Dawn Bennett, Host of Radio Show "Financial Myth Busting," Interviews Leonard Brecken, Potfolio Manager of Principal of Hedge Fund Brecken Capital LLC

Washington, DC -- (ReleaseWire) -- 11/30/2015 -- BENNETT: Leonard Brecken is a portfolio manager and principal of hedge fund Brecken Capital LLC. Brecken's expertise is oil. He's a regular contributor to oilprice.com. Leonard is here today because he has a belief that the Federal Reserve has a role in fostering the oil glut and price drop.

BRECKEN: Thank you.

BENNETT: Sometime in 2015, the Wall Street Journal published an article titled Banks "Struggle to Unload Oil Loans," which revealed the Fed's role in encouraging excess oil production that led to the inevitable price drop. I want to know, and I want our listeners to know, why is the Fed to blame?

BRECKEN: Well, if you looked at the open interest of oil futures going into the downturn—around June of last year is when it started—the open interest was considerably above what it was, say, on the last downturn in 2008, 2009. So in one sense, the easy money, in theory, allowed people to buy oil futures and other assets, including equities, and that, in turn, created an open interest bubble in financial oil futures. And I think that's what the theory is pertaining to.

BENNETT: As everyone knows, the fed responded to the 2007 bursting of the housing bubble by trying to re-inflate the bubble through quantitative easing. And since the housing market hasn't taken off as dramatically as it did from 2003 to 2007, some are actually saying there's a bubble in energy, and that many of these new type of Bakken producers only entered the market as a result of inflated money supply. Does that correspond with your perspective?

BRECKEN: The thing that I just explained to you was the financial speculation side of it. On the oil speculation side of it, the theory goes that since you had zero interest rates for so long, the borrowing cost was so low, companies levered up to pursue oil. And since oil was $100, their debt to equity ratios grew. And that is also true. That was another sort of result of easy money policy, zero interest rate policy from the fed. So that also played a role in overproducing. But let me just explain something to you as well, is that back in June of last summer, when the downturn started to occur, you had Iraq and Saudi Arabia; at the same time US producers were beginning to overproduce, ramping their production too, but not a lot of people realize that, so that had nothing to do with the Fed. They started to overproduce. Now, whether they did so as a change of policy, where they saw the market was becoming imbalanced and they were losing market share, they began producing. And we're not talking a significant amount of oil, in the scheme of the world oil production. I mean, I think both entities, both countries probably added about a million barrels over the course of the next 6 to 12 months from that period. But it's enough to cause an imbalance.

BENNETT: Is there a bubble in the energy market? What does that mean for a possible crash? And if the bubble bursts, what does our world look like? What happens in energy prices?

BRECKEN: Well, right now I think the car has gone off the cliff. I mean, hedges are rolling off. We have one more quarter of 2015, where most AMP companies are pretty much hedged. Then we go into '16, and hedges roll off by 20 percent to 30 percent. And one of the myths in the oil producing market is at $100, most shale producers, which caused the oversupply, weren't free cash flow positive, even at $100 oil. And so we're now at $40 oil, and even though they've cut capital expenditures by 20 percent, 30 percent, they're still nowhere close to being free cash flow, break even. Now, there's some exceptions—Pioneer Resources is one of them—where they're close to cash flow break even, and maybe a few others, like Continental Resources is going to get pretty close to that sometime in '16. But by and large, when I say the car's going off the cliff, it's already off the cliff. Unless oil recovers to $60, you're going to see a substantial amount of defaults in the energy sector. And by the way, I think we'll be seeing short interests in oil futures that has been on and off on the speculative side going the other way now, I think that's somehow tied to holding down oil prices, because the same people who are short the equities or short the junk bonds, that is finally going to come to roost. Now, that is going to have a significant impact in further slowing the economy, as you've already starting seeing in some of the industrial production figures and Capex figures, in that Capex has already started to eat into companies like Caterpillar's earnings, and it has significantly caused a slowdown already. Now, you asked me, 'Is there a bubble in oil?' There's not a bubble in oil; right now, I think it's quite the opposite. $40 oil couldn't be sustained, nor was $100 oil. As I said, even though the Fed was pumping so much money with zero interest, those companies weren't even free cash flow positive. That is the biggest misnomer, the biggest myth perpetuated by the financial community. Just defining free cash flow, a lot of these financial analysts on the south side say, 'These companies will break even at $50,' so on and so forth, there's a range of prices. But that's if you're looking just at the well. Well, when you take into account depletion, because in the order of magnitude, six months out, when you first start drilling, the well gets depleted by 60 percent, 70 percent in a lot of the largest producing areas, like the Bakken in North Dakota. So when you take that into account, they have to keep on plowing money into Capex, so when you add back Capex these companies weren't making cash at $100 and they're not making free cash flow at $40. So I think in '16, as this thing continues to play out, I think you're actually going to be in a severe shortage situation sometime in '16.

