After holding in the $60s for many months, crude has dropped precipitously
in the past few weeks, and is now in the vicinity of $50 a barrel. A number
of reasons have been given for the sharp fall in price, all of them more or
less linked.
To begin with, warm winter weather has resulted in lower seasonal energy use
than anticipated. (Global heating oil demand, for example, is estimated to
be off by 20-
30%.) At the same time, OPEC's production cuts are seen as ineffectual in
the face of cheating, and Russia has been hesitant to slash its record
output.
On top of this, commodity speculators have become bearish and institutional
investors are getting cold feet. When spot crude fetches a higher price than
the further-out futures contracts - a situation known as "backwardation" -
it becomes profitable to buy the back months and wait for prices to rise as
the spot draws closer. The persistence of backwardation in 2006 led
institutional investors and commodity index trackers to load up on
long-dated crude oil contracts; now that the market is no longer in
backwardation, those same players find themselves losing money.
As icing on the cake, the crude oil market is suffering from intrigue
fatigue. Like a jaded child desensitized to violence on television, the
market has grown bored with overly familiar catastrophe scenarios. (Yet if
anything, the geopolitical situation is more precarious today than a year
ago: Israel leaking plans for a tactical strike on Iran; Saudi Arabia
threatening to aid Iraq's Sunnis if the Shia majority pushes too far; US
military morale at low ebb; escalating tensions between Russia and Europe;
nationalization on the rise; Iran accelerating its nuclear program; and so
on.)
In light of all the recent bearishness, it is worthwhile to ponder the
Energy Information Administration's recently released "Annual Energy Outlook
2007 (Early Release version)." Here are the two most interesting sentences
out of the whole thing (in your humble editor's opinion):
"Oil, coal and natural gas...are projected to provide roughly the same 86%
share of the total US primary energy supply in 2030 that they did in 2005
(assuming no changes in existing laws and regulations...
"In 2030, the average real price of crude oil is projected to be above $59
per barrel in 2005 dollars, or about $95 per barrel in nominal dollars."
Trying to predict anything 23 years out is a foolhardy exercise...but the
EIA projections are nonetheless instructive.
For one thing, the projections show just how small the alternative energy
base still is in comparison with fossil fuels. It is not that the EIA
expects zero growth in alternative energy's slice of the pie over the next
few decades; rather, the EIA expects total energy demand to overwhelm all
else, with fossil fuels filling the breach. (For this same reason, the EIA
expects nuclear power's share of the pie to actually fall in percentage
terms, even as more nuclear power plants go online.)
The EIA's second prediction is chuckle inducing. For crude to be just above
$59 in 2030 - not far from where it is now - means little will have changed
on the whole.
And how helpful of the EIA to let us know that $59 in
2005 will translate to $95 in 2030. That's a wonderfully benign inflation
rate...just over 2% per annum between here and there.
As you might have guessed, the point here is not to put faith in government
agency predictions. Instead, it's to get some perspective on where we stand
for the long term.
As a government agency and an offspring of the Department of Energy, the EIA
is congenitally optimistic in its conclusions - much as the Bureau of Labour
Statistics is congenitally blind to inflation. And with all the data at
hand, the EIA's projected long-term price band of $50-60 crude (more or
less) is truly the optimistic case.
Such a prediction almost completely writes off the ramifications of Peak
Oil, and relies on heavily aggressive assumptions in regard to deep-water
drilling and Canada's oil sands. Such a prediction also requires an almost
touching naiveté in terms of US monetary policy; can we really expect
inflation to run just 2.1% per year for the next 23 years? (What happens
when the dollar goes down in flames?)
There are far too many variables to make an informed guess at crude oil's
2030 price. But we do have enough information to note that, given the piles
of data presently available, the optimistic number crunchers at the EIA see
crude trading solidly for the duration. In fact, their $50-60 price range
represents the shiny happy scenario, leaving out the ugly but all-too-real
possibilities looming before us.
