Thursday, September 18, 2014

Do lower oil prices help the US economy?

The US currently consumes around 19 million barrels of oil per day (5% of the world's population consuming 21% of global oil supply, which is roughly 91.5 million barrels per day).

A drop in prices of $1 per barrel equates to a $7 billion boost in non-oil US consumer spending when annualized. This is money which US consumers do not have to spend on oil and instead can spend on new mobile phones and other goods.

However, the US is also increasingly a larger oil producer. Since 2009 there has been an upward trend in US oil supply which had until then been declining steadily since 1973. This has been due to new high cost US tight oil (fracking) supply. With this increase in US oil production there has been a reduction in US oil imports which is expected to continue until around 2020 (see chart below). Whether this US trend can continue beyond 2020 is subject to a high degree of uncertainty at this time.

Netting the spending boost from US consumers against the revenue reduction to US oil producers, each $1 drop in oil prices currently provides only a net $2 billion annual boost to the US economy.

This is a small number given the overall scale of the US economy. For example, Apple Inc's revenue is running at $175 billion per year. So while lower oil prices in the 1990s and 2000s were almost always beneficial to the US economy, today they are neutral.

There are three caveats:

*1. Neutral until below $75: The recent increase in US oil supply is due to high prices. Marginal production from high cost tight oil (fracking) requires $75 per barrel (basis WTI crude). As a corollary to this, if prices were to decline below $75 per barrel, production from high cost tight oil (fracking) could decline and prices lower than $75 may, over the short term (1-3 years), hurt the US economy. In summary, lower oil prices are neutral to the US, so long as prices stay above $75 per barrel. Prices below $75 may be negative to the US economy.

*2. The big sign effect - consumer price psychology: A further caveat is the sentiment effect. Almost everyone in the US is aware of the price of oil due to large government mandated signs at refueling stations. If oil prices move below $3 per gallon at the pump (see chart below) then there may be an boost in consumer spending on non-oil goods due to pricing psychology which overwhelms the decline in revenue for oil companies.

*3. Shocks are unpredictable - speed of the price move: Consumers react to the speed of price movements in addition to the magnitude of the move. Oil prices halving or doubling in 6 months generates a much different and more unpredictable reaction than oil prices gradually doubling or halving over 5 or 10 years.

[Summary: Lower oil prices in the 1990s and 2000s were almost always beneficial to the US economy, today they are neutral. Oil prices below $75 may be negative to the US economy.]

[For the sake of brevity and simplicity I am not including economic multiplier effects in the above.]

Monday, September 15, 2014

Where is the floor for the price of oil?

Oil prices (WTI crude as a proxy) are close to $90 per barrel this morning, down from almost $110 earlier in 2014. $90 is also major trend line support (see chart below).

This is despite global unrest in Russia, Ukraine, Syria, Iraq and elsewhere. As I have mentioned before (see charts below or click link), wars over the past 30 years have generally been negative for oil prices, even when, and sometimes precisely because, oil producing and exporting nations are involved.

Over the short term (next 3-6 months) it looks like oil will continue to head even lower due to weakness in Chinese and EU oil demand and there are three levels which have to come into play to define the downside:

*1. Marginal Producers: At what price do the global marginal high cost oil suppliers, currently US tight oil (fracking) producers, begin to shut in supply and stall exploration activity? The general assumption is that this begins in the mid to low $70s per barrel (basis WTI crude).

*2. Consumers: At what price do oil consumers increase their consumption? Consumer behavior changes slowly over time with respect to oil - this is why oil demand is called inelastic. Oil prices have to go to extreme levels to change consumption behaviour - hence the rally to $150 in 2008 required to stall demand in the face of insufficient supply growth. So although lower oil prices will likely increase demand above historic patterns, this is likely to occur only over the longer term (3-5 years). So count this factor out for a hard floor level in the short term.

*3. OPEC: At what level will OPEC (which just means the Saudis these days) act? The Saudis already say they are cutting supply. However, they are still only matching reductions in demand growth and have yet to get ahead of the curve. The Saudi budget break-even is currently in the high $70s per barrel. This is the level below which the government there has to start borrowing money to pay for schools, roads, defense and so on.

