Brent Crude – The Walker Report

What a Race Car Driver Taught Me about Oil Prices

Tesla is all over the news. Most recently I have seen several postings about the new P85D Tesla’s Insane Mode, a setting in the car that delivers the maximum amount of power to the car (a big thanks to my client who sent me the link).

Tesla, and it’s CEO Elon Musk (who is a real life bond villain) has made quite a splash, building a high quality and competitive electric car with a solid range. A real first. And while his current offerings in the market remain decidedly high end, his ambitions include creating a more affordable middle class version as well.

But the economics of electric vehicles remain challenging at best. There are more options than ever, from Chevrolet, to Ford to Toyota. But these cars all tip the scales at the upper end of the car market, and are not sensible economically on a three year lease.

This is the Tesla Model X. It's due to hit the road in 2016, and is gorgeous. Notice the "Falcon Wing." Notice it! Did you notice it? Awesome, right? — This is the Tesla Model X. It’s due to hit the road in 2016, and is gorgeous. Notice the “Falcon Wing.” Notice it! Did you notice it?
Awesome, right?

But the problem for electric cars may be best explained by the new Formula E series that is currently in it’s inaugural season. Using a newly designed electric race car I was surprised to learn that there are limits on the power that drivers can use in races, (while fans can vote to give some drivers an addition 50 bhp to boost speed each race via twitter). Why is this? Ostensibly it is to help preserve the life of the battery, already the heaviest part of the car and not powerful enough to get a car through a single race without a second car. In other words, the economics of the battery is still the biggest challenge facing all auto producers.

By some good fortune my brother in law is a driver in Formula E for team Mahindra. Mahindra & Mahindra isn’t as well known in Canada, but is a large conglomerate and a significant auto producer that sells in many countries. This past year they have launched India’s first electric passenger vehicle, the Reva e2o, which they had loaned to Karun and afforded me the opportunity to test drive while visiting my extended family in India. It’s a good car, and I could see that Karun had enjoyed driving it. But he pointed out the first challenge to electric cars in India was that the Indian government is only just introducing an electric car subsidy (having previously canceled one in 2012). In fact it is government subsidies that have helped foster the boom in electric cars.

What this all leads to is the inevitable challenge poised by the sudden drop in the price of oil. Electric cars sit at the top of the market in terms of cost, and many aren’t even viable until after you both:

Don’t have to buy gas anymore when oil is over $100 a barrel.
Are given money by the government to help afford the car.

So if high gas prices underly the business case for electric cars, then a sudden cut in the price of oil does significant damage to that business case. It makes traditional petrol cars more cost effective, more competitive and more profitable compared to their e counterparts.

This tells us two things about oil and electric cars. The first is that while oil prices may stay depressed compared to previous market highs, the demand for oil is unlikely to decline and will likely recover as cheap oil spurs economic growth. The second issue is whether the rise of companies like Tesla is overstated. As exciting as they may appear, the market valuation of TESLA is the real insane mode, and certainly not in line with a traditional auto maker. The reality at least is that the end of oil, and the growth of electric cars is going to be dependent on considerable innovations in battery technology and will not be viable in the long term with cheaper oil and government subsidies. But who knows, next year’s Formula E series will allow teams to design their own cars and we may begin seeing some interesting innovations start in battery development.

February 5, 2015February 5, 2015 by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc

Will We All Be Victims of Cheap Oil?

Earlier this year we wrote that Russia’s economy was fundamentally weaker than Europe’s and that their decision to start a trade war in retaliation for economic sanctions over the Ukraine would hurt Russia far more than Europe. As it happened Russia has suffered that fate and had a helping more. The collapsing price of oil was a mortal wound to the soft underbelly of the Russian economy, leading to a spectacular collapse in the value of the Ruble and an estimated 4.5% contraction in their economy for 2015.

The Ruble’s earlier decline this year had already made the entire Russian stock market less valuable than Apple Computers, but as the price of Brent oil continued to slide below $60 (for the first time since 2008) investors began to loose confidence that Russia could do much to prop up the currency, prompting an even greater sell-off. That led to an unprecedented hike in the Russian key interest rate by its central bank, moving it from 10.5% to 17% yesterday. Moves like that are designed to reassure investors, but typically they only serve to ensure a full market panic. The Ruble, which had started the year at about 30 RUB per dollar briefly dropped to 80 before recovering at around 68 to the dollar by the end of trading yesterday.

The Russian Ruble over the last year. The spike at the end represents the last few weeks.

Cheap oil seems to be recasting the economic story for many countries and millions of people. The Financial Times observes that oil importing emerging markets stand to be big winners in this. Dropping the cost of manufacturing and putting more money in the pockets of the growing middle class should continue to help those markets. The same can be said of the American consumer, who will be benefiting from the sudden drop in gas and energy prices.

The Financial Times always has the best infographics.

Losers on the other hand seem easy to spot and piling up everywhere. Venezuela is in serious trouble, so is Iran and the aforementioned Russia. Saudi Arabia should be okay for a while, as it has significant foreign currency reserves, but as the price drops other member states of OPEC will likely howl for a change in tactic. But along with the obvious oil producing nations, both the United States and Canada will likely also be victims, just not uniformly.