The other thing we can gather from the EIA prediction is
this: Nobody knows nothin'. Meaning, all the data points in the world can't
predict the distant future. To grasp how ludicrous these types of specific
predictions are, just observe the fate of those who make them. In the real
world, the best you can do is marshal the facts to get a sense of what's
possible and what isn't...what makes sense and what doesn't. In this sense,
broad observations regarding the possible course of future events should be
rooted in the laws of physics. What goes up must come down...that which
cannot persist must eventually cease...and so on.
In the short run, a market can do most anything - especially one dominated
by speculators with a quarterly, or even monthly, time horizon. But in the
long run, as Jesse Livermore noted, the best and truest allies will always
be underlying conditions. You'll see all kinds of numbers fly around in the
coming weeks and months, feet stampeding this way and that...but through it
all, the long-term energy picture won't shift much.
We're dealing with sweeping sea change here, not ephemeral seasonal stuff.
That's why I'm not inclined to worry too much about this recent crude oil
slide. There's never any money in running around like a chicken with your
head cut off.
Traders rely on speed and reflex, investors on patience and fortitude; to
the best of my knowledge, nervous panic is no help to either discipline. If
anything, the short-term roller coaster gives an edge to those with a taste
for the long-term view.
Regards,
Justice Litle
for The Daily Reckoning
First, there was the New Woman.
Then, there was the New Economy.
Now there is the New Inflation.
Asset inflation is as different from the regular kind as an illicit affair
is from an ordinary one. It is much more agreeable when it comes in...and
much more painful when it goes away.
And it is not all created by central banks or Treasury Departments.
By now, we understand central bank inflation only too well. It worms its way
down to the consumer economy through the banking system. Eventually, but not
immediately, prices rise. And when prices rise too steeply, voters begin to
howl, businesses get jumpy, investors start to flinch and the whole economy
goes sour like old milk.
But this 'New Inflation' is different. It is the 'Wave of Liquidity' that is
floating up prices of capital assets - and rich peoples' toys - all over the
planet.
Yes, dear reader, the rich have done very well out of all this new liquid.
It has boosted up their wealth.
Their stocks, their bonds, their property, even the works of art that adorn
their walls have floated up.
Where does all this money come from? Ah, that's what is new about it. And it
is why the financial industry is making so much money.
It works like this. You have a house worth $100,000. You take out a housing
loan for $50,000. Then the loan is mixed together with other loans, stirred,
shaken and sold to a financial house, X. There, it is used as collateral for
a loan of $500,000, which is invested in a leveraged buy-out of a Company Y,
which then issues bonds worth $5 million, which are taken up by hedge fund
Z, that borrowed the money to buy them from the Japanese at a low interest
rate, exchanged it for dollars, and now invests in these junk bonds at twice
the yield.
At every step, the financial intermediaries make their commissions, their
spreads, and their fees. At every step, the amount of notional 'money' in
the world multiplies. Your income has not changed, your house is still the
same, business Y makes no more profits. The real economy remains just as it
was. This feverish financial activity, this 'financialization of the
economy' adds nothing, not one jot or tittle, to the real wealth that is in
the world. There are no more factories, no more diamonds, no more steak
sandwiches.
All this money-shuffling produces nothing but more profits for the
money-shufflers and more wealth for the rich people around the table.
As long as the credit bubble expands it also expands the values of the
assets held by the rich. Their stocks, bonds, junk bonds and all other
assets, go up in price.
Which means, that they are the beneficiaries of the New Inflation. When
their junk bonds or houses or stocks go up in value they have more
purchasing power. They can trade financial assets for other assets. They can
use them to buy a time-share in a corporate jet, or a holiday home at St.
Barts. Or, they can simply buy more 'stuff.'
We can be sure that they are not going to drive up the price of toilet paper
or margarine, however. Consumer prices are, broadly speaking, unaffected.
The rich don't use more toilet paper just because they have more money.
Nor do they eat more hamburgers. But insofar as they have more purchasing
power, thanks to this New Inflation, they grow richer, compared to the rest
of the world.
This might not make much difference, eventually, of course. Every dollar
created out of thin air eventually goes back whence it came. All this
pseudo-wealth – created by the New Inflation – will eventually disappear.
Credit booms are typically followed by credit busts. Junk bonds typically
have their moments of glory, followed by their hours of desperation and
defeat.
Things that go up so spectacularly can be expected to go down in a
sensational way too.