So the mid to high $70s may be the first floor to be tested. That is the level at which US tight oil producers and OPEC (Saudis) have to begin reacting by cutting supply to match the lack of robust oil demand growth.

Friday, September 12, 2014

US Energy Stocks Turn Red on Russian Sanctions

There were a slew of new sanctions against the Russian oil industry announced this morning by the US and EU. So why isn't oil rallying? And why are US energy stocks being hit?

Why isn't oil rallying on sanctions that could cut oil supply? Because the International Energy Agency (IEA) on Thursday reduced its forecast for the rise in oil demand this year for the third month in a row. European and Asian demand weakness are the main causes. The IEA expects global oil demand to grow by only 0.9 million barrels a day in 2014, down 65,000 barrels a day compared with last month's forecast and lower by 300,000 barrels a day since July.

Furthermore, according to the IEA the Saudis (the only OPEC country willing to cut production) reduced oil production by 330,000 barrels a day in August and are now producing at their lowest level since 2011. However, they are merely matching falling demand and so this cut in supply is not bullish for oil prices.

The Russian story is still very bullish over the longer term and if you look at longer dated oil contracts (December 2018, for example) the oil market is up almost $2 per barrel this week.

So the short term bearish outlook for oil continues, but longer term (2+ years) these Russian sanctions are fairly bullish for oil prices.

Why are US energy stocks down today? Because oil is a global industry with many US oil companies investing in Russian oil production. Russian oil companies also use US oil services companies for exploration and production. Sanctions cut both of these revenue sources.

[ Market Cap Changes today of Energy Sector of US S&P 500 ]

Wednesday, September 3, 2014

Oil market calling end to US tight oil (shale fracking)

There was an interesting article today on an oil trader betting that the US tight oil (shale fracking) boom will end soon.

The oil market appears to supports this thesis.

The front of the oil curve continues to sell off, while the back end (January 2015 onwards) is rallying.

Short term weakness in oil futures is likely to continue for balance of this year due to the bump up in US oil supply. However, despite this short term price weakness, longer term the market is saying that this new supply will be insufficient.

Production of $15 oil began to decline back in 2005. Oil producers since 2005 have shifted up the supply cost curve in order to produce more oil.  Fracking, Canadian oil sands and ultra deep offshore are all $50+ per barrel sources that had to be tapped to make up for the decline of $15 oil.  These three sources are very difficult to scale quickly due to cost and complexity and the market is telling us that they may not add enough supply to offset the decline in global $15 oil production.

Tuesday, August 12, 2014

Lower oil prices ahead over short term

I was on CNBC TV's live Fast Money show this evening talking about the likelihood of lower oil prices ahead in the short term despite geopolitical tension. WTI crude was $97.27 at the time of the show.  Watch the segment here

Tuesday, August 5, 2014

Financial Chat War

[Financial chat systems are an anti-competitive tool?]

Just as John D. Rockefeller locked in customers and shut out competition by controlling the rail network in the early days of the oil industry, closed financial chat networks are used by financial platforms to lock trading floors into overly expensive systems and shut out competition.

As with consumer chat apps, like WhatsApp and Viber, traders and brokers on trading floors use chat systems to communicate in short bursts – sending transaction inquiries, prices, and interesting news stories to each other.

These financial chat apps can come bundled with full financial information platforms, like Bloomberg and Thomson Reuters, or can, as in the oil and equity markets, be like Yahoo Messenger – where the same app that is used by consumers is used for trillions of dollars of oil and equities trading each year. All of these chats are recorded and monitored by compliance departments. 

Money.Net provides a professional platform at a fraction of the cost

Going Viral with a Vector 
At a time when the cost to deliver financial information platforms is collapsing due to technology advancements, these savings are not passed on. The price of some of these platforms creeps ever higher to around $25,000 per year per individual. The ability to push through price increases and withhold cost savings requires an inability of customers to switch.

As chat networks are the ultimate ‘stickiness’ factor on desktop or mobile devices, expensive financial information platforms put a lot of effort into using entire market information platforms as a gateway onto a desktop for the Trojan Horse of a chat app.

Success for financial chat applications is dependent on getting on the desktop, and then getting turned on automatically every day as default components of full platforms.

