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517: Peak Oil, Military Conflict and Currency – Property Investor’s Insights

09-26-2014 team

As a general rule, the following tends to go together:

Scarcity - Inefficiency

  • High commodities prices
  • High gold and silver prices
  • High food and fuel inflation
  • Low property price inflation
  • High interest rates
  • Low economic growth
  • High unemployment

Abundance – Efficiency

  • Low commodities prices
  • Low gold and silver prices
  • Low food and fuel inflation
  • Low property price inflation
  • Low interest rates
  • High economic growth
  • Low unemployment

Low Cost Energy Fuels Growth:  The ideal scenario is when there is an abundance of cheap energy in the form of oil and gas that drives the economy forwards, keeping a lid on inflation and creating high employment and low unemployment. The more efficient the energy business is at finding new plentiful oil and gas supplies – the faster the world economy grows with low inflation. This then sends property prices far higher – particularly as inflation is low and mortgage – borrowing costs remain low.

High Cost Energy Fuels Decline:  On the converse, for most western nations – those that import oil - the worst scenario is when there is a shortage of cheap energy in the form of oil and gas that drives price higher and the economy into recession – this drives inflation higher and lowers employment and increases unemployment. The less efficient the energy business is at finding new plentiful oil and gas supplies – the slower the world economy grows and the higher general inflation of fuel and food is. This then sends property prices lower, creates severe financial strains, deficits and can precipitate a financial crisis as inflation gets out of control, currencies decline, mortgage rates and borrowing costs rise.

Peak Conventional Crude Oil: In the period 1999 to July 2008 there was a massive run up in oil prices from $9/bbl to $147/bbl until just before the Beijing Olympics. Not only was China’s oil demand growing at 15% a year, the world economy was overheating and Peak Oil – for conventional "low cost" crude oil had been reached in 2005. The reason why oil production continued to increase was because of new higher cost supplies from Deepwater (>$35/bbl average extraction cost) and Heavy Oil from Oil Sand Deposits (>55/bbl average extraction cost). But the new supplies could not keep up with demand – oil prices rose sharply then the financial-economic crisis hit, in large part because the books in the Western oil importing world simply did not balance anymore with the outflows of cash to the Middle East and oil exporters like Russia and Nigeria.

Shale Revolution: What happened next was truly sensational. In 2004 the timing being by coincidence – the US oil companies started fraccing shale to produce natural gas – and they delivered such large quantities they made a lot of money in natural gas sales early on – riding a wave as gas prices rose from $5/mmbtu in 2000 to 12/mmbtu by early 2008. Then the financial crash hit caused in large part by $147/bbl oil prices and the US economy slowed dramatically, then gas prices crashed to $3/mmbtu – only 25% of their peak value. These gas companies then scrambled around and by then had found they could frac the shale and extract sizable quantities of light oil in the sweet spots – they all rapidly switched from drilling gas to light oil shale plays – and furthermore started drilling 3km long horizontal wells radiating out from central locations with up to 20-30 massive fracs (instead of say 5) – to produce as much of the higher value oil as possible. This bridged the gap in 2009 when oil prices recovered quickly from $50/bbl to $90/bbl during the US and European recession. By 2009, the US oil companies had learnt how to economically extract light oil from vast tracts of shale oil deposits in West Texas and North Dakota. In only five years, a massive 3.5 million barrels of extra US oil production was added that reduced the US deficit by $130 billion a year. Gas production had also skyrocketed from 2003-2010– leading to plentiful low cost energy for power stations and a switch by some commercial vehicles from higher cost oil to lower cost gas. This boosted the US economy enormously and improved its competitiveness against the Far East. The oil and gas boom also created about a million jobs directly and indirectly as Texas and North Dakota boomed.

Saving The Dollar:  This new injection of oil reserves – and it’ economic strength – in our opinion has saved the US dollar from a massive slide. As the US Fed continued to print money – when everyone was expecting the US dollar to decline in value against other currencies because of its economic problems and need for structural reforms, deficit and inefficiencies – this never happened. The main reason being the whole economy was propped up by cheap oil and gas – that made the US economy into a Petrocurrency economy again.

Reliance On Imported Oil: In the last five years as the US reliance on imported oil has declined, the US government has been able to take more of a back seat on global military matters. As wars have broken out in North Africa and the Middle East these have hardly impacted the oil price because of the additional 3.5 million barrels the US now produces and the outlook for more of this light oil arriving in the market in future years – to make up for any shortfall caused by the security issues. This has probably allowed the US to be less interventionist.

Inflation: The strength of the US dollar has also kept a lid on inflation – as has the abundant oil and low priced gas within the USA. This has positively impacted property prices and led to record low borrowing costs. Despite gigantic money printing of the fiat dollar currency, inflation of food and fuel prices in the US has been contained largely because of the strength of the dollar at this time.

More Military Excursions: The other interesting facet is that when the US starts a military campaign – as it did against ISIS in northern Iraq and eastern Syria on 23 September 2014, the dollar rose and oil prices actually dropped. This means that markets seem to have confidence that such military ventures will help the US economy and secure oil supplies and it reconfirmed the US as the dollar safe haven for now.