But here is where the real problem arises. While financial assets rose in
price so did the debt burden on the proletariat. The New Inflation meant new
wealth to the rich; to the lumpen, the booboisie, it meant debt- financing.
What the middle and lower classes got out of it was an opportunity to ruin
themselves; which they took up readily.
New Inflation is sure to be followed by New Deflation.
We wonder what that will feel like...
More news...from Chris in the US of A:
---------------------
Chris Mayer...in California:
- A darkness blacker than night is how it was often described. At least one
could pierce the black veil of night. Not so with this kind of darkness. It
was opaque.
People were afraid. It was only midmorning. They had never seen anything
like it.
- If you ventured outside into the cold and biting wind, sand would get in
your nose and mouth and ears. You would hurry back inside and cough up
black. While inside, people soaked sheets and towels. They would try to
stuff them around windowsills and doorframes. But it didn't help much.
Choking dust still filtered in. It spread out in little ripples on the floor
and seeped through windowsills.
- It was November 11, 1933, Armistice Day, South Dakota.
When it was finally over, families would stumble out of their farmhouses and
peer out at a new surrealist landscape. The fields were gone. The trees were
no more.
Just mounds of sand and eddies of dust swirling in the light autumn breeze.
There were no roads. No tractors or machinery, no fences. All of it laid
buried in sand. As one observer said, "The roofs of sheds stuck out through
drifts deeper than a man is tall."
- The great Black Blizzard of 1933 destroyed acres of farmland stretching
from the Texas Panhandle all through the Great Plains and clear to the
Canadian border. The following day, the skies darkened over Chicago. A
steady stream of filth fell on the city like snow. Even people as far east
as Albany in New York could see the menacing dark clouds roll their way
across the horizon. That winter, red snow fell softly on New England.
- Yet 1933 was "only a prelude to disaster," as Frederick Lewis Allen wrote
in his panorama of the 1930s, Since Yesterday. In 1934 and 1935, the dust
storms destroyed thousands and thousands of acres of farmland. The lives of
more than half a million Americans changed forever. Many hit the road,
forced to wander like refugees in their own land. Most headed west, looking
for a new start.
- The Dust Bowl was a seminal event in American history.
Unlike a natural disaster such as a hurricane, "There was a long story of
human error behind it," as Allen wrote. After World War I, there was a great
demand for wheat. Mechanized farming also became common. Farmers tore up the
sod that covered the plains and farms expanded. Production soared.
- The Plains were a region of high winds and light rainfall. Yet the 1920s
were pretty forgiving in terms of drought. There were warnings, though, such
as stories of topsoil blowing in Kansas after a stretch of dry hot weather.
But in the 1930s, we had some real drought in these places. The combination
of drought and desiccated farmland would create the epic dust storms.
"Retribution for the very human error of breaking the sod of the Plains had
come in full measure," Allen wrote.
- I recently spent some time looking over pictures of the aftermath of these
blizzards. They are incredible and simply hard to believe. Yet I see how
something like this could happen again. Except this time, it will be bigger.
And it will happen in China. But don't think it won't affect what happens in
America. Plumes of dust emanating from northern China have already hit the
US mainland.
- As Lester Brown, author of Outgrowing the Earth,
explains: "With little vegetation remaining in parts of northern and western
China, the strong winds of late winter and early spring can remove literally
millions of tons of topsoil in a single day — soil that can take centuries
to replace." These dust storms are so strong that they can peel the paint
off cars. They often force the closure of schools, airports and stores —
even in places as far away as South Korea and Japan.
- As with the Great Plains, northern China is dry and farmed intensely.
Already, China's farmland is turning to desert at an alarming rate.
Estimates peg the loss at more than 900 square miles per year. Chinese
farmers struggle to meet the demands of the Chinese people. Meat production,
for example, has grown at an 8% clip since 1980. That's the biggest increase
of any major meat- producing country in the world, yet it still falls short
of demand.
- It's not so much the basic demand for food as it is a change in the mix of
what people eat. Clearly, in poor countries, cereals and grains make up the
vast majority of a person's diet. But in richer countries, people eat more
meat, as well as fruits and vegetables.