BENNETT: There was something very odd taking place off the coast of Galveston, Texas, and just last week, right?

BRECKEN: Right.

BENNETT: There was a two mile long line of tankers full of crude, heading from Iran to the U.S., several weeks after reporting that China had run out of oil storage space. I'm curious what your thoughts are on that.

BRECKEN: That's another thing. I went through this in the natural gas market last season. In the media, they seem to be obsessed about measuring inventory of energy products on an absolute basis, without taking into account demand. Now, demand in natural gas is up significantly this year. Oil, as measured in demand for gasoline, hasn't been this high in probably five or six years. It's been running at 5 percent, believe it or not, in the United States. So the true measure of supply is the days of supply; how much inventory you have on hand that can go against the demand. Because if both rise, and you only measure just inventory, then it looks like, 'Wow, we have a huge glut.' So that's one. Another myth that is being perpetuated within the media and the financial community is that there's this huge glut of oil. The glut consists of, literally, maybe a few days of supply on a global basis. We're not talking about 100 days of supply; we're talking 96 days versus 90 days, or something like that, of supply. So you have to look at both demand and supply, and then I think that is the true measure. That is not being done at all. The hype about the oversupply, some of it is true—don't get me wrong—but I can make a very strong case that a lot of the numbers are being overstated, so that the glut makes it seem like it's a lot higher. Regarding the Iranian oil, I've just got to believe there is a whole plethora of coincidences that keep on adding up to continue to pressure oil, and the fact that now Iranian oil is coming to shore when we can't export oil, the ban is still on... I think the Iranian agreement also occurred at the time, and now we find out that congress has authorized, including the White House and its support of it, we're going to start selling out of strategic oil reserves. All of this is pressuring oil. I think there's a war on oil, actually, the price of oil. I think there's a concerted effort to keep the price of oil depressed. And I think that, in turn, ties into what the Fed policy currently is.

BENNETT: Let's talk a little bit about that. There's an ugly side to the fed's reluctance to raise rates. Buyers of CDs and other fixed income investments continue to just get punished. Why is it that the fed has become so reluctant to let the financial systems start functioning on their own in a free market way?

BRECKEN: Look, all of this started in the late '90s, when our wages grew at a faster rate than the developing countries. That caused a massive exportation of manufacturing to Asia, Mexico, and that started to metastasize, so to speak. To make up for that, the government overspent, and the Fed had to keep interest rates low to offset that non-competitive nature of U.S. wages abroad. That's what started the whole ball rolling. That was the systemic problem of the bubble in 2000. That's what started, to me, the whole imbalance of what is occurring in the United States. Now, I think the Fed actually wants to raise rates. I don't think on a sustained basis they want to raise rates, but they surely want to raise it in December.

BENNETT: Just to show people that they can. Because the fed's self-professed reasons for not raising rates—slow growth, weak housing, all that stuff—I think it's just actually prolonged the absence of a full, functioning capital system.

BRECKEN: The true measure of distortion that's going on is related to equity prices, for example. The Federal Reserve has said part of their mandate was to create a wealth effect through asset price appreciation. I mean, that goes into why they didn't want to raise rates for a while. That policy changed in June of last year, almost at the date that the dollar started rising and oil started falling. Every time the equity markets fell, it was tied to some tapering effect that was occurring in quantitative easing. However, that changed in the summer of last year. The Fed, if you look back in Fed officials' comments, they backed off on the use of quantitative easing, I think in part because they realized it wasn't working; they had to do something else. And that something else, to me, was a stronger dollar and lowering commodity prices, by allowing foreign governments to print money; at the same time, they draw bones, 'We're going to raise rates.'

BENNETT: You were talking about the price of the dollar. I think one area where spectators of all this can get a bit confused is with the dollar and its pricing, which has increased over the last year, even as the Fed has continued what it calls accommodative monetary policy. Why is the dollar strengthening against other currencies, and is this also part of the Fed's strategy?

