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Musings Report 2017-12 3-19-17 Is Another Oil Head-Fake Brewing?
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Is Another Oil Head-Fake Brewing?
Over the past decade I've addressed what I call Head-Fakes in the cost of oil/fossil fuel: even though we know the cost of extracting and processing oil will rise over time as the easy-to-get oil is depleted, oil occasionally plummets to such low prices that we're fooled into thinking it will remain cheap for a long time to come.
This drop in price is a head-fake, because over time the depletion of the cheap-to-extract oil will push global prices higher.
Why does this matter? Economists have noted for decades that spikes in energy costs tend to trigger recessions for the obvious reason: the more households and businesses spend on energy, the less they have to spend on goods and services.
When the price of oil drops, people buy larger, fuel-hungry vehicles because the operating costs are reasonable at the moment of purchase. The need to conserve declines across the board, setting up a high consumption level that establishes a high cost basis when oil returns to its "natural" price levels.
Correspondent Joel M. submitted an article that explains one reason why oil may plummet in price: oil companies are dramatically lowering the costs of production in order to remain profitable as oil has fallen from $100/barrel to $50/barrel.
Ironically, this drive to lower costs to make oil profitable at $50/barrel or lower is sparking a production and investment boom that promises to boost production in the near-term.
Race to Bottom on Costs May Cause Oil to Choke on Own Supplies (via Joel M.)
Wael Sawan, the head of Shell’s deep-water business, said the company had been able to reduce the cost of its wells by 50 percent over two years. The biggest reason: Shell now uses just four standard well designs worldwide, compared with dozens previously, according to Sawan.
"We are going to see more material cost saving in the next couple of years," he said in an interview.
With costs down from shale to mega-projects, companies big and small are starting to green-light more investment. Shell for example just approved the Kaikas deepwater oil field in the U.S. Gulf of Mexico, the first to get a go-head from the company in more than two years. The project will make money at less than $40 a barrel after Shell reduced its projected costs by 50 percent.
Though the global stock market is in a euphoric uptrend at the moment, many observers see the inevitability of a global recession as China dials back its astonishing credit expansion/housing bubble.
Having created $30 trillion in new credit, China's financial authorities are trying to cool down that runaway credit expansion without choking the Chinese economy. Their modest tightening in 2014 deflated their housing bubble, and the trickle-down effects soon slowed the global economy to a crawl.
As many of us have noted, no structural problems have been solved over the past eight years globally; all we've done is create unprecedented sums of new money in the form of credit and sovereign borrowing to keep the many asset bubbles inflated.
At some point, diminishing returns on new debt will trigger a break in the ability of households, corporations and nations to service their rising debt loads, and a retrenchment/recession of some size will occur--even if central banks flood the financial sector with liquidity and lower interest rates.
They can't force households and corporations to borrow more, though they will try.
Any reduction in global demand will trigger a sharp, sustained decline in the price of oil. The oil companies will be boosting supply at the very moment that demand is falling. This imbalance will crush the price of oil, perhaps as low as $25/barrel. Some analysts (Arthur Berman) are even predicting sub-$20 oil.
Such low prices will devastate profits and oil-exporting nation's oil revenues, and perversely remove incentives to conserve energy. These two dynamics will then set up the next oil spike, as production will be cut back while demand will be boosted as economies use more "cheap oil."
The global economy will quickly adjust to low oil prices, and decisions will be made to raise consumption based on those low prices.
When oil inevitably spikes higher as supply is slashed and demand holds steady, everyone will be "surprised" that low prices didn't last. That's the oil head-fake in a nutshell.
Summary of the Blog This Past Week
When Money Is "Free," Discipline Evaporates; When Discipline Evaporates, Decisions Are Disastrous 3/17/17
Now That Everyone's Been Pushed into Risky Assets... 3/16/17
Why Fragmentation Is the Solution, Not the Problem 3/15/17
Are Cities the Incubators of Decentralized Solutions? 3/14/17
Solutions Abound--on the Local Level 3/13/17
Best Thing That Happened To Me This Week
I read that Tom Garrett (R-VA) and Tulsi Gabbard (D-HI) introduced legislation in Congress earlier this month to exclude cannabis from the federal Controlled Substances Act--essentially legalizing it on the federal level. Yes, we know the bill won't pass, but even proposing it is some progress.
Market Musings: A Glance at Volatility
The classic measure of volatility in the stock market is the VIX, the so-called "fear index" that rises when participants shift from a risk-on euphoria to a fear-based caution.
Correspondent Chad D. alerted me to the SVXY fund, which is an inverse of the short-term VIX (i.e. the VXX).
As we can see, the SVXY has been in a strong uptrend for over a year, reflecting a decline in fear/caution and a powerful confidence in future stock market gains. This complacency surprises many observers, who see plenty of shoals ahead in the global economy.
The MACD and stochastic indicators show no signs of weakness, and based on this weekly chart, it looks like volatility will remain suppressed and investor confidence will continue marching higher.
Should the SVXY break its uptrend, that would provide a signal that the stock market advance was due for a pause--or perhaps even a trend reversal.
From Left Field
The biggest threat facing middle-age men isn’t smoking or obesity. It’s loneliness.
The Coming Islamic Culture War: What the Middle East's Internet Boom Means for Gay Rights, and More
Remembering Rocketdyne: Discussing America's Worst Nuclear Meltdown (Not Three Mile Island) With Erin Brockovich
On July 12, 1959 that experiment went horribly wrong, and there was no one around to report on it. We lived about 5 miles away at the time, and my brother, sister and I were playing outside every day for the 14 days the radioactive plume dissipated over San Fernando valley...
Nobel Prize Winning Economist Blasts America's "Rent-Seeking" Economy -- echoing Michael Hudson...
Paul Tudor Jones' 10 Trading Principles (via Moaxian)
We need to talk about TED: Science, philosophy and technology run on the model of American Idol – as embodied by TED talks – is a recipe for civilizational disaster.
Is Denmark On The Brink? --speaking the unspeakable--at least in Europe...
John Cochrane on Growth and Why the Public Policy Debate is Like an Old Marriage
Algorithmic Control and the Revolution of Desire
Will Democracy Survive Big Data and Artificial Intelligence? We are in the middle of a technological upheaval that will transform the way society is organized.
The CIA and the Cultural Left --strange bedfellows, to say the least...
Scraping by on six figures? Tech workers feel poor in Silicon Valley's wealth bubble -- seems unreal but it's true: $100K is just getting by...
Architect Turns Old Cement Factory Into His Home --nice work...
"It’s not the load that breaks you down, it’s the way you carry it." Lou Holtz (via GFB)
Thanks for reading--
charles |
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