- Meat is incredibly expensive to produce, because raising the necessary
livestock requires large amounts of grain. According to The Silk Road to
Riches, the average cow consumes 2.5–3% of its body weight in grains every
day. "A typical 1,200-pound beef steer could consume about 35 pounds of feed
per day," the authors write, "or more than 13,000 pounds annually. That's
enough grain to feed more than 10 average-sized adults for an entire year."
- It's also very water intensive. It takes about 6,600 gallons of water to
produce just 8 ounces of beef. As you can imagine, this puts meat beyond the
pale of many poor countries.
- There is limited arable land in northern China. So the Chinese rely more
on fertilizers to boost yield.
Currently, fertilizer use in China is more than three times the global
average.
- China's ability to produce the fertilizers it needs — in particular,
potassium and phosphate — is limited. As a result, China is one of the
largest importers of these fertilizers. This is one of the reasons companies
doing this thrive today.
- So you have chunks of Chinese farmland turning into desert every year.
You've got limited water resources in a dry region. Already you've got dust
storms that kick up plumes of dust that travel thousands of miles. All of
this is reminiscent of the US in the 1930s.
- We all have a stake in what happens in China. If China relied on the rest
of the world for even 20% of its grain needs, there would be an incredible
strain on the world's grain producers.
- Many of the challenges China faces exist in the world at large already.
Grain production per person is falling worldwide. So is cropland acreage per
person. We are also approaching the limits of what fertilizers can do in
terms of boosting crop yields. Plus, strong demand for biofuels — like
ethanol — now competes with food demand.
- By some estimates, we'll need to produce about 136 million tons of grain
in 2007 to prevent grain stocks from falling again (they fell in 2006). Yet
annual increases in grain production have averaged only about 20 million
tons since 2000. That gives you something of a snapshot of the hurdle in
front of us.
- The investment conclusion from all this seems to be that we are in a long
bull market for grains. Expect the prices of corn and wheat to keep rising.
Expect the price of meat to rise. It also seems that fertilizer producers
should continue to do well.
---------------------
And more views from Bill:
*** "Died in Burma in World War II..."
"Fought in Zulu Wars..."
"Victim of Rajasthan Uprising..."
"Died at Verdun..."
We were taking a little tour of Canterbury Cathedral before the Matins
service on Sunday morning. What was striking was how many monuments there
were to fallen soldiers of the British Empire. We think of the British
Empire as a commercial undertaking. And it was commercial, in the sense that
the profits were realized by private companies, not by the British
government directly. But like all empires, it needed its fighting men to
maintain order and subdue the locals. The English army – with its regiments
made up of soldiers from all over the British Isles and its auxiliaries
drawn from its colonies and vassal territories – established a Pax
Britannica. Then, the English, being in the superior position, were able to
set the terms of trade.
The story of the British colonial wars is either a story of great heroism
and sacrifice in the service of bringing civilization to the heathen...or a
story of brutality, bamboozling and bumbling in an effort to make a
buck...depending on how you look at it. Either way, many of its most
illustrious participants seem to be memorialized at Canterbury Cathedral.
We haven't been writing much about the American Empire recently. Not because
we've changed our minds about it; we just thought you were getting tired of
hearing about it.
But our visit to Canterbury rekindled our interest.
First, we note that the US now has its soldiers garrisoned in 144 different
countries. That is a far bigger empire than even the Romans had. And bigger,
in some ways, than the British Empire, too.
But ours is a much funnier empire than the other two.
Now the word is that the total cost of US war in Iraq may rise to as much as
$2 trillion. When it was said to be $1 trillion near the beginning of the
adventure, the amount was so high that it was dismissed or ridiculed.
Now, we find that the tab might be twice as much. Either way, it's a lot of
money, especially if you don't have it.
There is one thing you have to remember about empires.
They are vast public spectacles. As such they must follow the rules of all
public spectacles. They must begin with lies, develop into farces and end in
disaster. No empire has ever failed to do so. When no substantial enemy
threatens it, an empire must find one; and if no rival empire can be found
to destroy it, it must find a way to destroy itself.
That was what we thought was really behind the war in Iraq from the
beginning. There were so few terrorists, more needed to be created. This
goal seems to have been achieved.