Manufacturers may be breathing a sigh of relief in Ontario, but Canadian oil producers are sweating it big. Tar sand oil requires lots of refining and considerable cost to extract. Alberta oil sands development constitute some of the most expensive projects around for energy development and a significant drop in the price of energy, especially if it is protracted, could stall or erase some future investments. This is especially true of the Keystone Pipeline which many now fear isn’t economically viable, in addition to being environmentally contentious.

Saudi Arabia has continued to allow the price of oil to fall with the intention of hurting the shale producers in the United States. This price war will certainly claim some producers in the US, but it will difficult to know at which point that market will be effectively throttled. Certainly new projects will likely slow down but the continued improving efficiency of the fracking technology may make those producers more resilient to cheap energy.

But there is one more potential victim of the falling price of oil. That could be all of us. I, like many in the financial field, believe that cheap energy will enormously benefit the economy. But our biggest mistakes come from the casual confidence of things we assume to be true but prove not to be. A drop in energy should help the economy, but it doesn’t have to. If people choose not to spend their new energy windfall and save it instead, deflationary pressure will continue to grow. As I’ve previously said, deflation is a real threat that is often overlooked. But even perceived positive forms of deflation, like a significant reduction in the price of oil, can have nasty side effects. The loss to the global economy in terms of the price of oil is only beneficial if that money is spent elsewhere and not saved! For now confidence is that markets will ultimately find the dropping price of oil helpful to global growth, regardless of the early losers in the global price war for oil.

December 17, 2014 by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc

The Media is Turning Market Panic up to 11 – Learn to Tune Them Out

The current market correction is about as fun as a toothache. Made up of a perfect storm of negative sentiment, a slowing global economy and concerns about the end of Quantitative Easing in the US have led to a broad sell-off of global markets, pretty much wiping out most of their gains year-to-date.

Screen Shot 2014-10-15 at 3.38.09 PM — This is what my screen looked like yesterday (October 15th, 2014). The little 52L that you see to the left of many stock symbols means that the price had hit a 52 week low. The broad nature of the sell off, and indiscriminate selling of every company, regardless of how sound their fundamentals tells us more about market panic than it does about the companies sold.

One of the focal points of this correction has been the price of oil, which is off nearly 25% from its high in June. Oil is central to the S&P/TSX, making up nearly 30% of the index. Along with commodities, energy prices are dependent on the expectation of future demand and assumed levels of supply. As investor sentiment have come to expect that the global demand will drop off in the coming year the price of oil has taken a tumble in the last few weeks. Combined with the rise of US energy output, also known as the Shale Energy Revolution, or fracking, the world is now awash in cheap (and getting cheaper oil).

Screen Shot 2014-10-16 at 12.32.36 PM — The price of Brent Crude oil – From NASDAQ

But as investors look to make sense out of what is going on in the markets they would be forgiven if all they learned from the papers, news and internet sites was a barrage of fear and negativity masquerading as insight and knowledge. The presumed benefit of having so much access to news would be useful and clear insight that could help direct investors on how to best manage the current correction. Instead the media has only thrown fuel on the fire, fanning the flames with panic and fear.

Contrast two similar articles about the winners and losers of a dropping price of oil. The lead article for the October 15th Globe and Mail’s Business section was “Forty Day Freefall”, which went to great lengths to highlight one big issue and then cloak it in doom. The article’s primary focus is the price war that is developing between OPEC nations and North American producers. Even as global demand is reportedly slowing Saudi Arabia is increasing production, with no other OPEC nations seemingly interested in slowing the price drop or unilaterally cutting production. The reason for this action is presumably to stem the growth of oil sand and shale projects, forcing them into an unprofitable position.

This naturally raises concerns for energy production in Canada, but it is not nearly the whole story. The Financial Times had a similar focus on what a changing oil price might mean to nations, and its take is decidedly different. For instance, while oil producing nations may not like the new modest price for oil, cheap oil translates into an enormous boon for the global economy, working out to over $600 billion a year in stimulus. In the United States an average household will spend $2900 on gas. Brent oil priced at $80 turns into a $600 a year tax rebate for households. Cheaper oil is also hugely beneficial to the manufacturing sector, helping redirect money that would have been part of the running costs and turning them into potential economic expansion. It’s useful as well to Emerging Economies, many of which will be find themselves more competitive as costs of production drop on the back of reduced energy prices.

A current map of shale projects, and expected shale opportunities within the United States and Canada.

Business Reporting isn’t about business, it’s about advertising revenues.

While Canada may have to take it on the chin for a while because of our market’s heavy reliance on the energy sector, weakening oil prices also tends to mean a weakening dollar, both of which are welcomed by Canadian manufacturers. Corrections and changing markets may expose weaknesses in economies, but it should also uncover new opportunities. How we report these events does much to help investors either take advantage of market corrections, or become victims of it. As we wrote back in 2013, business reporting isn’t about business, it’s about advertising revenues. Pushing bad news sells papers and grabs attention, but denies investors guidance they need.

October 16, 2014 by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc