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The Real Reason For the Oil Crash… And Why It Could Happen In Other Asset Classes
It looks like Oil’s bounce is over.
Traders have been playing for a rise in Oil based on two things:
1) Oil being sharply oversold due to its 60% collapse in the span of six months.
2) We’re heading into “drive season” (the summer) in which gas demand increases.
This has seen Oil surge 45% since its March 2015 bottom.
However, the larger story for Oil, like all things, concerns the US Dollar. Below is a chart showing Oil against an inverted chart of the US Dollar chart (so if the US Dollar strengthens, the blue line falls).
You can note the close correlation between the two:
It is not coincidence that Oil bottomed the very same day that the Us Dollar peaked and began to correct. Oil exploration is an extremely capital intensive business: drilling a new Oil well costs at a minimum ~$4 million… and can easily run up into the $100+ million range.
Unless it has a multi-billionaire for a backer… any Oil exploration company will issue debt to drill. This debt is denominated in US Dollars. When you borrow in US Dollars you are effectively shorting US Dollars.
When the US Dollar rally starting in July 2014 this forced the price of Oil down… which in turn made many new Oil projects uneconomical… which lead to Oil companies going bust and defaulting on their debt.
And so the US Dollar carry trade took down Oil.
With that in mind, consider the price of Oil against the recent strength in the US Dollar:
Oil has a ways to catch up… and if the US Dollar continues to strengthen, (remember the above chart for the US Dollar is inverted, so if the US Dollar strengthens, the blue line falls) Oil will collapse.
This is jut one small part of the massive $9 trillion in US Dollars that has been borrowed and invested elsewhere. To put this number into perspective, it’s larger than the economies of Germany and Japan combined.
The US Dollar bull market is not over… Indeed, if the US Dollar carry trade really begins to blow up… we could see another Crisis that would be even worse than 2008.
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Just to put your incessant contrariness to rest, I am going to put everything I own into an oil short in 5 minutes.
If i don't make a whole lotta FRNs by next week at this time, I am going to sue you.
UPD: 12:37 pm EST: I'm down $850.00,,,,,
iT'S NOT could happen, it will happen to every asset class, unless it's owned and controlled by the Roths. It's their last ditch effert to fix a broken system.
The Last Man Standing principle, and so far they are winning. Silver, Gold, Oil, Bonds all trashed while the US $$$ gains in value and at the same time is dropped in acceptance.
I can speak to "driving season" ,, my wife has a restaurant in the Disney area of Orlando ,,, when the economy stinks people take cheaper driving vacations instead of flying somewhere ... Disney usually benefits greatly... This year the beginning of the summer rush seems delayed... it could be that the cheaper vacation is to stay home for many people...
$100 per person to stand three hours in the Florida sun for a five minute thrill ride just ain't what it used to be...not to mention the 2nd mortgage required to feed a family inside the park.
Agreed but where is Disney stock these days?
This is a good arguement for the decrease in value of Oil. This is an older article but I had read an article that suggested that the concrete production in 2011-2013 was more than the entire 20th century for the United States and that has all but stopped since 2013. The amount of oil needed to produce Concrete is enormous. If that is the case then oil ain't coming back anytime soon. That would mean that this is pure supply and demand at the Crude level.
http://www.forbes.com/sites/niallmccarthy/2014/12/05/china-used-more-con...
Thoughts?
I don't question your thesis, but I'd like to know why so much oil is necessary to produce concrete.
??
In my opinion its the giant gas deals between Russia and China which had established a new benchmark. Worth many billions over 20 years time fixed price.
NG is the cleaner fuel compared to oil. It does not need refining. So its from a quality point of view better than oil.
If one compares then calorie gas against calorie oil, prices can be exactly compared.
Thats why I'm asking myself the following. What are the prices agreed for gas betwwen Russia and China ? I guess when comparing it exactly with oil its about 60 $ a barrel at present days Yuan/Dollar fx rate.
Russia was then for sure also ready to sell oil for this price but in Yuan. Since Russia has the biggest oil reserves in the world and is willing to sell for this price this is now the price of oil.