But the point where this empire is weakest is the financial. Every previous
empire had found a way to make the business pay, but America has not made a
profit at empire for twenty years. Its businesses are now at a competitive
disadvantage; they have higher costs and no domestic source of new capital.
Americans do not save.
What's more, maintaining the empire has become an expensive business. Even
Osama bin Laden saw the weakness and publicly announced his strategy - he
would make America bleed cash. Now, we see that this is exactly what has
happened. The war in Iraq cost $2 billion per week in direct costs. It costs
$10 million for each Iraqi 'insurgent,' whatever that is, killed.
Plus, the war on terror costs billions more.
So far, at least, if the great empire wants to ruin itself, at least it is
doing what it must.
*** But watch out! The plebes and yahoos are starting to catch on to how the
world's money system actually works:
"The 'mortgage weapon' has been used effectively to thrust millions into
debt servitude and shift the nations' wealth to the upper 1%. Meanwhile the
Decider- in-Chief has been busy rewriting the nation's laws so they meet the
requirements of an economically polarized society. (The erosion of civil
liberties is the unavoidable consequence of the greater divisions in
wealth)," writes Mike Whitney.
"The first wave in the tsunami is timed to hit in late
2007 when $1 trillion in ARMs reset, wreaking havoc across the country. That
means that millions of borrowers will see dramatic increases in loans on
homes that are of steadily diminishing value. (Many monthly payments will
nearly double!) The number of foreclosures will skyrocket, unemployment will
soar, and America's consumer economy will swoon."
When you consider that 90% of growth and about a third of job creation in
the past few years has come from the housing industry, you can figure what
is in store.
Already, consumers are getting less and less out of their home ATM machines.
In 2006 they took out $327 billion, almost half of what they took out in
2005. What happens in 2007?
Whitney goes on:
"The Centre for Responsible Lending (CRL) issued a report which says that
they anticipate a 'humanitarian disaster worse than Katrina.' The report
states:
"'The sub-prime market was designed with a built-in time bomb. At the end of
two years, even without a rise in interest rates, the payment will typically
rise to 96% of the purchaser's monthly income. No wonder then, that the
study conservatively forecasts that one-third of families who received a
sub-prime loan in 2005 and 2006 will ultimately lose their homes!'
"96% of the purchaser's monthly income! That leaves a measly 4% of one's
earnings to pay for clothes, food and other essentials!"
Now why would the banks abandon safe lending practices all of a sudden? The
explanation that Thomas Jefferson gave still holds good, we think:
"I believe that banking institutions are more dangerous to our liberties
than standing armies. If the American people ever allow private banks to
control the issue of our currency, first by inflation, then by deflation,
the banks and the corporations that will grow up around (the
banks) will deprive the people of all property until their children wake up
homeless on the continent their fathers conquered. The issuing power should
be taken from the banks and restored to the people, to whom it properly
belongs."
What Jefferson feared is now coming about, thanks to the Fed's power to
manipulate interest rates and money supply.
The Daily Reckoning PRESENTS: Everyone is wondering what the falling price
of crude means - and how long it will last...
Amusing Predictions
After holding in the $60s for many months, crude has dropped precipitously
in the past few weeks, and is now in the vicinity of $50 a barrel. A number
of reasons have been given for the sharp fall in price, all of them more or
less linked.
To begin with, warm winter weather has resulted in lower seasonal energy use
than anticipated. (Global heating oil demand, for example, is estimated to
be off by 20-
30%.) At the same time, OPEC's production cuts are seen as ineffectual in
the face of cheating, and Russia has been hesitant to slash its record
output.
On top of this, commodity speculators have become bearish and institutional
investors are getting cold feet. When spot crude fetches a higher price than
the further-out futures contracts - a situation known as "backwardation" -
it becomes profitable to buy the back months and wait for prices to rise as
the spot draws closer. The persistence of backwardation in 2006 led
institutional investors and commodity index trackers to load up on
long-dated crude oil contracts; now that the market is no longer in
backwardation, those same players find themselves losing money.
