David Fuller and Eoin Treacy's Comment of the Day
Category - General

    Musings from the Oil Patch July 19th 2017

    Thanks to a subscriber for this edition of Allen Brooks’ ever interesting report for PPHB. Here is a section:

    The latest topic of interest in the oil and gas business is the lack of new discoveries given the cutback in capital investment in keeping with Mr. Dudley’s “capital diet.”  What does this mean for the industry’s future?  The International Energy Agency (IEA) has sounded the alarm over sharply higher oil prices in the 2020-2022 time frame due to a lack of industry capital spending.  With capital spending cut by 25% in 2015 and by another 26% in 2016, prospects are increasing for a growing gap in the future output trajectory for oil.  Current expectations call for a modest increase in capital spending during 2017, but that increase could prove overly optimistic should oil prices fail to recover in the second half.   

    The IEA warned in its Oil 2017 report of a possible imbalance between demand and supply growth, leading to the smallest global spare production capacity surplus in 14 years by 2022.  That conclusion is based on demand growth for 2016-2022 of 7.3 million barrels per day (mmb/d), which exceeds the projected supply growth of under 6 mmb/d.  A possible relief valve might be the growth in U.S. shale output.  As Dr. Fatih Birol, the IEA’s executive director put it: “We are witnessing the start of a second wave of U.S. supply growth, and its size will depend on where prices go.”  He went on to say, “But this is no time for complacency.  We don’t see a peak in oil demand any time soon.  And unless investments globally rebound sharply, a new period of price volatility looms on the horizon.”

    The supply shortage view seems to be gaining traction among oil and gas industry professionals.  Halliburton Company’s (HAL-NYSE) Mark Richard, senior vice president of global business development and marketing, told the World Petroleum Congress that “You’ll see some kind of spike in the price of oil, maybe somewhere around 2020, 2021."  This fits with Bernstein Research’s latest oil price downgrade.  The firm now sees oil prices exhibiting a U-shape cyclical pattern: after having declined from over $80 a barrel in 2014, they traded in the $40s for 2015-2016, and will now be flat at $50 for 2017-2018 before slowly climbing back to $70 by 2021.   


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    Asia's Top-Performing Currency Is Missile-Proof

    This article by Lilian Karunungan for Bloomberg may be of interest to subscribers. Here is a section:

    One major draw for the won is a strengthening in global trade that’s benefited South Korean exporters, along with regional neighbor Taiwan, which has also seen its currency appreciate this year. South Korea’s current-account surplus is projected by the International Monetary Fund to exceed 6 percent of its gross domestic product this year and the next two years.

    “Ironically, the ones that are appreciating are the low yielders,” Soon said. South Korean 10-year government bonds yield 2.26 percent, a little less than that of U.S. Treasuries. By contrast, Malaysian debt yields 3.96 percent and India’s notes 6.45 percent.

    Rapprochement Policy
    President Moon Jae-in has spurred foreign investor interest after taking office in May on a platform of reducing the influence of the chaebol and seeking a diplomatic rapprochement with its belligerent, missile-firing neighbor to the north. South Korea’s stocks and bonds attracted a net $4.6 billion so far in July, reversing the outflows seen earlier this month.

    The won hardly blinked after North Korea said on July 4 it fired an intercontinental ballistic missile for the first time. Moon is currently following on campaign pledges to pursue dialogue with Kim Jong Un by proposing some military and humanitarian exchanges.

    Export-oriented economies like South Korea as well as Taiwan are benefiting from an upturn in the global technology sector that’s still “has got some legs to it,” Jonathan Cavenagh, head of emerging Asia currency strategy at JPMorgan Chase & Co. in Singapore, said in a Bloomberg Television interview with Betty Liu and Yvonne Man, last week.


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    Quarterly Market Commentary: The Investment Case for Real Assets

    Thanks to Peter Van Dessel for example of his firm Abbington Investment Group, LLC’s letter which may be of interest to subscribers. Here is a section:

    Chart 13, below, provides an indication of the price risks involved in a commodity such as Wheat. Using a log scale visual, we can see that Wheat is remarkably cheap when compared to its longer-term inflation-adjusted price history. We understand the reasons for today’s lower price range: the far higher productivity that comes from mechanisation, agronomy, the use of pesticides etc.; but to an impartially-minded statistician, and using the data that supports Chart 13, a five-fold increase in Wheat prices would represent no more than a mean reversion event.

