems like that would reinforce the point I was making
Hi Arjun,
I've read all the Super-Spiked posts, watched all the videos, and I keep coming back to this post. I think volatility is the critical question for us as investors during these supervol years.
I have a question from the perspective of 'upcycle/supervol cycle investors', meaning those investors looking to invest at the beginning of the long upcycle to provide capital, hold throughout the volatility, and hopefully benefit from the structurally higher ROCE through the duration of the upcycle/supervol cycle. If you could address this specifically from the perspective of longer-term individual investors that would be very helpful.
Let's agree with the supervol framework, and let's assume that there is a "volatility trap" developing which is driving away even long term investors and making the ROCE secondary to the extreme short term price fluctuations, reducing liquidity and making the volatility worse. The only two practical approaches I can think of for investors in this environment are:
1. Compare one's estimate of the likelihood of various oil prices to the market's estimate of that likelihood, the way you describe in the "What is a more practical example of how to embrace volatility?" paragraph;
or
2. Sell/sell short only at what appears to be the very top (in practical terms this is WTI somewhere well above $100 and we're seeing demand destroyed/recession triggered), or buy only at what appears to be the very bottom (in practical terms WTI is $30, $40, etc. and we're seeing shut ins/bankruptcies). This approach gives investors a buffer of protection because we know these scenarios are fairly close to the historical high/low extremes. I know these are rough estimates and people will object, but this is the best approach I can think of - any method more complicated than this I think many investors will feel is too complicated and has too many unknowns.
Question:
Are these the two basic approaches? Or is there another way longer-term investors can operate in this supervol environment? Any thoughts are appreciated.
Best,
J
J,
Your #2 approach is definitely one of the ways a long-term investors can think about trading around a core position. I think for your #1 approach, I might phrase it differently which would be to have an estimate of various long-term earnings/cash flow/ROCE scencarios for various companies and then compare to what it appears the market is assuming. There likely still would be a preference to buy/add on the pullbacks as you describe in #2.
I think the bigger point, which I think you are getting at, is that the super vol macro backdrop will cause continuous fear and doubt cycles that "its over" for traditional energy. Through the ups and downs, does the sum of those earnings/cash flow/dividends justify what you are paying today (or whatever price you find attractive)?
Hi Arjun,
Thanks for another excellent column. The 1970s was a pre-NYMEX decade. So the data for calculating volatility such as that shown in the three charts are presumably hard to obtain. Can you offer any qualitative comparisons and contrasts in volatility between the 1968-1980 cycle and the 2002-2014 cycle?
Thanks again.
Thank you Tonyforever. I would recommend Bob McNally's outstanding book "Crude Volatility" for an excellent history on volatility in crude oil. In the earlier era, we certainly had jarring moves in crude oil. The difference really is you don't have the day-to-day noise that comes with NYMEX. But it's an excellent point to raise: the existence of NYMEX is not what creates volatility. It is supply/demand/geopolitical fundamentals that do. Without NYMEX you simply don't have the daily trading noise that comes with an exchange.
Thank you. I will check out his book
Thx Arjun. I hope you had an awesome time in Iceland. The photos looked great.
Thanks John! Great trip.
Will be very interesting to see if geothermal can successfully expand beyond conventional resource locales like Iceland…
https://www.vox.com/energy-and-environment/2020/10/21/21515461/renewable-energy-geothermal-egs-ags-supercritical
Limited geographic potential. Unfortunately no one informed Zak Effron during his visit to Iceland (though I enjoyed the episode and it’s focus on geothermal prospects as an alternative to traditional fuels/sources)