As icing on the cake, the crude oil market is suffering from intrigue
fatigue. Like a jaded child desensitized to violence on television, the
market has grown bored with overly familiar catastrophe scenarios. (Yet if
anything, the geopolitical situation is more precarious today than a year
ago: Israel leaking plans for a tactical strike on Iran; Saudi Arabia
threatening to aid Iraq's Sunnis if the Shia majority pushes too far; US
military morale at low ebb; escalating tensions between Russia and Europe;
nationalization on the rise; Iran accelerating its nuclear program; and so
on.)
In light of all the recent bearishness, it is worthwhile to ponder the
Energy Information Administration's recently released "Annual Energy Outlook
2007 (Early Release version)." Here are the two most interesting sentences
out of the whole thing (in your humble editor's opinion):
"Oil, coal and natural gas...are projected to provide roughly the same 86%
share of the total US primary energy supply in 2030 that they did in 2005
(assuming no changes in existing laws and regulations...
"In 2030, the average real price of crude oil is projected to be above $59
per barrel in 2005 dollars, or about $95 per barrel in nominal dollars."
Trying to predict anything 23 years out is a foolhardy exercise...but the
EIA projections are nonetheless instructive.
For one thing, the projections show just how small the alternative energy
base still is in comparison with fossil fuels. It is not that the EIA
expects zero growth in alternative energy's slice of the pie over the next
few decades; rather, the EIA expects total energy demand to overwhelm all
else, with fossil fuels filling the breach. (For this same reason, the EIA
expects nuclear power's share of the pie to actually fall in percentage
terms, even as more nuclear power plants go online.)
The EIA's second prediction is chuckle inducing. For crude to be just above
$59 in 2030 - not far from where it is now - means little will have changed
on the whole.
And how helpful of the EIA to let us know that $59 in
2005 will translate to $95 in 2030. That's a wonderfully benign inflation
rate...just over 2% per annum between here and there.
As you might have guessed, the point here is not to put faith in government
agency predictions. Instead, it's to get some perspective on where we stand
for the long term.
As a government agency and an offspring of the Department of Energy, the EIA
is congenitally optimistic in its conclusions - much as the Bureau of Labour
Statistics is congenitally blind to inflation. And with all the data at
hand, the EIA's projected long-term price band of $50-60 crude (more or
less) is truly the optimistic case.
Such a prediction almost completely writes off the ramifications of Peak
Oil, and relies on heavily aggressive assumptions in regard to deep-water
drilling and Canada's oil sands. Such a prediction also requires an almost
touching naiveté in terms of US monetary policy; can we really expect
inflation to run just 2.1% per year for the next 23 years? (What happens
when the dollar goes down in flames?)
There are far too many variables to make an informed guess at crude oil's
2030 price. But we do have enough information to note that, given the piles
of data presently available, the optimistic number crunchers at the EIA see
crude trading solidly for the duration. In fact, their $50-60 price range
represents the shiny happy scenario, leaving out the ugly but all-too-real
possibilities looming before us.
The other thing we can gather from the EIA prediction is
this: Nobody knows nothin'. Meaning, all the data points in the world can't
predict the distant future. To grasp how ludicrous these types of specific
predictions are, just observe the fate of those who make them. In the real
world, the best you can do is marshal the facts to get a sense of what's
possible and what isn't...what makes sense and what doesn't. In this sense,
broad observations regarding the possible course of future events should be
rooted in the laws of physics. What goes up must come down...that which
cannot persist must eventually cease...and so on.
In the short run, a market can do most anything - especially one dominated
by speculators with a quarterly, or even monthly, time horizon. But in the
long run, as Jesse Livermore noted, the best and truest allies will always
be underlying conditions. You'll see all kinds of numbers fly around in the
coming weeks and months, feet stampeding this way and that...but through it
all, the long-term energy picture won't shift much.
We're dealing with sweeping sea change here, not ephemeral seasonal stuff.
That's why I'm not inclined to worry too much about this recent crude oil
slide. There's never any money in running around like a chicken with your
head cut off.
Traders rely on speed and reflex, investors on patience and fortitude; to
the best of my knowledge, nervous panic is no help to either discipline. If
anything, the short-term roller coaster gives an edge to those with a taste
for the long-term view.
Regards,
Justice Litle
for The Daily Reckoning
