What Cheap Oil Really Means
Written by Frehiwote Negash
When Oil prices crossed the $100 per barrel threshold in 2008, there was a prevailing thought that this might be considered the new normal. Oil prices have crossed that benchmark numerous times in the last 6 years hitting $115 as early as June (Isadore, 2014). Since then, oil prices have dropped over 50 {92d3d6fd85a76c012ea375328005e518e768e12ace6b1722b71965c2a02ea7ce} in the last 7 months; a staggering drop for a popular commodity. With Saudi Arabia’s Petroleum Minister announcing that Opec will not cut oil production regardless of the price per barrel, the days of $100 per barrel of oil are officially over (Defterios, 2014).
Countries like Canada and Russia are net energy exporters with oil being their largest export. While sanctions might have limited Russia’s economic prospects, the fall of oil prices has done more to damage their economy as evidenced by the free fall of the ruble last week. Yesterday, the Canadian dollar hovered near its 5 year low today hitting .85 against the American dollar (Nguyen, 2014). While the performance of the American dollar is boosted by its strengthened economy, the fall of the loonie can be attributed to fluctuating price of commodities, oil being the trigger point. Other oil producing countries such as Norway also suffered as the krone also hit a 5 year low upon the Opec announcement (Nguyen, 2014). This serves to further complicate things for non- Opec countries as the surplus of oil on the market will force them to slow production substantially and cancel future project in order to stay competitive.
As oil prices drop, Canadian consumers are delighted at the prospect of paying a little over a $1.10/l at the pumps during the holiday season. While it is clear that consumers benefit directly from lower oil prices, the same cannot be said for investors, governments and their respective economies. The recent fall in oil prices has had a massive impact on world markets. It has triggered panic selling forcing governments to act swiftly and adjust to the new reality. The price of oil is a major indicator for government projections. It helps governments determine how they plan and execute annual budgets. It can determine foreign policy and the outcomes of elections. In the short term, consumers see more money in their pocketbooks. However, with the free fall in oil prices and a weaker loonie there will be by-products of this crisis that affect all Canadians by way of government policy. Consumers have to remember that the loonie is a commodity currency so as the oil goes, the loonie goes.
For Canadians heading south for the holidays, that means less bang for your buck. For Albertans, lower oil prices means less in the public coffers as Premier Jim Prentice announced yesterday that Alberta will be $7 billion short of their estimated windfall (Curry, 2014).if you live in Southern Ontario, the hope is that the lower dollar will help boost the flagging manufacturing sector. The price of oil has created ripple effects in the Canadian economy but a sustained period will cause a tidal wave that affects every Canadian.
Works Cited
Curry, Bill. “Dropping loonie, sliding oil price redraw provinces’ economic pictures” Last accessed December 24, 2014. http://www.theglobeandmail.com/news/politics/federal-budget-revisions-shake-up-provincial-finances/article22184872/
Defterios, John .”Saudi Arabia: We’ll never cut oil production.̎Last accessed December 23, 2014. http://money.cnn.com/2014/12/22/news/economy/saudi-arabia-oil-production/index.html?iid=EL
Isadore, Chris. The end of $100 a barrel oil. Last accessed December 23, 2014, http://money.cnn.com/2014/12/23/news/economy/saudi-oil-minister-100-dollar-oil/
Nguyen, Lannah. ”Loonie near 5-year low as U.S. economy surges”. Last accessed December 23, 2014. http://www.bnn.ca/News/2014/12/23/Loonie-near-5-year-low-as-US-economy-surges.asp
- Published in Blog, Oil and Gas
Putin Just Gave An Amazing End-Of-The-Year News Conference
Russian President Vladimir Putin gave a big end-of-the-year news conference Thursday that lasted about three hours, speaking about his country’s economy and the collapse of the ruble.
He also addressed Russia’s conflicts with the West.
Several English-speaking journalists, including Max Seddon of BuzzFeed and Paul Sonne of The Wall Street Journal, tweeted translations of Putin’s statements, and NBC News carried a live stream with an English translation.
Here are some highlights:
- Putin insisted that growth was “inevitable” and that Russia could dig out of its economic crisis in two years at most.
