Famed investor Jeremy Grantham is still kicking himself for missing out on one of the more lucrative trading opportunities in recent years – buying put options on oil in 2014.
The sharp decline in crude prices was both inevitable and predictable, because global demand was not growing fast enough to absorb the increased supply coming from U.S. frackers, Mr. Grantham writes in his latest quarterly letter to institutional clients.
"We were rapidly approaching a binary choice: either OPEC, particularly Saudi Arabia, would decide to lower its production or the oil price would break," says Mr. Grantham, chief investment strategist with Boston-based GMO, the global fund manager he co-founded in 1977. "Only those utterly confident in the Saudis' willingness to cut should not have been nervous about the price, and it is hard to say where such certainty would have come from."
He exclaims: "How on Earth did I miss this!" Psychologists might label this a classic case of hindsight bias – the tendency to regard market-shifting developments as entirely predictable.
But Mr. Grantham, who started out as an economist with Royal Dutch Shell, is widely known for his shrewd analysis of energy and other commodity trends. He is rarely caught by surprise and blames "a combination of laziness and distraction" for failing to capitalize on what was happening to oil.
"My motto in investing is always cry over spilt milk, for analyzing errors is how you learn almost everything," he writes.
Mr. Grantham then offers a typically contrarian assessment of both the Saudi strategy to regain market share and the perceived strengths of U.S. shale oil, whose rapid development has triggered seismic shocks across the global industry.
The Saudis, he argues, may have erred on two counts. The first was a failure to take sufficient account of the dangers of "unintended consequences," including worsening economic and fiscal woes for certain producing countries and overleveraged oil companies, the potential for greater regional unrest and renewed global financial upheaval that could shake the Saudis' conservative universe to the core.
"Major shocks like this to the status quo are just plain dangerous, and Saudi Arabia, which loves stability much more than most, may come to regret not having sucked up the pain of selling less for a few years," he warns.
Their second mistake? Likely overestimating the impact of U.S. shale production on future pricing and demand.
"All of the fracking oil that can be produced for under $100 [U.S.] a barrel will almost certainly be produced eventually anyway. Current events are very probably merely postponing the production for a while. And the same goes for the bankruptcy of some U.S. oil companies, whose properties will just be taken over by stronger players. Neither of these events appears to be of any longer-term benefit to Saudi Arabia or OPEC in general."
Mr. Grantham suggests the smarter move would have been "to let the U.S. fracking industry unload its easy production as fast as possible," peaking in three to six years. With the frackers largely a spent force, Saudi Arabia could regain its role as the world's stabilizing swing producer.
"The Saudis could probably have absorbed all U.S. fracking increases in output [from today's four million barrels a day to seven or eight] and never have been worse off than producing half of their current production for twice the current price.
"If I were on the Saudi long-term planning committee that would definitely have been my vote."