Christopher Henwood: Get Out of the Way and Let Markets Work
Source: George Mack of The Energy Report (8/23/11)
Thomson Reuters' Commodity and Energy Specialist Christopher Henwood believes bailouts of too-big-to-fail companies and countries addicted to entitlements have cast an ominous shadow over the global economy. Nevertheless, he finds room for optimism as global economic turmoil puts downward pressure on energy prices, which should give the economy some breathing room. In this exclusive interview with The Energy Report, Chris shares a bit of his market knowledge and economic philosophy.
Christopher Henwood: What we're seeing is a cascading of events. If we go back even a little bit further into earlier July, it seemed like the market was at least temporarily hopeful during that time. But once it became clear that politics were going to trump and the economic well-being of the country was going to take a backseat, that really put the markets on their heels. We see the consequence of the debt ceiling debate and the lack of clear direction that came out of that. I'm a market-based guy, and I've lived my entire career in the markets. I think that there's probably no better indicator of what the real result of any sort of policy or political wrangling is than how the markets interpret them. Now, they're not always 100% right, but more often than not people who are very smart in general move their money accordingly. This is, I think, no exception to that.
TER: What about the S&P downgrade on August 5?
CH: The S&P downgrade is just the latest cascading element to this kind of waterfall of negative economic news we're looking at. So, what we're seeing is that the market is coming to the realization that the economic outlook here in the United States and globally is still pretty grim and that the oil markets in particular are taking a beating due, in large part, to their increased sensitivity to macroeconomic factors that are increasingly playing a dominant role in that marketplace.
Conversely, gold is an asset that's soaring as traders and investors are flocking to what is a solid asset. I won't say gold is a safe haven. I'll say it's a solid asset and one that is being looked to increasingly as a counterweight to economic risk. So, I think we're seeing the markets play out the skepticism of what we have going on policy-wise and politically.
TER: We've seen Brent and West Texas Intermediate (WTI) crude prices weaken through this turmoil. I'm wondering if this disproves what some people have been saying that energy is something of a currency like gold has been.
CH: It is being treated by some as a currency. You have a lot more players outside of the pure oil industry who are influencing the price of oil and playing it as an economic barometer. I think that's why you're seeing oil taking such a beating. If that's how you're going to trade crude, whether it's WTI or Brent, it really makes no difference, you're taking a huge risk because crude is not a currency like gold. Crude is consumable. Does it have value? Yes. But, if you start to cross that line and move into currency-type status for WTI or Brent, I think you're running huge risks and it's entirely inappropriate.
TER: Do higher energy prices mean a stronger economy?
CH: I actually think it's the converse. I think that the high energy prices we have seen have been largely event-driven moves. The Arab Spring has been a huge driver of increasing energy prices where the market had to price-in the uncertainty and the fear factor that the supply side of the equation was going to become disrupted over time, or even in the short-run. Now we've seen Libyan oil taken off the market, but we've also seen Saudi Arabia step in and fill that void to a large degree.
What I think has been driving oil prices to their current highs is on the supply-side of the equation. We saw this in the big run-up in 2007–2008. As a trader I fought that and went short crude on a number of occasions because I just didn't see the justification from a fundamental perspective for the price of oil during that period. What was always being cited in the marketplace was this increased demand coming out of China and India that was going to drive crude oil prices over $200/barrel (bbl.) in the very near-term. Three months later we were trading down in the $30s. If the demand-side of the equation is driving that, how could that possibly change in just three months?
Steadily rising energy prices being reflected in increased demand in good economic times is a better characteristic of a healthy economy.
TER: What does this recent downturn mean to energy investors?
CH: Well, I think the term investor is broadly overused. I think it's important to distinguish between the energy investor and the energy trader. I think they're two distinct people. I never consider myself an investor. I always consider myself a trader. I think traders and investors operate under completely different risk parameters and completely different mindsets. So, toward your point for investors, I think obviously as price goes down, margins decrease and profits decrease for the energy companies. But as a trader, downside offers sometimes the greater opportunity because of that mindset to the successful bear trader in a falling market. So, I think the investor will probably take some lumps. But savvy traders will benefit as a result.
TER: As a trader you think in terms of over-bought and over-sold probably.
CH: Sometimes, yes.
TER: What about a term that traders probably don't use, value. Do you see value in certain areas of the energies today?