- He refused to call the ruble’s collapse a crisis, and he blamed it partly on sanctions from the West.
- He said that regarding Ukraine, Russia was right and the West was wrong.
- He compared the Russian invasion of Crimea to taking Texas from Mexico.
- He implied that the US was aiming to disarm Russia and asked: “Do we want our bear to just become a stuffed animal?”
The Economy
The ruble weakened against the dollar just ahead of the news conference. Russia’s currency has fallen over 40{92d3d6fd85a76c012ea375328005e518e768e12ace6b1722b71965c2a02ea7ce} against the dollar and the euro since June, hitting a record low of 80 rubles to the dollar and 100 rubles to the euro earlier this week.
Early on, Putin commented on Russia’s currency crisis. He said it had been “provoked by external factors” and that the central bank and government were taking adequate measures to deal with the economic situation.
He also insisted that growth is “inevitable” and that Russia could dig out of the crisis in two years at most.
Putin said he is optimistic because he thinks the economy will eventually adjust to low fuel prices. He also said that Russia must step up efforts to diversify its economy so that Russia is not so reliant on oil.
Before discussing the ruble crisis, Putin opened on a higher note, citing 2014 gross-domestic-product growth of 0.6{92d3d6fd85a76c012ea375328005e518e768e12ace6b1722b71965c2a02ea7ce} and noting that Russia saw a record agricultural harvest despite turbulence in financial markets.
He later shied away from calling the ruble collapse a crisis.
“I don’t think I can call the situation a ‘crisis’; you can call it whatever you want,” he said, adding that he thinks the central bank and government are taking the correct approach.
He also blamed Russia’s economic situation partly on sanctions by the West over Ukraine, saying the sanctions are responsible for 25{92d3d6fd85a76c012ea375328005e518e768e12ace6b1722b71965c2a02ea7ce} to 30{92d3d6fd85a76c012ea375328005e518e768e12ace6b1722b71965c2a02ea7ce} of the ruble’s problems.
Russia’s economy is widely expected to fall into a recession next year because of collapsing oil prices and economic sanctions by the West.
Putin noted that the country’s central bank has reserves of $419 billion, which he said is enough to maintain the “social situation” in Russia. He was also careful to say Russia would not drain its reserves trying to protect the ruble.
Despite the country’s economic troubles, Russians still widely support Putin. His approval rating hit record highs this year, with 80{92d3d6fd85a76c012ea375328005e518e768e12ace6b1722b71965c2a02ea7ce} of Russians saying they support him.
The West
Putin also addressed tensions with the West.
“Our Western partners decided that they won and that they are an empire, and they began to squeeze everyone else out,” he said.
He also referenced the Berlin Wall, saying that new “virtual” walls were being built through a NATO expansion.
“We want our partners to understand that the best way is to stop building those walls and to build a united humanitarian space,” Putin said.
Putin later implied that the West is trying to disarm Russia.
He compared the country to a bear and said the West would “always try to put it in chains and … take out its teeth and claws, which in this case means our strategic nuclear deterrent.
“Sometimes I think, maybe they’ll let the bear eat berries and honey in the forest; maybe they will leave it in peace,” he added. “They will not.”
Putin concluded by asking: “Do we want our bear to just become a stuffed animal?”
When a journalist asked Putin about talk of a “new Cold War” brewing, Putin said that Russia had just been defending its interests, and he implied that the US was the aggressive party, not Russia. He insisted that Russia was not attacking anyone.
He then said the sanctions that had been imposed on Russia were “illegitimate and illegal.”
Ukraine
A Ukrainian journalist asked Putin how many soldiers Putin sent to Ukraine and what he told the families of dead soldiers.
Putin said Russian soldiers in eastern Ukraine were volunteers and couldn’t be called mercenaries because they were not paid. He also blamed Kiev for starting the conflict.
“The problem is that after the coup d’etat … instead of starting a political dialogue, the new authorities started using law enforcement officers,” Putin said. “When that didn’t work out, they started using the army; when that didn’t work out, they started using other means, such as an economic blockade.”
Putin also said that regarding Ukraine, Russia was right and the West was wrong.
He didn’t address how many Russian fighters were in Ukraine, nor did he give a death toll from the conflict.
