By Mike Berry
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Bob Farrell’s Rule #9: When all of the experts and forecasters agree – something else is going to happen.
I have been through two previous oil swoons. In March 1999 oil bottomed at $10 per barrel. I was invested - a money manager with Heartland Advisers at the time. The Economist magazine (March 6, 1999) forecast oil to move lower, perhaps $2. It was a painful experience but oil never went lower.
I read Gary Shilling's excellent Insight last week. He opines, and I agree, that it is marginal production costs that count for most current oil producers. Yes, US rig counts are falling and will fall further, but there many sunk costs especially in the shale oil fields in Texas. These will continue to flow for 15 years, at much reduced rates, of course. But oil production will continue to add up.
For many good reasons Gary sees oil at $10 to $20 per barrel. I agree. This is the "good" deflation of excess supply - but it is deflation! The Fed (FOMC) has to think about this in its forthcoming June or September Fed Funds interest rate decision. I read the WSJ yesterday where 6 or 7 Fed Presidents now speak of a June interest rate increase. I will speak at the Fed on Monday March 2 in Arlington, Virginia. The topic they have asked me to present (3 times this year) is the impact of higher interest rates on the banking system.
One really good lesson I learned in my years as a professor and money manager is:
Never confuse spot price with long term value. Just take advantage.
It's hard to imagine a barrel of oil priced at $100 again. That would immediately revive the horizontal industry (shale). It is an industry that can mobilize quickly and cut costs efficiently. But, never confuse price with value!!!!
Behavior always and everywhere trumps value.
However, in spite of their attempts to destroy the North American tight oil industry be assured that the Saudis have failed. In many areas as technology improves, many shale producers will do quite nicely at $70 oil. Those that haven't levered will survive. Most are hedged through 2016 at least in part. The question is, who will blink first in the longer term?
Incidentally, Eagle Ford crude gets Brent pricing (actually a slight discount to Brent) because it is light oil. Brent spot traded at $61.56 per barrel this AM.
Yes, I do agree with Gary that $10 to $20 oil will likely be in our future. That will certainly cause the marginal producers to cease production. But it won't last - it never does. Each year we must replace 4 million barrels of production.
If Washington wanted to save its nascent oil industry, a tax break would put our Saudi "allies" on notice. Even exporting crude or infrastructure development (GTL?) would be most welcome to an underemployed US work force.
This US oil renaissance has been welcome to investors in the big oil and oil services companies as well as the huge downstream economy. At present the oil services industry is shrinking itself. For example, Schlumberger recently announced 9,000 layoffs. Just one of many in retrenchment
Every US president in my lifetime (with the possible exception of President Obama) has categorically stated that the US must become energy independent. What better time? What better technology? Does Washington still care about our energy independence? Is Kissinger's Petro Dollar sacred?
The world should never underestimate American innovation and technology!!! As my son Chris has opined in our new web site, "American technology can often be trans-formative" especially when confronted with a challenge.
In the meantime, deflation? Yes! - Excess supply and deficient global demand in the intermediate future are almost assured. Smart royalty players in the shale oil patch are buying properties up at much reduced rates.
The Deflation Issue
Though I do not have enough ammunition to boldly state the obvious, I do see a global retrenchment. I think deflation (not only excess supply but also deficient demand) will dominate the global economy for several years – at least till deleveraging takes place..
I believe this in part because there is just so much unwinding of global Keynesian Central bank mis- management yet to do. I think Gary Shilling has the debt trap right (finally).
Russia will have serious (now 30 trillion Ruble debt) problems, Greece is staring into the abyss and with it the EU, and the Middle East is, to say the least, unsettled. US banks have exposure to various high yield shale oil loans, commodity countries are hurting and must produce. On top of this we have extreme disinterest in Washington in both the administration and Congress. Both are bereft of adequate leadership. There are structural, fiscal, and monetary issues at stake.
We are far past the point of economic salvation from printing - that has been tried, again and again.
I dare the Fed to raise rates in June. We shall see. Sometimes irrationality wins the day.
Three to five years will likely see the dawn of a new day.
Have a great day ladies and gentlemen and prepare to defend yourselves!
There, I've said enough. Comments welcome.
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