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243: Oil price crash sows seed for next massive oil spike

12-20-2008 team


Oil prices crashed midday 19th December to $33/bbl. They have crashed from $147/bbl in May 2008. Because the US dollar has declined in value and through inflationary affects, the real terms price of oil is close to the lows seen in 1999 ($10/bbl) and below the lows seen in 1986 ($8/bbl) in Sterling/Euro terms.


So what's going on?


There has been a massive unwinding of leveraged speculative long positions that helped drive the oil price upwards off the back of tight oil supplies and high demand from China and BRIC countries up until mid 2008. Many banks and investment houses have also needed to sell to raise cash to severe. Oil was also considered a good hedge against inflation – now deflation looks possible, the speculators have dumped their oil holdings and converted to cash – also to cover losses in other areas such as mortgage lending.


Meanwhile, new oil supplies were just beginning to come on stream as they became economic when oil prices rose above $40/bbl about four years ago. Further supplies will come on stream in 2009 in places like Angola, Brazil and Saudi Arabia. Meanwhile demand has slumped and is in decline in western economies. In the east, demand is now broadly flat. Overall, because of the global recession, demand is likely to be flat overall in 2009, and it may even decline slightly – by ca. 0.5 millions a day (out of the current 85 million bbls/day demand).


OPEC has been forced to cut supply by 2.2 million bbls/day – but compliance may not be above ca. 70% - the market thinks cheating will occur and this has probably been priced into the market.


Low oil prices should give a massive boost to western oil importing economies – as an example, oil at $125/bbl was draining the USA’s economy to the tune of $800 Billion a year – or 4% of GDP. US import bills will likely reduce to about $200 Billion a year, or 1% of GDP. Meanwhile, Middle East economies will suffer with $40/bbl oil – many countries will go into deficit. They will be forced to reduce oil and gas investments. This is a serious concern. Various studies have calculated the world needs about $1 Trillion of annual energy investment to keep pace with demand. However, the current relatively high levels of oil investments running at only $400 Billion per year are now being dramatically scaled back because of:


This will likely lead to tightening of supplies in a few years time and another big oil price spike. Stability in oil prices is what is needed to allow good investment planning – the current gyrations are very damaging to supply/demand balance and the overall global economy.


What does this mean for the property investor?


Expect inflation to come crashing down along with interest rates - there is a chance a (likely) brief period of deflation could start by mid 2009. Then expect the global economy to recover fairly sharply when fiscal stimuli, interest rate cuts, reforms, increase in money supply (Governments printing money) and low oil price effects start to kick in. Then expect a tightening of oil supply-demand very rapidly – as early as end 2009, then oil prices again sky-rocketting, then inflation kicking back in, interest rates rising, GDP growth slowing again and the whole cycle starting again! Sorry – it’s bleak. The oil price gyrations are and will be damaging for property investors. No wander the building societies are refusing to make predictions on house prices for 2009. Things can change very quickly one way or the other depending on how measures start feeding through.


As governments start printing money to kick-start economies, there is a real chance another bubble will be created that could be worse than the one that was created off the back of the bust and 9/11 stock market crash. A steady 6 year bull run from end 2001 to early 2008 came to an end as the bubble popped. Our guidance is, expect the next bull run, if it starts, to be rigorous, fast and then to pop quickly again. This bull run could start in January 2009 - but only last a year or so. So you’ll need to ride the wave, because it could be coming quickly. But make sure you get your money off the table before it crashes again. If you think inflation will take hold for the longer term, or government will print huge amounts of money – best invest in gold.


Babyboomers - head for the hills


Also bear in mind, if you are aged 45 to 65 years - the babyboomers of the western world start retiring this year - many will want to cut their losses and head for the hills. This happened in Japan in 1990 - this is when the Japanese babyboomers started retiring. The Nikkei was 39,000 and crashed to 9000 and never recovered! Beware the same could happen in USA and UK, albeit the demographics for both USA and UK are far better than Japan in 1990 (Japan has a declining and aging population, and fiscal-economic reforms were very slow after their crash in 1990). Don't be the last one to head for the hills...there wont be anything left! 


What next


But for the time being, with oil prices being so low, we believe oil companies are a good place to invest. Plus investing in istressed property sales. We would avoid retail.  We don’t believe we’ll see $33/bbl back again ever! Midday 19th December was a pivotal moment when the world finally realized that these low oil prices were sowing the seeds for the next massive oil price spike!


And as previously communicated, oil prices below $50//bbl are a massive stimulus to property in western oil importing nations (USA, most of Western Europe). Oil prices over $50/bbl will pu the brake on house price increase through inflation and high interest rates and big fiscal deficits.


So when the US government announced $800 Billion of bail-out finance, this was the same as the oil import bill at $125/bbl - so they've managed to find $600 Billion of the bail out money from low oil prices as prices ave crashed from $147/bbl to ca. $40/bbl.


On the left is a "Peak Oil" scenario showing an expectation of oil production declines from now onwards. Whilst we do not believe the decline will be as sharp as in this chart, indeed we will probably never produce as much conventional crude oil as was produced in January 2008. We believe oil production - because of lack on investment in the next few years - will start a steady an rather bumpy decline from now onwards. And the sooner countries can switch to electric cars the better and other forms of no oil power generation the better.


Be warned - as OPEC cuts oil production it will mask the underlying decline in oil production from older fields and lack of new oil from under investment in new fields. So we may not notice oil has peaked until it's time to open the taps - and nothing happens! Thence oil prices will skyrocket again as markets realise supply is stretched and demand has recovered temporarily. 


We hope you have found these insights helpful - we aim to give guidance to help you plan your investment moving into these challenging times. Good investing for 2009 and we hope you have a restful festive period. team






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