Estimates put the number of dead at about 4,000 since fighting broke out between Ukrainian forces and pro-Russian rebels in April. Kiev, Ukraine’s capital, says Russia is supporting the separatists and has about 10,000 troops on the ground.
Crimea
Another journalist asked whether Russia’s economic crisis was somehow payback for the country’s annexation of the Ukrainian peninsula of Crimea.
Putin said the troubles with the ruble were not payback for Crimea, but rather “payback for our natural desire to survive as a nation.”
“It’s not a matter of Crimea; we are defending our independence, our sovereignty and our right to exist. We should all understand this,” he said.
Putin also compared the invasion of Crimea to the US’ taking Texas from Mexico, saying Russia was just managing its territories and protecting its sovereignty.
Mikhail Khodorkovsky
Putin was asked whether he regretted pardoning Mikhail Khodorkovsky, once Russia’s richest man and owner of the country’s biggest oil company, because Khodorkovsky recently said he wanted to be president.
To that Putin replied: “President of which country?”
Putin said he ordered the pardon because Khodorkovsky’s mother was ill, and a mother is a “sacred thing.”
He added that he didn’t regret it. Khodorkovsky spent a decade in prison for fraud and was released last year.
China
Putin said China is Russia’s biggest trade partner and that there were no problems between the two countries.
He said the two have many common interests and have helped stabilize the international arena.
Putin added that Russia would seek to increase trade with China and noted that their trade balance with China would reach $90 billion this year.
He also said Russia’s gas deal with China would be beneficial for both sides despite the high costs.
Russia brokered the deal in an effort to become more independent from the West, given the sanctions that have hindered Russia’s ability to develop energy reserves and raise finance abroad, Reuters reports.
A Possible Coup
A Reuters reporter asked Putin whether he thought a coup was possible in Russia.
Putin said he isn’t worried and that he would not be ousted because Russians knew that he acted in the “overwhelming interest” of the majority of the population.
He also noted that the Kremlin is well protected and said: “We don’t have palaces, so there can’t be any palace coups. We have the Kremlin, and it’s well secured.”
The reporter also said that although Putin blamed the economic crisis on external forces, even those within his circle were known to blame Putin.
Putin, grinning, said: “Give me their names!”
Inequality
Putin insisted that there are not elites in Russia and that while there are rich and poor, all people are equal.
“There is elite wine, resorts, but not people,” he said. “Who is the Russian elite? The peasants, the hard workers.”
Russia has notoriously high wealth disparity.
A report from Credit Suisse in 2013 said that Russia has the highest rate of income inequality in the world.
- Published in Blog
Oil’s demise is a Symptom of Something Big
Dear fellow investors:
The “well known fact” with regards to oil over the last decade read like this: because of huge GDP growth in emerging markets like China, there were going to be 400 million new middle class citizens born of uninterrupted prosperity; they were going to want all the autos, consumer goods, $10,000 watches and food that Americans have.
The demand for commodities was going to be endless because capitalism practiced under authoritarian control was going to be better than the “invisible hand” of the free market. No recessions or depressions required.
Now, with oil dropping from $95 per barrel to below $57 through the first half of December 2014, many pundits seem to focus on the over-supply of oil and falling demand in a slowing global economy. But we think they miss the long-term view.
As long-duration common stock investors, we don’t see oil dropping merely because OPEC and Bakken Shale have produced too much supply. Instead, we see oil’s demise as a symptom of something larger: the unwinding of a globally synchronized trade tied to the “well known fact” stated above.
Part of the job of the long-term contrarian investor is to identify a body of economic information which is not only known to all market participants, but has been acted upon by anyone in the marketplace who wishes to participate. We call this the “well known fact.” If we know where the vast majority of investors are, then we can contentiously go where they are not.
Nearly every major institutional and high-net-worth individual investor had to adjust their portfolio to this particular “fact” about China and the emerging markets over the last decade. The most successful money managers of the prior decade, who had successfully participated early in the “well known fact,” were validated and received adulation for promoting it (think BRIC-trade). As Warren Buffett likes to say, “What the wise man does at the beginning, fools do at the end.”
The boom created by a once-in-a-generation and massive capital re-allocation toward everything related to the globally-synchronized trade did what all booms do. It turned to bust. Few experts or pundits view it this way, but for many it’s often tough to see the forest through the trees.