Unlike consumer chat apps, it is much more difficult to make financial chat apps go viral. Getting any software onto a financial professional's desktop usually requires passing several gatekeepers. To address this, entire market information platforms sell themselves to traders as a utility for data and news, and then out of convenience traders begin using the chat system. Then after a trader has 5-25 connections on chat, the trader is stuck without the ability to easily change financial information platforms.

What to do? 
Several banks are trying to break their usage of chat. However, the challenge of launching a new standalone financial chat product is not the technology, which is somewhat trivial – it is getting on a desktop and getting a user to run it (whether they intended to or not) automatically each morning. Becoming part of a user’s daily routine is key.

Some banks are investing in a standalone financial chat app. The purchase of Perzo by Goldman Sachs brought this to the fore this week. There is also an Open Federated Chat initiative led by a few market information systems.  However, the hosts of Open Federated are platforms costing also a huge amount per month to have information plus the chat.  There are several other chat systems start-ups all plying low cost encryption, and building walls against government snooping as the end goal. Defense against unwarranted and illegal government search is a valid goal, but it doesn't solve the problem at the core of the chat issue.

These standalone chat apps face the same challenge as every other system in first, getting on a desktop, and secondly, in having the user run the app each morning.

Maybe instead of using standalone chat apps to break financial chat systems open, entrepreneurs should instead focus on more open and less expensive financial platforms, which also have open chat. We at Money.Net believe that this is the model for future success.

In summary, financial platforms have become too expensive and financial markets are looking for alternatives by dancing around the edge with partial solutions, such as chat, to the core problem.  Instead, we should address the issue directly by passing on technology advancement savings to deliver lower cost and more innovative financial information platforms.  Open chat can be a part of this larger better solution.

We at Money.Net are the solution.  A complete fine platform with open chat integrated with everyone for a trivial cost per month.  Get it for everyone.

Morgan Downey is the CEO of Money.Net. Prior to Money.Net, Morgan was Global Head of commodities at Bloomberg, LP. Morgan managed development of the Bloomberg Professional terminal. At Bloomberg, Morgan used his market experience to build a suite of revolutionary, unique, and innovative products. Before Bloomberg, Morgan spent 15 years running trading desks, as manager and head trader, for banks including Citibank, Bank of America and Standard Chartered, in the US, UK, Australia, and Singapore. Morgan is the author of the book 'Oil 101', a best-seller explaining the oil industry. Contact

Thursday, March 27, 2014

SPR: Oil Subsidy & Weapon

[SPR: Industry kickback, political slush fund, & weapon of war?]

The International Energy Agency (IEA) was formed by large net oil consuming nations in response to oil supply shocks of the early 1970s.  The IEA has required member nations, including the US, to have 90 days oil import coverage stored in a Strategic Petroleum Reserve (SPR).

The original mission of the SPR was to shelter oil consuming economies against unexpected oil supply shocks.  However, this mission expanded to become a free insurance policy for the oil industry as well as, most recently, an economic weapon. Releases are also occurring much more frequently just prior to national elections in net oil consuming nations.

Most countries require their oil industry to fund the 90 days of SPR. The US is different. In the US, taxpayers, via the Department of Energy (DOE), pay to store SPR oil.  The taxpayer funded US SPR currently holds 696 million barrels of crude oil (the red line below).

Free Insurance for the Oil Industry
This taxpayer funded storage failed to increase storage per oil consumer. It had the opposite effect.  As the US government (funded by taxpayers) began storing more and more oil in order to provide a buffer against supply shocks, it provided the US oil industry encouragement to do exactly the opposite - store less.  Storing oil is expensive, and so industry is happy to allow taxpayers to subsidize storage.

Running inventories so low is risky for private industry.  However, if industry runs short, due to a hurricane or storm, it now simply taps taxpayer funded storage without any penalty - effectively free insurance.  The frequency of these loans have increased dramatically since 2000.

New Economic Weapon
In addition to being a taxpayer-funded free insurance policy for the oil industry, the SPR has now become an offensive, rather than defensive, economic weapon.  The most recent volley from this weapon was a test release of 5 million barrels of oil from the SPR announced a few weeks ago coinciding with a hugely oil dependent Russia invading Ukraine's Crimea.