The present price is profitable for Russia and other big producers like Saudi, Iran, Iraq. But the surcharge for the US energy tax on the world is not anymore included.
During the times of higher oil prices the Saudis and all others including Russia bought US treasuries for the amount exceding the present oil price level. With one exception, Iran, thats why Iran was sanctioned.
So what we see now is the price established between Russia and China without the US tribute surcharge on top.
Thats why the low oil prices do not harm Russia at all since the surcharge from the past went anyhow directly to Washington. The additional profits were only on paper , bloating Russias Dollar reserves of which it still has today more than enough,
So in my opinion its Russia and China determinating the world energy price. The biggest producer and the biggest importer. The Dollar is in my opinion presently only of minor influence and maybe this last forever. My opinion is, it needs much more war to turn this back, maybe too much for mankind.
Poor article.
While there is ceratinly some correlation between dollar strength oil price, that is far fromthe whole story.
False statements:
1) Oil is financed through debt????? Am I to believe that oil companies never issue equity/stock?
2) Borrowing dollars is shorting them??? That is true if you go abroad, convert them to a foreign currency (e.g. Polih zlotys) and pay the local Polish roughnecks in said zlotys. But if you paid them in dollars and sold the crude in dollars, why would there be a problem? Some foolish Poles borrowed Euros for their mortgages and then had to pay back Euros after the zloty had fallen. They were very, very unhappy. I am unhappy because the Bernanke made me pay for that by covert bailing out of the Euro banks back in '08.
Methinks the oil price is manipulated as is everything else. The new car fleet and low labor participation rate in the US have made a dent in demand. Banks don't lend for drilling projects if the price has fallen. Oil depletion rates are high. Production drops off and prices rise. Wash rinse repeat. Fifteen years ago, one could see intot he oil bidness. Today all of the real oil market info was lost with Hillary's emails.
Agreed but where is Disney stock these days? This is a good arguement for the decrease in value of Oil. This is an older article but I had read an article that suggested that the concrete production in 2011-2013 was more than the entire 20th century for the United States and that has all but stopped since 2013. The amount of oil needed to produce Concrete is enormous. If that is the case then oil ain't coming back anytime soon. That would mean that this is pure supply and demand at the Crude level.
http://www.forbes.com/sites/niallmccarthy/2014/12/05/china-used-more-con...
Thoughts?
Thank you. You provide some useful insights.
Sorry. I don't have time to read the Forbes article. Cettainly I agree with China's concrete usage. You can't build empty cities forever.
Are you sure that crude is used to make concrete? i would have thought natural gas. China has a lot of natural gas, and I would think that they make their own concrete.
Construction requires a lot of heavy transportation, all of which runs on oil. I know, I know, some day Elon Musk will have solar powered tractor trailers, but until then.....
1. Oil companies have alot more debt on their books than equity
2. US only produces only 10% of the global oil production
I agree with you on some points and disagree with you on some points.
Oil inventory is financed on debt since, oil company's do not set oil price, banks set price and debt is used to finance the derivative contracts that lock in profits for the oil companies and oil traders.
And banks set ForEx rates. There is no free market in ForEx. It is all managed by the banks.
While I also see a correlation, I do not see causation.
A. There is a leverage factor. It is not 1:1 on a percentage basis.
B. Both the dollar index and oil price could be dependent on some other factor. If not, then all commodities should react exactly the same as oil, based on the dollar and that is not the case.
... or (and most likely) it is just management of the financial system by the banks for their own reasons and that management also entail changes in currencies and commodities.
perfect fib retracement from the $75 break. $45 here we come.
Oil is in a holding pattern. The world economy is starting to stagger around and the true demand is down. Right now in the US they are hoping for a good summer and if it doesn't pan out the price of oil will likely drop $20-30 per bbl and bond payments won't be covered. With government interference increasing, I'm not hopeful...
yup..... think into it logically... if oil had bottomed for real at $40 it would have sat without volatility 1990s style for some months... commodities don't bottom and then have a 50% price increase in the next couple of months.... stocks can because people buy bottoms, but real bottoms in commodities have no one buying, no one hedging, just sitting, sitting, sitting.....
