Oil: Lower for Longer

We’ve done a little video to try and explain why analysts now expect the price of oil to stay much lower for much longer. It’s a different format than our previous videos, but we think it offers an opportunity to be more informative with a greater impact than some of our other videos.

We’ll be playing around with this idea for a while, experimenting with ways to make it interesting and quick, so please send us your thoughts and any topics you’d like us to cover.

In other news, the Canadian and global markets have been taking a beating over the last couple of weeks. Much of this is tied to an expected Federal Reserve rate hike for the end of December. The rate hike will be unbelievably small, but markets have been selling off in anticipation of it’s arrival.

The “normalising” of interest rates is a hot topic for many. Some American manufacturers worry that rising rates will inflate the USD further than it already has this year. In Emerging Markets the rising USD has meant a collapse in investment while funds flow back to American shores. Proponents of the rise have argued (persuasively I believe) that seven years after a major financial crisis it makes no sense to have interest rates at emergency levels. Long term cheap credit can’t be allowed to continue.

Canada is also getting badly beaten by the continuing falling price of oil and the end of the commodity super cycle. The slowing down of China has meant that there is simply less need for the huge amount of raw materials we have been selling. Prices on iron ore and copper have all been falling with the price of oil.

Canada is also saddled with other problems. Debt to income just hit a new high, while government debt is expected to grow substantially over the coming years while the economy looks to be doing worse.

We’ve been extremely busy in the second half of this year, which has kept us from writing as much as we have in the past. But we will try and be back later in the week with some more analysis on the markets and economy.

 

 

Will We All Be Victims of Cheap Oil?

OILEarlier 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.
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.
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.

Carbon Tracker Initiative
Carbon Tracker Initiative

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.

This chart was produced by Scotiabank
This chart was produced by Scotiabank

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.

My Car Runs on Geopolitics – Why “Fracking” is an Important Investment for Your Portfolio

frackingI’m an environmentalist. But as a Financial Advisor I consider that some of the best opportunities I can provide to my clients is exposure to the burgeoning US and Canadian energy markets. That’s right I’m a big proponent for one of the most ecologically damaging and publicly derided forms of energy extraction.

However, next time you put gas in your tank consider this: 7000 fighters are currently making a mockery of whatever pretense Iraq was making at being a legitimate country. ISIS, the Islamic faction currently pushing into northern Iraq from Syria with aims to establish an Islamic Caliphate in the region has been routing Iraqi government forces. An army a quarter of a million strong, equipped with the latest in weapons, tanks and aircraft are losing regularly to a rag tag group of extremists equipped only with machine guns.

Meanwhile in the Ukraine we have fresh assurances that Russia will abide by a new ceasefire between Ukrainian government forces and rebels loyal to the Russian government. While Russia may have undone its own objectives of building a rival economic group, they have successfully reminded everyone why Russia, no matter how weakened it may be, is a powerful force that controls a great deal of energy needed for global consumption.

Across many of the nations that produce some form of energy (oil, natural gas, coal, etc.) there are very few that can claim to be a democratic, civil society not embroiled in some kind of sectarian civil war. But as of this year the United States has become the world’s largest producer of energy, outpacing Russia and Saudi Arabia, and that promises to change the way we think about economies and economic opportunities going forward.

production

In many developed countries there is a great deal of hand-ringing about the sudden rise of hydraulic fracturing – a relatively recent method of energy extraction that is reducing the cost of production and breathing new life into American manufacturing. “Fracking” comes with a number of environmental downsides, some of which are both scary and quite dramatic.

But energy is the life blood of civilisations and a steady supply of affordable energy is what gives us the ability to grow our economies and invest in new technologies. Sometimes this means making hard choices about how we allocate resources, and what the long term impacts of certain industries to our environment might be. But affordable energy, in the form of both oil and natural gas, provided from countries like Canada and the United States doesn’t just help bring back domestic manufacturing. It also economically weakens dictators and states that ignore human rights and puts power back in the hands of liberal democracies to enforce sanctions.

In other words there are numerous political and economic benefits that come along with cheaper Western energy. While this doesn’t address our environmental problems it’s important to love your monsters. The tools that give us our wealth and prosperity shouldn’t be abandoned just because they pose challenges, rather it invites us to both reap profits and seek new ways to conquer those problems we face. That is at least until either Google or Tesla solve all our driving problems.