Erste Oil Special Report: "Force Majeure - Middle East"
Erste bank has released the definitive report on oil price dynamics (attached) accounting for all the latest geopolitical hoopla. For what it's worth, the Austrian bank is constructive on oil prices, and see substantial upside from here: "We see mainly upside risk for the oil price. Even though the supply in the market is currently still sufficient, we believe that the wave of revolutions will continue to roll and could thus push the oil price to new highs. For technical reasons we therefore expect the upward trend to continue at least in the first half of the year, and we also think that new all-time-highs are possible. As soon as the parabolic phase has been reached, the sentiment starts spiking, and first divergences are emerging, we recommend stops be set. However, it currently seems to be too early for that. We expect an average price of Brent of USD 124 for the full year." 57 pages of pure factual and chart goodness.
- As discussed in our Oil Report 2010, “Too fast, too furious… now time for a break”, the risk/return profile for oil-investors was of limited attractiveness last year, both in absolute terms and in relation to equities or other commodities. But to be fair, we have to point out that the correction that we had anticipated for the second half of the year never happened. We underestimated the amount of ink that the Federal Reserve was going to pour into its “virtual printing press” and the extent of relentless deficit spending and, at the beginning of 2010, failed to foresee how little importance was going to be attached to monetary stability. The weak US dollar is logical consequence of the quantitative easing, which in our opinion is really just a euphemism for printing “virtual” money.
- We believe that the “Bernanke put” is the main reason for the price increases in the commodity segment. The Fed has repeatedly emphasized the positive effects of higher stock prices. Commodities also benefit from the investors’ increased willingness to assume risks, as the following chart clearly illustrates. It is quite impossible to explain the extremely high correlation of the equity market and the oil price with classic supply/demand patterns. According to Dave Rosenberg1 there is a 86% correlation between the movements in the Fed balance sheet and in the S&P 500 since the onset of QE two years ago. Indeed, the monetary policy seems to have turned into the most important determining factor. Since QE2 was announced, the speculative net exposure of wheat and oil for example at the CBOT has doubled; the one of copper has increased by 90%, and that of soy by 40%. One can therefore assume that the rally is mainly driven by liquidity.
- As discussed in our latest Gold Report, the discussion about inflation these days focuses on the symptom of the price increases rather than on their causes. Rising prices are therefore only a valve for the increased money supply. Many a time the fact that the expansion in money supply is responsible for the rising price levels is simply forgotten. The FAO Food Price index also illustrates this, having set a new all-time-high recently. Natural disasters, structural imbalances and a sharp increase in speculative demand were also crucial to the uptrend in soft commodity-prices. The correlation coefficient with the oil price has been 0.91 since 1991. On top of that, it seems like the FAO index is slightly leading in relation to oil, particularly when it comes to impulsive upswings.
- That said, the wait-and-see stance taken by OPEC also contributed to the recent price increases. At its latest meeting, the organisation had indicated that it would only intervene from USD 100/barrel onwards. The fact that the ordinary meeting in March was cancelled would also suggest a further increase in prices until the next ordinary meeting in June, where we believe OPEC will step up production again. We do not think that the cartel would wish to provoke another price spike like in 2008.
- On the demand side, China clearly remains the driving factor. The recent interest rate hikes and the numerous increases in the minimum reserve requirements are supposed to facilitate a “soft landing”, but have so far shown little success. In 2010 money supply was up 19.7%, and credit growth expanded by 18% (after 35% in 2009).
- We remain critical of the blind faith in the Chinese economic engine. China can and will not be the single driving force of worldwide recovery, the sheet anchor and messiah of the global economy, or the only hope of oil demand. We will discuss the reasons for our bearish stance on China on the following pages.
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