Here's to the crazy ones, the misfits, the rebels, the troublemakers, the
round pegs in the square holes... the ones who see things differently -- they're
not fond of rules... You can quote them, disagree with them, glorify or vilify
them, but the only thing you can't do is ignore them because they change
things... they push the human race forward, and while some may see them as the
crazy ones, we see genius, because the ones who are crazy enough to think that
they can change the world, are the ones who do.

Steve Jobs
US computer engineer & industrialist (1955 - 2011)

Monday, March 16, 2015

The Oil Overdose

Oil is done as a "gold" standard. "Black Gold" is now more like "Black Coal". It's everywhere and plentiful. Many countries in the world, and provinces in Canada (like my home province of Newfoundland and Labrador) have bet the farm on unending oil wealth to fuel their growth. Some, like Norway, have banked all those petro dollars into a trillion dollar savings fund that essentially makes every Norwegian a millionaire. Others have used the big bucks to build massive militaries - like Russia; Saudi Arabia; and Iran to name a few. The old black gold has been a God send for those that have it, but those days have come and gone.

Some economists are predicting a relatively short turn around for oil prices - somewhere between a year or two. Very few economists have ventured into the permanently depressed price projection. So, does the evidence support a short term downturn or a fundamental, long-term decline in the price of crude oil? One of the few interesting trends in oil, that has not been discussed much, is the narrowing of the price for oil between the benchmarks of West Texas Crude (WTI) and Brent Crude. Generally, Brent Crude is a world price for oil, while the WTI is the American price. Not too long ago there was a 20% difference in the two benchmarks - WTI being the cheapest. Today that gap has narrowed to the point of near parity. What does that indicate? In two words - European deflation. The European economy is spiraling downward with massive unemployment in places like Spain and Greece, and negative bond issues in places like Germany and Switzerland. In effect, Europe as an economic entity is tapped out.

Then there is the suppression of oil exports into the world oil trade. Most notably Iran. Iran has been severely restrained from exporting oil due to US led sanctions. It has some of the largest oil reserves in the world, and is strategically located to send that oil to market at a low cost. In effect Iran's oil has already been priced out of the market price. Then there is Libya. It has been torn apart by civil war like conditions, inter-tribal warfare, and now Islamic warfare. Its oil exports have been essentially removed from the market. Nigeria is falling into a similar position. Ditto for Iraq, In other words, the glut of oil in the world is really only a small measure of what that glut would look like if and when these countries come back into the market in a significant way.

There is the major factor of new discoveries and technology to consider. A massive oil and gas field has been discovered off the coasts of Israel and Gaza, and is as yet untapped. There are major oil plays in the Kurdistan region of Iraq and to some extent Turkey that remain well underutilized. The dueling technologies of fracking and offshore sub sea "tentical"lines have revolutionized the ability to recover oil from previously trapped locations.

In other words, there is just too much oil in the world, for the foreseeable future, to warrant a scarcity price. The current prices really reflect almost a Debeers - type strategy. Debeers of course controls the world diamond market and ensures that prices remain high by restricting volume in the market. A similar trend is happening with oil. In reality, oil should be at $15-25 per barrel US. Prices above this reflect artificial interventions in the market place, which cushion the fall for many governments that have built societies based on $100 + oil. My province is no different. In fact, even at the current inflated prices, Newfoundland and Labrador looks to be taking a 15-20% hit on its annual budget. Addressing these issues of revenue loss for governments is guaranteed to add further to deflation as consumer confidence crashes and the internal markets realign to economic reality. The same can be said for countries like Russia, Iran, Iraq, Saudi-Arabia, etc.

Predicting the future is a tough task indeed. But, as the CSI saying goes: "people lie, the evidence doesn't." In order to see that future we need to understand demographic trends, political/trade trends, supply and demand trends, etc and synthesize them into one living organism (our world). It's abundantly clear that artificial barriers, primarily caused by speculators in the trading markets, are becoming more and more redundant. As the world economy deflates, which it is, those artificial barriers to the true market value of oil fall away. Expect to see oil decline as the world economy deflates. They go hand in hand, with one racing before the other. Unfortunately, for people like ours that have been subjected to "good times" spending and zero savings, the end of the oil bounty is the end of the party. The government has suffered an oil overdose, and we let them.

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