BRECKEN: I think it absolutely is. I think they continue to jawbone rates higher. Whether they actually do it next month, we'll see. I suspect they will, because they seem to be hell-bent on doing it. It's no coincidence, back in the last summer, that both Japan and the EU—which started their own quantitative easing back then, and Japan just continued theirs—began, and the Fed sat on its hands. If you're the Fed and you basically realize that quantitative easing isn't doing anything but enriching the 1% by blowing up equity prices, and that measure, by the way, can be shown. If you measure the NASDAQ and the price of oil, it has never diverged by that much in the history of the stock market, never. And that is a function of what the Fed was trying to do, keeping equity prices high and lowering the price of commodities, because that was the only thing they could've done without printing more money or doing some non-traditional things. And I think that is why they're jawboning the dollar higher, to depress commodity prices, which they thought was going to boost consumer spending, but it never has. So they're sort of caught in between quantitative easing, unleashing another round of inflation on the populous, when the populous' wages are stagnating; I think that's a recipe for disaster. They can't go down that path anymore. And they even found out that quantitative easing really isn't even working. In fact, Janet Yellen was even quoted to say that we have to study whether quantitative easing even worked, in an article on Bloomberg recently. So I think the only course that they tried was, 'Hey, we'll strengthen the dollar, crash commodities,' and that would help the consumer on the discretionary income side, and let Europe begin its rounds of quantitative easing. So I think that was the strategy.

BENNETT: Analysts who are willing to look at data soberly, they're forecasting another major crash. I understand you are too. What are your thoughts on when this might come to fruition, and what might precipitate that crisis or that crash?

BRECKEN: Are we talking a crash in oil prices or are we talking a crash in equity prices?

BENNETT: Equity prices and oil prices; take one at a time.

BRECKEN: On the equity side—look, I didn't come from an Ivy League school. I'm sort of a person who looks at things that I can feel and touch, and I can tell you that, despite common belief, if you look at commodity prices, they're back to where they were in 2008, 2009. So that tells you something's out of whack, when NASDAQ is almost nearing an all-time high. You have a disconnect. Housing prices, although they're recovering, at least where I live, I can tell you for sure that I studied this, and in most of the houses in a lot of the affluent neighborhoods haven't gone up since 2005. So you look at certain classes of assets; they haven't appreciated at all, and yet NASDAQ has. That, to me, tells you why prices are so distorted because of Fed policy, and I think it will revert back to the mean, which is probably where the indices were back in 2008, 2009. I think it's going to happen in '16. Whether this latest round of terrorism's going to spur slow growth in the economy, which was already starting to show up, I think, even before it occurred, and that will accelerate the trend. I think it's going to happen in 2016. On the oil side, I don't think there will be a crash in oil on a sustained basis, because as I said before, on free cash flow basis, the U.S. producers can't. OPEC's own capacity, and U.S. producers can't sustain any more cash bleed.

BENNETT: Leonard Brecken, thank you for being on Financial Myth Busting.

For over a quarter century, the experienced advisors of Bennett Group Financial Services, LLC have been successfully guiding clients through the complexities of wealth management. Bennett Group Financial Services provides individual investors, corporations and foundations with holistic investment strategies using unique portfolio solutions across a breadth of asset classes. Our unique vision and insight into market trends makes Bennett Group Financial Services a much sought after expert resource with regular appearances on Fox News Channel, CNBC, Bloomberg TV, and MSNBC as well as being featured in Business Week, Fortune, The NY Times, The NY Sun, Washington Business Journal in addition to our highly regarded weekly talk radio program - Financial Mythbusting. Through attentive service and prudent, thoughtful advice, Bennett Group Financial Services, LLC strives to consistently provide its clients with the highest quality of guidance and personalized service available.

About Dawn Bennett
Dawn Bennett is CEO and Founder of Bennett Group Financial Services. She hosts a national radio program called Financial Myth Busting http://www.financialmythbusting.com

She discusses educational topics and events in the financial news, along with her thoughts on the economy, financial markets, investments, and more with her live guests, who have included rock legend Ted Nugent, as well as Steve Forbes and Grover Norquist. Listeners can call 855-884-DAWN a as well as take podcasts on the road and forums for interaction.

She can be reached on Twitter @DawnBennettFMB or on Facebook Financial Myth Busting with Dawn Bennett.

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