Today, a number of economic commentators are calling for use of this new economic weapon to be expanded.

Wednesday, November 20, 2013

Haymaker: The Origin of Big Natural Gas

[Natural Gas 101]

Natural gas, so called as it is naturally occurring rather than being man-made, has been piped in small volumes over short distances in the US for street lighting since the 1820s.  Manufactured gas, produced by processing coal in gas works, was carried out a few years earlier.  Both natural and manufactured gas were used on small scale street lighting.

It took a massive discovery on November 3, 1878 in Murrysville, near Pittsburgh, Pennsylvania to bring natural gas to widespread industrial and home use.  The well was drilled by the Haymaker brothers.

Obediah ("Obe") Haymaker was murdered for the discovery. His brother, Michael, lived to tell the tale.  The well is now forgotten, almost.

(click photo to enlarge - The plaque placed on a boulder at the well site in 1961 incorrectly refers to Michael Haymaker as Matthew.  The name Michael is confirmed from multiple published sources, including the 1880s New York Times.)

Obe and Michael had been looking for oil.  They had seen a neighbor using gas emerging naturally from a creek (usually a good indicator of oil) as a fuel to boil down maple syrup.  To the Haymakers' disappointment they stumbled upon natural gas alone, which is more difficult to transport than oil and thus to this day trades at a discount.

Natural gas emerged uncontrolled from the Haymaker well for three years.  As the capital-starved brothers were trying to finance, and later sell the well, it caught fire and burned for a further year.

Visitors from all over the US, including President Grover Cleveland, came to see the fire.  Finally, after four years, the well was tamed. Pipes were constructed to bring natural gas the 18 miles to steel producing city, Pittsburgh, Pennsylvania.  Most steel plants at that time used coal. This was the first industrial scale use of natural gas in the US. Air quality in Pittsburgh improved dramatically.

Apart from a boulder covered by a tree (see the photos above and below I took on a recent visit) in the backyard of a house (the precise location is oddly incorrect on both Google and Bing maps - the correct location is here), there is little marking the place: the site of riots; the murder of one of the wells discoverers; and the fuel that to this day powers a large portion of US and global electricity generation as well as cooking stoves, home heating, and a large part of the future of transportation.

(click photo to enlarge)

Below the fold is a detailed recounting of the discovery, published in a 1936 edition of Sun Oil Company's 'Our Oil'.  Sun Oil Company later became Sunoco Inc.  The article below (after the "read more" link) was written by Michael Haymaker, then 90 years old in 1936.

Thursday, August 29, 2013

Do Wars Cause Higher Oil Prices? Not Generally

[Wars are fought over oil.  But do wars mean higher oil prices?]

Military intervention by the US in Syria is looking increasingly likely. Here is a quick cheat sheet.

Many are calling for a rally in oil prices from its current $107 per barrel to $150 or $200 on the initiation of action.  Others are calling for a price spike higher which will quickly reverse.

Syria is a relatively small oil producer, with trivial production globally.   It's  the potential disruption from spillover into larger regional oil producing nations, including Iraq and Iran, that concerns oil consumers.

Predicting the reaction of the oil market in such situations is not straightforward and it's always worth considering a range of scenarios. It is precisely this uncertainty that has caused an abundance of caution historically, and caused supply-side over-reaction, with lower prices after Western forces finally act.

Over the past 30 years, military interventions involving external, US or UN, forces against Arab nations or Iran have generally resulted in lower oil prices.  It is only regionally internal, Arab vs Arab or Arab vs Persian, warfares that resulted in higher prices (charts below, click to enlarge). 

Perhaps this is because by the time Western military operations begin the market has already priced in the event due to a more free press. Traders monitor Western political sentiment, military jet fuel purchase requisitions, and fleet movements, ahead of time.  Or maybe it is the actual, or threatened, impact of an IEA global release of strategic petroleum reserves, along with the willingness of US ally Saudi Arabia to increase production from its spare capacity during disruptions.


Tuesday, June 18, 2013

Coming Soon...

Great to be back. So much to discuss... Follow along on Twitter: @CommodityMD
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