We think it would be helpful at this point to review other psychologically-driven boom-bust cycles to analyze the depth of their declines and the duration of the bear market which followed. In this way, we might prosper from the disarray of investment managers and the largest institutional pools. They remained trapped chasing an over-capitalized belief in the 400 million new middle-class citizens on “a permanently higher plateau” in commodities.
Go-Go Mutual Fund Boom Peaked in 1968
- Well Known Fact: Technology sparked by the space race was limitless.
- Result: Small-Cap Stock Boom.
- Declines to 1974 Bear-Market Low 60-80{92d3d6fd85a76c012ea375328005e518e768e12ace6b1722b71965c2a02ea7ce}.
- Duration: 6 years.
Nifty-Fifty Large-Cap Stock Boom 1972
- Well Known Fact: 50 companies having limitless earnings growth and consistency.
- Result: Institutions had 74{92d3d6fd85a76c012ea375328005e518e768e12ace6b1722b71965c2a02ea7ce} of their portfolio in common stocks at the beginning of 1973.
- Declines of 50-80{92d3d6fd85a76c012ea375328005e518e768e12ace6b1722b71965c2a02ea7ce} and no ultimate bottom until 1982.
- Duration: 10 years.
Commodity Boom of the 1970s peaking in 1981
- Well Known Fact: Never ending double-digit inflation demanded investments which benefit from inflation (Oil, Gold, etc.).
- Result: stock, Gold stock and Commodity Boom.
- Declines of 70{92d3d6fd85a76c012ea375328005e518e768e12ace6b1722b71965c2a02ea7ce} in Oil and 60{92d3d6fd85a76c012ea375328005e518e768e12ace6b1722b71965c2a02ea7ce} in Gold ending in 1999.
- Duration: 18 years.
Tech Bubble 2000
- Well Known Fact: The Internet Will Change Our Lives.
- Result: Tech-Heavy NASDAQ Index fell 78{92d3d6fd85a76c012ea375328005e518e768e12ace6b1722b71965c2a02ea7ce} and isn’t back to even 15 years later.
- Duration 3 Years.
Residential Real Estate 2005
- Well Known Fact: Houses always go up in value and are geographically diverse.
- Result: Homes fell 50{92d3d6fd85a76c012ea375328005e518e768e12ace6b1722b71965c2a02ea7ce} in hottest markets and the leverage attached to them created the biggest financial meltdown since the 1930s, helping to cause a 50{92d3d6fd85a76c012ea375328005e518e768e12ace6b1722b71965c2a02ea7ce} decline in stock prices.
- Duration: 7 Years.
What can we as long-duration common stock investors glean from reviewing these past episodes of financial euphoria? First, it appears that stocks confess sins and cleanse faster than other asset classes. Second, the connection to leverage and the inter-connectedness of multiple asset classes seemed to cause longer-duration declines in the past.
For example, tech stocks had very little debt and most investors weren’t using margin in 1999. Therefore, the grief didn’t spread to the real economy; however, owners of leveraged oil tax shelters and garden-style apartments in the Sun Belt in 1981 were illiquid and everything inflation-related was tied together.
Third, our observations suggest that asset quality affects decline duration. Exxon paid dividends from 1981-1999, while gold and commodity indexes didn’t. Investors had something to fall back on like earnings, free cash flow and dividends.
Lastly, how fast can money managers purge? Most institutions and high-net worth individual investors have the stamp of the well-known-fact all over their portfolios as evidenced by studies like the 2013 NACUBO study of endowments and foundations. It should take years to rearrange their commitment to all aspects of the globally-synchronized trade.
What do we look for among common stocks as we bargain hunt in sectors which get unwound by a vicious bear market following the unwinding of a “well known fact?” We will watch for the shaming of the globally-synchronized-trade apologists in the media and the closing or liquidation of sector mutual funds, ETFs, hedge fund and private equity vehicles tied to the globally-synchronized trade. This is historically what occurs near the bottom as capacity contracts severely.
