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Oil Prices - 10 Reasons To Be Bullish

Summary

Ten reasons why the price of oil will end 2016 higher.

It's not all smooth sailing, but the risk/reward is promising.

My favorite names for making money on the upside.

Introduction

It's been a tough year to be an oil bull. Like many others, I have a view that given enough time, low price will eventually reduce supply and balance the market. Many famous names in commodities have gotten the price of oil wrong; Andy Hall, Harold Hamm, David Demshur, Mike Rothman, and Boone Pickens are a few of the renowned bulls that have been proven wrong in 2015. Like these gentlemen, I maintain that timing is the variable that was miscalculated. Don't get me wrong - timing is everything if you actually want to make money in the stock market, but it's not a reason to change your thesis on the direction of a commodity like oil.

2015 was also a tough year for investors in a popular oil exchange-traded funds (ETFs) like the United States Oil ETF (NYSEARCA:USO) or the iPath S&P Crude Oil Total Return Index ETN (NYSEARCA:OIL). I've been long energy in 2015 via Linn Energy (NASDAQ:LINE), BreitBurn Energy Partners (NASDAQ: BBEP), Transocean (NYSE:RIG), First Solar (NASDAQ:FSLR), and more recently, Legacy Reserves (NASDAQ: LGCY) and Mid-Con Energy Partners LP (NASDAQ: MCEP).

In this article, I will provide 10 reasons for my bullishness and explain why I think the price action in 2015 will be very different from that in 2016. I believe being on the sidelines in oil right now is akin to selling the S&P 500 when it ran up 50% from the low of 676. Many retail investors missed the recovery because the arguments that drove the S&P to 676 were still being presented as it moved up. If you hang onto the reasoning of why the market moved down and ignore the reality that the market probably wildly overshot the downside to 676, you'll think it's way overpriced several hundred points later. Of course, history shows you would have been wrong.

My current view is that oil is likely capped at $65 for the next couple of years, but it will not stay below $40 for any extended period of time from now on.

For some key background and my take on the recent history and background of the current glut, please read here.

Ten reasons why oil will trade in a $40-65 price range

Reason 1: The marginal cost of a barrel is much higher than $40. The marginal cost is the cost to produce one more barrel of oil in the current environment. In a perfectly efficient market, that final barrel would be the most expensive one to produce, and would only be produced if the market price supported it. I go into more detail on this in my fourth point. However, arguments have recently been presented suggesting that $40 is too high of a price in the current market for oil. These arguments appear to be mostly rooted in the feeling that because it was momentarily priced at $26, $40 is too high. That's an emotional argument, not one driven by data. The market can be largely driven by emotion, but eventually, data will win. This brings me to my second point.

Reason 2: The quality of the data around crude oil production is terrible. Even the solid monthly EIA production data is a couple of months behind and only represents the U.S. This data gets revised with little coverage, and can be wildly misleading for all but the most eagle-eyed of investors. For example, the December 2015 monthly data was revised downward 27 Mbbl/d (thousand barrels per day), but this was largely missed in the reporting of this critical decline number. If you look at the difference between the December and January production alone, you'd see only a 56 Mbbl/d decline and miss this adjustment. That small miss can make all the difference when it's extrapolated. If you modeled U.S. production for the rest of the year based on the...


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