    Although a spike in the price of Wheat on such a scale may seem unlikely, the risk of it happening is real and the potential consequences are severe.

    The following is a list of potential outcomes that would accompany a broader range of commodity price rises (Ref. Department of Agricultural and Resource Economics, University of California, U.S. Department of Agriculture, Goldman Sachs):

    Unequivocally negative consequences for urban dwellers
    Lower real incomes
    Rising wage pressures
    Lower income groups will be more negatively effected
    Lower consumer confidence
    Higher risk of stagflation
    Social and political instability

    Understandably, the secondary effect of these outcomes on overbought and over-leveraged  financial markets would be significant. So too would the flow of investments from financial assets to real assets.

    With the continued backdrop of low interest rates and the current high levels of money supply, the risk of significant flows of investment from large financial markets, such as fixed income, to the far smaller, inflation-sensitive, commodity complex is substantial. If such an event were to happen, the recent 30% move higher in Wheat prices will prove to have been an early indicator of a broader trend.


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    Australian dollar soars to two-year high on RBA minutes

    This article by Jens Meyer for the Sydney Morning Herald may be of interest to subscribers. Here is a section: 

    The currency staged a remarkable rally following the release of the RBA's minutes in which the board stuck with its "glass half-full" view of the local economy, repeatedly underlining the "positives" in the outlook. But it also surprised by discussing the level of an appropriate neutral interest rate, which could be seen as a sign the central bank is mulling a rate rise.

    Officials revealed that they now believe a cash rate of 3.5 per cent - well above today's 1.5 per cent - would be a rate level that neither stimulates the economy nor holds it back.

    In reaction, the Aussie dollar jumped more than 1 US cent to as high as US79.04¢, its highest level since May 2015, after rallying 3 per cent last week.


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    Copper price jumps on gangbusters China growth

    This article by Frik Els for Bloomberg may be of interest to subscribers. Here is a section:

    Copper futures trading on the Comex market in New York jumped on Monday on renewed optimism about economic strength in top commodity consumer China.

    Copper for delivery in September jumped to a high of 2.7375 a pound (just over $6,000 a tonne) in lunchtime trade, up 1.7% on the day to the highest level since end-March. LME copper's 2017 year to date gains in percentage terms are now within shouting distance of 10%.

    Commodity-intensive sectors continue to expand at a faster rate than the broader measure of industrial production

    The economy of China, responsible for nearly half the world's consumption of copper, expanded at an annual rate of 6.9% in the second quarter against expectations of a slight decline and at a quicker pace than Beijing's own target of 6.5% growth for 2017.

    In seasonally-adjusted quarter on quarter terms, growth was even more significant, picking up from 1.3% to 1.7%. If the trend continues, this year would be the first time since 2010 that the Chinese economy grew faster than the year before.

    Industrial production data for June released today also pointed to a significant improvement. Growth in industrial output picked up from 6.5% year on year to 7.6% led by greater electricity and steel production. Bloomberg consensus forecasts pointed to no acceleration for Chinese industrial output.


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    What If Big Oil's Bet on Gas Is Wrong?

    This article by Jack Farchy and Kelly Gilblom for Bloomberg may be of interest to subscribers. Here is a section:

    Driving the shift has been a sharp decline in the cost of building new renewable power –- which, unlike generating electricity from coal or gas, is almost free to run after the initial capital investment has been made.

    “Wind and solar are just getting too cheap, too fast" for gas to play a transitional role, said Seb Henbest, lead author of the BNEF report.

    The consultant estimates that onshore wind and solar power are already competitive with coal and gas in Germany, and that within five years they will be cheaper to build than new coal and gas plants in China, the U.S. and India. By the late 2020s, it will start to even be cheaper to build new onshore wind and solar power than run existing coal and gas plants.

    The trends that are undercutting optimism about the global gas outlook are already playing out in Europe. Natural gas demand remains well below a 2010 peak, as greater energy efficiency, rapid adoption of renewables and resilient coal consumption cut into its market share.

    The IEA does not see European gas demand returning to its 2010 high. In its base case scenario, European gas demand would be at the same level in 2040 as in 2020.


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