CH: Sure. I was primarily a spread trader when I traded. So, you do see value. I'm not an equities specialist, and I don't really follow energy equities as part of my role, but I actually did a show at the end of January on energy master limited partnerships (MLPs) for a lot of midstream assets. I think that sector probably has a lot of opportunity as infrastructure is continually and acceleratingly being built out because of the increased shale plays we're seeing in various parts of the country such as the Marcellus, the Bakken in North Dakota, the Eagle Ford in Texas. All these new shale finds and these new increased natural gas finds are requiring increased infrastructure to deliver and to store it and to figure out how to best capture and transport all this new discovery. With that comes new infrastructure that needs to be built. So, the MLPs probably provide a nice value at this point and one that will continue to grow.
TER: What would a good trade be today in terms of shorter term and longer term?
CH: Shorter term, I think gasoline prices have found some support right here on this $2.77-$2.75/gallon level. A break below the 200-day moving average in gasoline would be a nice short-term play. Conversely, if it can struggle back above the $2.85 area, that would be a great short-term buy. So, in either direction there's good opportunity. Looking at it economically, I'm more biased to the downside. I think gasoline prices will resist for a little bit longer but eventually they'll fall under the weight of the underlying crude.
On a longer-term basis, I have to go back to what I've been talking for the past year and a half, gold. It's something that, as I mentioned earlier, is being used as a counterweight to manage virtually any manner of financial risk right now in the marketplace, whether it be currency risk, inflation risk, deflation risk or sovereign debt risk. If I have risk exposure to grains in Russia, I'm going to buy gold against that currency risk and against everything else. Mexico has bought a ton of gold. South Korea and Thailand just added a significant amount of gold to their reserves as a hedge against what is perceived as global risk. I would wait until it dropped down to like the $1,650/ounce (oz.) area again. I think the next range you're going to see in gold is $1,725–$1,800/oz. before it makes the next big move up. It'll be driven by some sort of economic problem more likely coming out of the EU than anything else. We have Italy and Spain now moving to the fore because of their risk profiles and their being on the verge of bankruptcy, and that's going to drive people to buy more gold to hedge against it.
So, longer term I think gold is where you have to go. Shorter term, as an energy play, I like gasoline on the short side.
TER: You've managed a natural gas floor-trading operation in the past. Are you bullish on gas?
CH: I managed an operation for Goldman Sachs up until 1998. In 1998, I opened my own operation and I traded for myself from 1998 until mid-2009. I was on the floor the day natural gas trading opened for the first time in 1991. It was a real watershed moment on the floor in the energy business and for natural gas.
Right now we're seeing natural gas in a very stable supply environment. With the development and proliferation of shale gas, the natural gas supply curve has been redefined all the way out. And every time the market starts to rally, we've seen producers selling into that rally in order to hedge that production. I think they're becoming a little bit aggressive in terms of hedging their production given the flat projections for natural gas prices. But one thing I've learned as a trader is that as soon as everyone thinks something's going one way, you can almost invariably bet your bottom dollar that something's going to crop up that's going to change the equation and redefine how that market is viewed across the board. Conventional wisdom quickly becomes a trap in this environment. So, I think longer term there's tremendous upside here. I think what we're seeing here now with prices at sub-$4/thousand cubic feet (Mcf) is probably a very good opportunity for some upward movement. I could easily see natural gas prices in the next several months run back up to almost $4.50/Mcf, maybe even $4.60/Mcf.
TER: Natural gas is half as polluting and one-fourth the cost of gasoline. What would it take to bring natural gas online for vehicles?
CH: I would welcome it. I think the first step would need to be a demonstrable demand. I'm not a fan of governments decreeing and mandating virtually anything. So, private industry would need to determine that there's a real market and a real hunger for natural gas for vehicles among the population. We've already seen a number of fleets convert, which is great, and it's easy to do where you have a fleet that returns to a specific base or operates within a certain range. You can build the infrastructure to fuel those vehicles, and that's been very successful. I think the air quality in some of the major cities has improved as a result of the aggressive adoption of natural gas. I think it would be a great boom for natural gas domestically. It would be another supply piece and a great environmental benefit.
TER: Where are you seeing innovations in the energy industries?
