Hope and a Kiss

Oil prices had demonstrated tremendous strength despite the global slowdown maintaining $100 and above. This happened principally due to China’s energy intensive growth and global monetary expansion. However, oil prices have been on a downward tear for the last few weeks crashing new technical levels. OPEC countries, Russians and Venezualans (and some large banks) are sweating how this massive downward revision will impact their economic stability and the geopolitics they practice.

But first how it came to this. North America has witnessed a massive revolution in energy driven by shale and oil sands. US today has begun to produce almost twice the volume oil it produced in 2005 (5 million barrels per day) and Canada has added almost 1mbpd.  This US production is poised to expand with some estimates of shale standalone being 12mbpd. In addition Canada oil sands could add another 2mbpd over the next 4-5 years. This is in the context of US consumption being ~19mbpd. EU and Japanese demand has declined by 1mbpd each in the last 5 years and US automotive efficiency has increased by 25% since 2008 keeping global demand fairly static at 90mbpd. This decline will surely make shale gas finds unviable and impact future investments in the sector. But what it importantly does is put a cap to prices in the sector. "We think the world has plenty of oil at $90 going forward," Morse (Citibank) writes, "but supply may be less adequate on a sustainable basis at prices much below $70...even though on a shorter-term basis, US shale production can continue to grow robustly even at lower prices."

As I have written previously, Saudi is the lowest cost producer and is able to balance its budget at $85 at current production levels (they have a swing capacity of around 1mbpd). Anything below puts a significant stress on OPEC and Russians. Russians will surely remember the economic crises leading to a break-up that low oil prices brought in the 1980s while Iranians apparently have already cut their budget to Hamas by a third.

This fall in prices if it lasts in excess of 6 months and begins to seem more enduring will begin to change geopolitical behavior globally. Americans already are moving towards reconciliation with Iran, despite Saudi reservations, changing the contours of the middle-east and higher oil production will begin to reduce cost of production in the US reviving manufacturing impacting exporting nations like China and Germany.  Saudi and the Iranians will have to turn their focus on internal stability and have lesser economic ability to fuel the various clandestine programs. Russians typically always prioritize politics to economics but theirs is now an economy more integrated than any time before in history, it will be interesting to see their moves in Ukraine. “Oil creates the illusion of a completely changed life, life without work, life for free. Oil is a resource that anaesthetises thought, blurs vision, corrupts.” ― Ryszard Kapuściński, Shah of Shahs

The deflationary push of oil prices and commodities ranging from iron, cotton and sugar is likely to lead to rate reduction to stimulus measures in EU, Japan, China, Australia and Brazil. Japan has already added to its QE program and China has reduced interest rates (driven more by a massively slowing economy though). Oil prices will provide an added push to the USD leading to further depreciation in commodity prices and creating pressure on global liquidity, consequently emerging market financial assets.

By the turn of the 20^th century, oil has been a key determinant of a nations’ prosperity and even its survival. And, as the tide turns, its impact will play out.

“Never let a fool kiss you or a kiss fool you”