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Chen Lin: Low Oil Prices Fuel Bonanza Increases in Ethanol Stocks

Source: Kevin Michael Grace of The Energy Report  (12/11/14)
Chen Lin
Chen Lin was one of the very few who foresaw the collapse in oil prices, so investors are well advised to pay attention to his advice. In this interview with The Energy Report, the author of the What is Chen Buying? What is Chen Selling? newsletter explains why cheap oil means high profits for U.S. ethanol producers.

The Energy Report: You anticipated the collapse of the price of oil. How did you see this coming when so few others did?

Chen Lin: I was very fortunate. In an interview with The Energy Report last year, I expressed my fear that the price of oil could fall as low as $47 per barrel ($47/bbl). Because I invest in and follow a lot of fracking companies around the U.S. and Canada, I knew how fast North American oil production was increasing. Coincidentally, major Wall Street firms started to agree with my assessments one year later.

On Sept. 5, 2014, I alerted my subscribers that I had sold out a lot of energy stocks and reduced a lot of other positions to raise cash. Thanks to these timely sales, I've had a good year so far. But it's been very tough watching oil fall as far and as fast as it has.

As the oil price is in free fall, many companies with high leverage to the price will likely go under. Investors need to be extra careful in picking beaten-down stocks in the energy sector. My personal view is that the oil price is likely to continue to fall into next year, and possibly won't find a bottom until next spring. I am watching it closely. It is very important to stay with companies that can survive this downturn, if not benefit from it.

TER: Angelos Damaskos of Sector Investment Managers Ltd. told The Energy Report that increased North American oil production due to development in the shales has been balanced by decreased oil production elsewhere in the world. Therefore, he argued, there must be another cause for the oil price fall, and suggested significantly reduced buying from China. Do you agree?

CL: No. China's oil demand has been increasing, and there's no way the Chinese government can hide it. China is the second-largest oil importer after the U.S. In fact, China's oil imports have increased by as much as 50% recently because of the price reduction. China is filling up its strategic reserve.

North American oil production has increased, so if demand stays constant, the Organization of the Petroleum Exporting Countries (OPEC) would have to reduce production to keep the price stable.

TER: Since the price has fallen, does this suggest that OPEC has increased production?

CL: Possibly. I can understand Saudi Arabia getting sick of Canada and the U.S. taking its market share and acting accordingly. Partly because of the American military presence in the Gulf region, those countries cannot squeeze U.S. shale production without American permission.

Another possibility is the U.S. acting to squeeze Vladimir Putin and Russia. The U.S. and the Saudis, acting together in the 1980s, brought the price of oil so low it was a big factor in the collapse of the Soviet Union. I can see the Saudis and the U.S. doing that again. You have Goldman Sachs calling for an oil price crash, and the Saudis are selling aggressively—and selling to the U.S. at much lower price than to Asia and Europe. The West Texas Intermediate (WTI) price is based in the U.S., and Saudi Arabia wants WTI to go down.

TER: About 90% of Saudi Arabia's revenues come from oil production. How long can the country keep prices down?

CL: When oil was over $100/bbl, Saudi Arabia built up its cash reserves, so it can easily ride out $80/bbl prices for 2–3 years. The real losers in this price war are oil producers with much higher costs—countries such as Russia and Iran. In November, the Russian ruble was defending 40 to the U.S. dollar; now it's defending 50.

TER: Back to China, are you worried or sanguine about the state of the Chinese economy? We hear stories about overleveraging, problems with debt and the banks, and a real estate bubble.

CL: All this is true. China definitely has a property bubble. Bank leverage is definitely high. The situation is not good and getting worse. But the Chinese government has more freedom to take action than the U.S. does, or the countries of the European Union do.

Ideally, China needs to depreciate its currency to stimulate exports to Japan and Europe, its biggest trading partners. The U.S. would not allow devaluation, however, so China is somewhat stuck. But I believe China can weather this situation for some time.

TER: Is the "revolution of rising expectations" a threat to China's stability? People who have long been poor become inured to poverty. When they become a little bit richer, however, they come to expect ever-increasing prosperity. When this doesn't happen, people can get very angry very quickly.

CL: That's a very good point. It's a possibility. We must keep in mind, however, that the Chinese government retains strong control of the media and other means of popular discontent. Despite the recent problems, the current Chinese regime has been very popular because of its anti-corruption campaign and its moves against the state monopoly. The new regime's honeymoon isn't over yet and is likely to continue for the near term.

TER: How long before oil prices again reach $100/bbl?

CL: It's hard to say. The lower oil price will decrease production, but not immediately. This will occur in 2–3 years. As I see it, the drop in oil price will actually help the price reach $100/bbl in the future. Many oil companies are now reducing capital expenditures (capexes), so exploration is being curtailed. Fracking companies are reducing their activities. Ultimately, this must lead to higher prices.

TER: Lower oil production will lead to higher oil prices, but lower gold production hasn't led to higher gold prices. What's the difference?

CL: We cannot live one day without energy, without oil. Without oil, we cannot drive our cars, get to our jobs, heat our homes. We can, however, live without gold for a few years. Gold is more of a financial instrument than a commodity.

TER: How much damage will oil at less than $70/bbl cause to shale oil and oil sands operations?

CL: Many companies in these spaces are cutting capexes by 20–30% for next year. Production could be down 20-30% in 2–3 years.

TER: Shale oil and oil sands operations are, by their nature, very high capex. And shale oil wells don't produce for long. Could three years of $70/bbl oil kill off shale oil?

CL: No. I have checked with a lot of companies—some I own, some I follow—and the word is that prices of $50–60/bbl would be needed to kill shale oil.

TER: Now that the Republicans control both houses of Congress, will the Keystone XL Pipeline be approved?

CL: This is one of the top priorities for the Republicans in Congress. Though the recent efforts to approve the pipeline failed, Congress will likely bring it up next year. Keystone approval would be great news for Canada. Canadian oil producers have suffered so much, so I'm glad they would profit the most. The oil sands would benefit hugely as well.

But this would be a long-term benefit because it will be years before Phase 4 would go into operation. In the near term, what could be a huge problem for the Canadian producers are new rail regulations coming into effect in 2015. This is in reaction to the many shipping accidents of recent years. These regulations will be really tough. They will raise shipping costs and reduce exports. Canadian oil companies are facing more pain before the Keystone starts.

TER: Are we looking at a natural gas price crash due to overabundance?

CL: Some recent finds have been phenomenal, so the price could potentially go even lower. Hopefully, we can build up liquefied natural gas exports soon.

TER: Do you think ethanol companies are a better bet than oil companies?

CL: I do, especially from now until the end of the year. We have a tax-loss selling season. I see a lot of funds potentially going out of business or facing heavy reduction. Meanwhile, ethanol is booming.

TER: Chen, thank you for your insights.

Chen Lin writes the popular stock newsletter What Is Chen Buying? What Is Chen Selling?, published and distributed by Taylor Hard Money Advisors Inc. While a doctoral candidate in aeronautical engineering at Princeton, Lin found his investment strategies were so profitable that he put his Ph.D. on the back burner. He employs a value-oriented approach and often demonstrates excellent market timing due to his exceptional technical analysis.

Email: jluther@streetwisereports.com



Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in precious metal products, commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.
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