You puttin’ the hurtin’ on ‘em now.
– Tommy Wilkerson
Dear Diary,
Again, we quote our old friend.
Mr. Market has been puttin’ the hurtin’ on gold bulls.
Yesterday, he went after the gold shorts. Gold rose $42.60 – or 3.6%. That’s proportionally equal to a move of 640 points on the Dow.
But today our sympathies go to poor Vladimir Putin and Nicolás Maduro. In Russia, the ruble is falling and growth is grinding to a halt. In Venezuela, the whole economy is falling apart. The proximate cause of this hurtin’ is a fall in the price of oil.
Yesterday, US crude oil rose $2.85 – or 4.3% – to $69 a barrel, its largest daily gain since August 2012. But it’s still down 32% from its 52-week high, set in June.
Outside of the big oil exporting countries and the US shale-oil business this big drop in prices is widely seen as good news.
Consumers fill their tanks at lower gas prices and have a few bucks left over – money that can be used to buy things. According to the current and conventional delusions of the economic profession, this leads to sustained higher economic growth, more jobs and a cure for impotence.
But dear reader, was there ever in the history of the world a hurtin’ that stayed put?
That’s the trouble with hurtin’: It moves around.
In today’s Diary we look more closely at the subject of hurtin’ generally… and the effect of lower oil prices, specifically.
In passing, we observe that the secret to investing success is to buy what is hurtin’ when it is hurtin’ most… and to sell what ain’t.
Economic Warfare
It came out last week that OPEC is deliberately adding to the suffering of US shale-oil producers.
At its meeting in Vienna last Thursday, the 12-nation oil cartel decided to leave its output ceiling at 30 million barrels of oil a day, where it has been for the last three years.
As Chris put it yesterday in The B&P Briefing – our subscriber-only bonus letter – this is economic warfare.
OPEC believes, or so it seems, that cheaper oil prices will put pressure on high-cost US shale-oil producers. Although production costs vary, fracking costs more than pumping straight up.
Middle Eastern oil comes as readily up from the sand as water from a hand-dug well. That’s why the Saudis are the world’s lowest-cost producers – at just $2 a barrel.
All else being equal, the more they pump, the lower prices go, and the harder it is to make a good living in South Texas or West Siberia.
Conventional Middle Eastern oil is still profitable – even with oil as low as $67 a barrel. Unconventional shale and offshore oil may not be. Abdalla El-Badri, OPEC’s secretary-general, reckons half of all US shale output is unprofitable below an oil price of $85 a barrel.
Still, you may say, lower energy costs will revive the US consumer economy… no matter who pumps it. (Chris wrote about this recently here.)
Lower oil prices make it possible for Americans to buy more stuff. Or even save their money!
Pity the poor Russians and Venezuelans: They’ll have to live with less.
A World of Hurt
On this point, we congratulate Mr. Maduro for his deep philosophical reflection on the nature of hurtin’. Rather than whine about it, he noted it was “an opportunity to end superfluous luxuries and unnecessary spending.”
So you see, the hurtee may come out ahead. He may emerge from the hurtin’ in better shape – like the gold mining companies that have had to take free soda machines out of their corporate dining rooms.
When the hurtin’ moves to someone else, they are leaner and meaner than ever.
For instance, low oil prices squeeze out capital investment in the energy sector.
Who wants to drill a new well with the price falling? Who wants to put in solar panels? Who wants to buy a new Prius or a new Tesla? Who invests in future production?
No one.
Higher-cost shale-oil producers go out of business. Alternative energy producers go to sleep. The bulls go broke and the shorts count their money. Then, the hurtin’ is ready to move on – from the producers to the consumers.
Low oil prices have the same sort of unintended, but fully predictable, consequences as low interest rates. Consumers catch a break – temporarily. But capital investment goes down. And output declines.
Worldwide, oil use is still increasing. Without more investment to bring forth more supply, prices will shoot up again.
Gold is hurtin’. Oil is hurtin’. Russia is hurtin’. Venezuela is hurtin’. Greece is hurtin’.
Our back is hurtin’ from lifting those poles.
Eventually, the pain will go away. But the hurtin’ may also get worse before the hurtin’ moves on.
Regards,
Bill
Who Will Blink First in the “Oil Wars”?
Bill’s right… Oil at under $70 a barrel could put a hurtin’ on some of the higher-cost US shale-oil producers.
But it could put an even bigger hurtin’ on the government budgets of foreign oil exporters.
According to Citigroup, the fiscal break-even cost – the price governments need oil to stay above to meet their spending commitments – is $161 for Venezuela, $160 for Yemen, $132 for Algeria, $131 for Iran, $126 for Nigeria, $125 for Bahrain, $111 for Iraq, $105 for Russia, and $98 for Saudi Arabia.
If that doesn’t happen, they have two choices: cut spending or borrow money.
Venezuela and Yemen need the oil price to double to meet their government spending needs. Even Saudi Arabia – which has the lowest fiscal break-even cost of this group – needs a nearly 50% rise in the oil price to avoid having to either cut spending or borrow funds.
This is made worse by the fact that lower oil prices tend to push up the cost of borrowing for oil-exporting nations. Lenders understand that a lower oil price means more strain on these economies and a higher risk of default.
The problem for these big oil-exporting nations is they have to recycle their profits into government spending. Instead of supporting welfare states, US shale-oil producers can use profits to invest in cheaper extraction technologies.
Over time, this makes them more competitive relative to more conventional producers.
Also, all US shale-oil producers aren’t as vulnerable to $70 dollar oil as OPEC claims.
According to the Paris-based independent energy research group the International Energy Agency (IEA), most drilling in the Bakken formation – the roughly 200,000-square-mile shale formation that stretches from Montana and North Dakota in the US to Saskatchewan and Manitoba in Canada – is profitable at $42 a barrel.
And in McKenzie County, the most productive county in North Dakota, the break-even cost price is $28 a barrel, according to the IEA.
Make no mistake: OPEC’s decision to keep output steady in the face of a supply glut and falling prices is economic warfare.
But it may end up inflicting more damage on the big conventional oil exporters, who rely on oil revenues for government spending, than on increasingly competitive US shale-oil producers.
P.S. Will you be joining Bill, Chris – and a group of Bill’s close personal advisors – at the private meeting they’re hosting next year in Nicaragua? If you haven’t yet seen your invitation, you can access it here.