Now here's the ringer... oil goes down, drags the bonds and stocks with it (massive energy components in stock indexes, bond defaulting on energy companies failing)....
Then right at the low of the low in the economic cycle, oil production will bottom out... add in political unrest that poor economics will bring... and bang... $100-150 oil with no production to increase because everyone's been washed out... the saudis are banking on this....
the saudis are banking on tanking oil from $110 down to $45, losing up to $65 per barrel for months and now, possibly a couple years, to wash out producers so that oil can go back to 100? - 150?. That makes a ton of sense. Because, I can't see any new producers restarting any of those wells when oil is back at $100+. So what does SA gain?
An yet, I know a couple of people who work in shipbuilding. New oil platforms have been built and sent North along the west coast of the US.
There are also rumors that the ANWR (supposedly more oil than Saudi Arabia) has been drilled and is ready to produce. What would the Keystone pipeline have done? Maybe tie the Bakken, to Alberta to the ANWR?!? I don't know, but looking at a map it makes sense.
... and the US still has the Colorado fields that have been off limits.
It seems to me that more oil could be drilled and pumped, but until the last few years, supply has been restricted to act as a cover for moving price up.
Anwar is a relatively small resource.
If prices go back up, why wouldn't drillers start back up? There will always be new market entrants when there is a business case.
Exactly. Unless supply is restricted by agreement, in a free market, the price moves toward the marginal cost.
What is the marginal cost (not fully loaded and capitalized cost) of oil being pumped today?
What does SA gain? A protection guarantee by the US from ISIS ,, those sand niggers trust Obunghole because he's one of them. That and it's just another "oil jihad" against American production.. it worked for them before. Don't think it out too much ,, they don't... they still have their harems and Bentleys.
I guess you nailed it. No point in discussing it further with you.
Good discussion here. We haven't had one of those for a while.
I think the Saudis are desperately hanging on to market share, in the foolish belief that whoever is shipping now will still have markets in the future.
Their real future revenue depends on selling gas to Europe, which is why they, Israel, and the US are all in on destroying the Syrian regime. Interesting times.
The Saudi's cant stop pumping. Sewater recharge is a dynamic process. They already have 30% seawater in Ghawar or more. If they stop pumping the field could be ruined.
The Saudi's also cannot stop pumping because they need the cash. They are very rich, but cash poor, relative to the size of their obligations.
they also can't stop pumping because their own people (and a lot of the world) hate them. Like the US idiots, they are desperately trying to hang on to power by using and abusing it.. and they're losing it
they also can't stop pumping because their own people ( and a lot of the world) hate them. Like the US idiots, they are desperately trying to hold on to power and losing the battle
Good point. I don't know how wide spread that problem is,
but sand has consequences;)
A little late Phoenix capital. I wrote the root cause analysis a while back, more thorough as well. While I can’t argue that debt played an important role, you barely scratched the surface, and without knowing the real root cause, there is no prayer you will be able to play the oil sector in the coming years.
http://www.debtcrash.report/entry/oil-price-drop-root-cause-analysis
I am not sure you answered the question of why low cost debt money was made more available to the oil industries (as opposed to other industries that could have yielded high returns) and why oil prices remained so high for so long given that the cost of money was very low for a long time.
Personally, I believe, but do not have proof, that the decision to make debt money massively available to oil field development was sociopolitical in nature.
Why?
To further destabilize the middle east. (Oil price does not have to decline just because there is excess supply. As long as the inventory can be financed (just like the equities market, price can be maintained at what is perceived to be too high of a level just by creating more money), there is no compelling need to drop prices. However we have experienced a broad based drop in commodity prices, which not only caused losses to derivative contracts, but also reduced the amount of commodity-based collateral, as measured by the value of commodities marked to market.}
Why? and that IMO, is the real question. Why would those controlling money creation and price want to further destabilize the middle east ... or all oil producing countries?