Fraccing Is Not New: The reason for mentioning the US oil and gas shale boom is for context for the rest of the world and property investing. The oil business has been fraccing wells for 60 years – it is nothing new. The hysteria related to this rather conventional approach to improving the productivity of an oil or gas reservoir or well is beyond comprehension to anyone working in the oil business from our understanding. France has banned fraccing. The UK has not fracced an onshore well for many years now. If we want jobs, wealth, a stable economy and good health care and low taxes – we need low cost energy – otherwise we start moving back to the dark ages. If we don't produce low cost oil and gas, the result will likely be more burning of coal. Low cost renewable energy sources for most countries are decades away – anyone in the UK that has seen energy prices skyrocket will attest to that – since carbon taxes and renewables subsidies came into play driving up energy prices -  doubling them in seven years, as UK oil and gas production crashed by 50% in the same period. Interestingly the US has reduced its CO2 emissions whilst Germany has increased its emissions in the last 7 years - the reason being that fraccing has produced plentiful natural gas that has offset coal burning in power stations. Meanwhile the so called environmentally conscious Germany that signed up to Kyoto is busy shutting down nuclear power plants and switching to coal (plus some belated renewables projects) - and overall their CO2 emissions have shot up. The German pollution levels have also shot up with it. What we are saying is in most circumstances - fraccing reduces CO2 emissions and reduces the threat of climate change. It's also far safer than nuclear power - anyone in Japan will attest to this. 

Healthy Economies Have Low Energy Costs: For the property investor, the most successful economies with the rising property prices will be those that have low priced energy, low levels of oil/gas imports leading to a healthy economy – and a scarcity of home building.

UK Sterling Should Be Lower: In the UK we have a strange mixture. The UK produces only 40% of its oil needs and 35% of its gas needs. Its deficit is quite massive and will increase as oil and gas revenues decline further – after three successive tax increases in 12 years on North Sea oil companies killed off investment “they shot the goose that laid the golden egg”. In the 12 months after the last increase in March 2011 – North Sea oil production crash 23% for example – a catastrophe for any country and certainly one for the UK.

Labour To Precipitate a Sterling Crash: The value of Sterling has risen in the last few years primarily because of the confidence that the Tory government are trying to do something about the deficit. Sterling took a knock just before the Scottish Referendum – and will probably recover in the medium term, but as the general Election approaches – Sterling is bound to slide as more people get worried that Ed Balls will be the new Chancellor – and will wreck the economy with anti-business taxes, mansion taxes and any other tax he can throw at hard working people to pay for a public sector expansion and hand-outs for people on lower wages or not working. The combination of Ed Miliband – who even forgot to mention any reference to the deficit in a one hour speech at the Labour Conference – and Ed Balls who is another career politician who has no training in economics – is a very dangerous one for the UK economy. Regrettably we think they will be voted into power in May 2014 then there will be an assault on property investors, landlords, anyone in the private sector who works hard and tried to earn any money or make a profit. The word profit will become something of a swear word or taboo – something no-one will feel comfortable admitting they are actually doing.  This will without doubt drive property prices down in almost all areas – particularly central London as wealthy people desert the city and move overseas, like they did in France when Hollande got into power.

Stalling Market: The property market is starting to stall now in our view because investors – indigenous and overseas – are slowing down and first time buyers are easing off because of the threat of a new Labour government in May 2015. The uncertainty caused by the introduction of a “Mansion Tax” and the knock-on impact for the whole property market is starting to feed through to demand. The levels of home building will also start to slow down soon in response to the uncertainty. Beyond doubt, if Labour get into power, property prices in SE England will stall at best or drop sharply at worst.

Mansion Tax: It’s interesting to note that a so called “Mansion Tax” bracket of £2 million catches a 4 bedroomed terrace house in a place like Clapham or South Hackney. More than 75% of properties in London costing £2 million or more are either flats or terraced houses – hardly “Mansions” as the term describes. Because of stealth taxation, a modest 3 bedroom terrace house in a place like Fulham is likely to get caught in this trap within a few years. If it was a one off windfall tax, one could understand – but an annual tax that targets higher end London property will in our view raise relatively little money and have many negative un-intended consequences – like driving the very people London and the UK is trying to attract that create new jobs and new businesses – driving the wealth creator away from the UK as these mobile people will not want to pay such punitive annual taxes on their properties. If Labour gets into power, they will implement this tax and we will see the consequences fairly rapidly.

Best Areas: The way for investors to try and reduce their risks against such a tax is to purchase properties for no more than £500,000 – close to the new Crossrail Stations which are likely to see the biggest property price increases in London in the next few years as the new line opens. One of the best places is between Farringdon and Tottenham Court Road – which will be the area with probably the best north-south and east-west communication within London by tube, Crossrail and Thameslink. A one bedroom flat in a quiet street in this area will see it’s price rise sharply in our view. Another area is around Acton Central – where there will be a new Crossrail station that will halve the time to commute to the City of London for wealthy bankers. Ealing is also interesting – a little more leafy and further out with some good schools in the area, popular with the Japanese.

We hope you have found this Special Report is insightful and helpful to mould your property investment strategies. If you have any questions or queries please contact us on   



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