CH: The greatest area of innovation the last three years has been in the development and the ongoing evolution in fracking technology. It has made huge strides. There were original forecasts that fracking of shale would only be economical if we were looking at $6/Mcf natural gas, and before that it was $8–$10/Mcf. That number has now come down and it's been demonstrated that at $4/Mcf natural gas these fracking operations can still make money. And we're seeing it now being exported to other countries around the world. Poland, for example, has identified a huge amount of shale resources. It has actually brought over some major U.S. companies to help them retrieve it. As that technology is brought to new areas, adapted and developed, it's going to evolve. It's the same thing in South America, where a number of countries are developing these programs.
Now the next level of innovation is going to have to be in the safety aspect for these drillings. The last thing this industry needs is a BP plc (NYSE:BP)-like disaster in the space that will really have much farther reaching consequences than the immediate damage to whatever water source that they've unfortunately harmed. So, the safety aspect—the drillings, the casings, what is in the fluid—all these things are getting much greater scrutiny. You're going to see a lot of that applied in crude because nobody wants to see another disaster in any waters anywhere in the world. I believe in private industry's ability to develop, to innovate and to be creative, which is what has defined energy in our country. And I think that's going to continue.
TER: Efficiencies in fracking and safety must certainly translate into a play on services.
CH: Absolutely. Services are definitely going to be key, and they're probably going to play a more important role as we go on. A lot of people weren't even aware of the service aspect until the BP disaster when a number of the companies were involved in the process. It became the focal point in the discussion. And, I think that the services are definitely going to play an increasingly important role.
TER: When we first began our conversation today you told me you were pessimistic—"grim" was the word. Where is your pessimism, and is there any room for optimism here?
CH: My pessimism is mostly policy driven right now. The policy coming out of the United States and the handling of the European debt crisis highlight how money is being put into losing propositions. Cost cutting seems to be almost toxic to some of these countries that have enjoyed large entitlement programs and have an entitlement culture. I think that's what we're getting to in this country. So, my pessimism is driven by the fact that it seems that there are very few people willing to make very hard decisions economically in this country and across the globe.
As a self-supporting trader for many years, if you make a bad trade, you feel the pain. You've lost money, and you learn accordingly. What we're seeing is companies that are too big to fail and banks that have taken outsized risks that are not feeling the pain. When they get into trouble, they get bailed out. And when countries get in trouble, they get bailed out. They're not expected to curtail their activities to any extent, but they get bailed out. That's what's fueling my pessimism on the global macroeconomic scale and where I see it hurting energy prices.
Now I think there's always cause for optimism. There are always people fighting for and injecting common sense economics into policy and into politics. I'm always hopeful that things will turn around and change. I'm always hopeful that there can be a new viewpoint, but I'm skeptical. So, again, politics and policy have made me skeptical and pessimistic but private industry and innovation give me optimism.
TER: Do you believe markets will correct these global policy errors?
CH: I believe they should. Unfortunately, what I think sometimes happens is that government and government agencies try to rein in the markets to correct a situation of their own causing. I think that's an inherently flawed approach.
TER: We're seeing lower energy prices as a result of the selloff in July and August. Is this going to be good for the economy?
CH: In the short to medium term they're definitely going to be good—a net positive for the economy. You don't ever want to see any price get depressed and then stay depressed for a long period of time because that's indicative of some major economic problems. But if oil prices can establish a range, such as between $75/bbl. and $80/bbl., I think you'll see a significant amount of relief in gasoline and fertilizer prices and petrochemicals and a lot of the consumer products in the value chain, including grains, milk, meat, cheese and bread. That would be a welcome relief.
TER: Thank you, Chris. I've enjoyed this very much.
CH: Thank you.
After coming within 43 votes of winning the Republican nomination for his local township committee, Commodity and Energy Specialist Christopher Henwood is evaluating his campaign to discover what worked and what didn't work in much the same way as he might assess a move in energy prices in his day job at Thomson Reuters. Each day Chris' work pits him squarely against the nuance and volatility of markets as he evaluates energy markets from both a technical and fundamental perspective. Chris has a law degree from Rutgers University School of Law–Newark in 2010, and was admitted to the New York State Bar in January 2011. He earned his undergraduate degree at Dickinson College.
Want to read more exclusive Energy Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Exclusive Interviews page.
1) George Mack of The Energy Report conducted this interview. He personally and/or his family own the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report: None.
3) Christopher Henwood: I personally and/or my family own shares of the following companies mentioned in this interview: None. I personally and/or my family am paid by the following companies mentioned in this interview: None.