So far, nobody has even been criticized yet, let alone vilified. Wait for the time when few are mentioning the new 400-million middle class citizens and when the word “damn” gets put in front of the stocks, commodities and asset classes involved. Finally, we believe that you shouldn’t give too much weighting to any mid-December 2014 explanation which doesn’t include the psychology of a boom/bust cycle and the long-duration nature of the law of supply and demand.
Warm Regards,
William Smead
Smead Capital
- Published in Blog, Oil and Gas
What’s Affecting Oil Prices?
The last year has been an exciting one for oil, to say the least. Starting the year in the high $90s a barrel, today it sits at 66$. There have been many factors that have tied into this story – here is some of the highlights.
US Shale Production is booming, through a combination of horizontal drilling and hydraulic fracturing. Production increased to 9.08 million barrels a day through Nov. 28. Weak Chinese trade data did not help matters.
“Notwithstanding day-to-day movements, the fundamental picture hasn’t really changed, and that is one of supply outstripping demand growth for most of the year,” said Phin Ziebell (senior analyst at National Australia Bank).
As Russian sanctions rev up, Washington has banned imports of high technology oil equipment to Russia and imposed sanctions on Russian oil majors. This has stopped Western firms from supporting exploration and production of shale oil reserves in the Arctic. Russia is the second largest oil exporter, with production hovering around 10.5 million barrels per day. Russia is depending on the development of new reserves to maintain it’s current output.
To make matters worst, a recent report from Morgan Stanley suggests that Brent crude, an international standard, could hit as low as $43 a barrel.
Saudi Arabia, Top producer of oil in the Middle East, blocked OPEC output cut. This shift represents a major shift in the groups policies, and essentially means a battle for market share between OPEC and non-OPEC countries.
OPEC forecast that demand for its oil would drop to 28.9 million barrels a day next year, compared with 29.4 million barrels a day in 2014, the lowest amount in 12 years! Some suggest that recent shifts in OPEC have effectively killed the group.
“The U.S. is producing in a very, very bad manner. Shale oil, I mean it is a disaster from the point of view of climate change and the environment,” Foreign Minister Ramirez, who represents Venezuela at OPEC, said.
Yet as oil prices continue to show weakness, several countries such as India, Indonesia and Turkey stand to gain through leverage of their deficits.
- Published in Blog, Oil and Gas
The Venture Hitting New Lows – Is it Time for a Turnaround Yet?
The S&P/TSX Venture Composite Index dropped -12.81 points today, hitting a 10 year low.
Contrarian investors must be salivating today as oil scraps at the bottom with an 5 year low. Morgan Stanely said that oversupply would most likely peak next year with OPEC deciding not to cut output.
China’s exports rose by 4.7{92d3d6fd85a76c012ea375328005e518e768e12ace6b1722b71965c2a02ea7ce}, down from 10.6{92d3d6fd85a76c012ea375328005e518e768e12ace6b1722b71965c2a02ea7ce} in October. While the US economy is doing well, China’s economic growth slowed to 7.3{92d3d6fd85a76c012ea375328005e518e768e12ace6b1722b71965c2a02ea7ce} in the last quarter, the lowest in 5 years. We are beginning to see history repeat itself on the venture – after 4 years of dropping, it would not be unusual to expect a turnaround in the shortterm. It might go sideways a bit like back in 1991-92 or 2000-2003, however a pattern emerges – take a look back from 1990 to now on the index.
1991-1992> sideways
93> up
94> down
95-96> up
96-99> down
2000> up
00-03> sideways
03-06> up
06-08> down
08-10> up
10-14> down
See the pattern? There is almost a clear back and forth that happens, and following the history, it looks like we are soon to see an uptrend.
- Published in Blog
The Market at a Glance
S&P/TSX Composite Index rose to 14,754.06, or up 0.92{92d3d6fd85a76c012ea375328005e518e768e12ace6b1722b71965c2a02ea7ce} today. The big shakers were TSX gold, energy and material sectors.
S&P/TSX SmallCap Index returns today, breaking a seven day streak of decline.
Gold prices rose today, as crude oil saw a rally. “The move up in crude prices is giving gold the boost,” said Phil Streible, a senior commodity broker at R.J. O’Brien & Associates. A contrarian analysis of gold-market sentiment suggests however this may be a weak foundation.
- Published in Blog