Well I guess the Moody’s story got pushed to the back burner – since oil rallying hard along with the Fed minutes took center stage. However, Moody’s did get hit over 15% (7 points) – for now their story is being over shadowed – but keep it filed away – it could cause serious pressure in the financial sector (and pensions). The oil news took center stage as it made a huge rally. It’s as if that one opening statement in the interview with Pickens on CNBC (Tuesday morning) got people really thinking about the REALITIES of oil ($600 billion leaving this country per year and that we are at maximum (or close to) extraction vs. ever increase in consumption.)
The Hirsch Report (for the Department of Energy) in 2006 – has predicted peak oil in 2010 (on average) (range 2006-2020) – is starting to see that inversion sooner rather than later. Additionally – supply seems to be a real problem since Congress voted to stop shipping oil (70k barrels per day) to the Strategic Petroleum Reserve – to free up supplies. Add in that refinery capacities are running at full capacity – we don’t have much more room to go higher.
After hearing about the refineries running 24/7 at full capacity – it reminds me of those old Star Trek episodes when Capt. Kirk is yelling to Scotty for more power, and Scotty is yelling from the engine room with red lights blinking and smoke pouring out of the warp drive “I’m given her all she’s got, Capt’n!” – I see that picture happening in every refinery in this country. Typically you don’t want to be “red-lining” your refineries for very long and would rather maintain operations around 80-90% - not 110%, well at least not days on end._____________________________________________________________
Oil - the world's life blood!
The blame is every-where, Oil companies, OPEC, speculators, weak dollar, the Fed, the Government. We traditionally don’t care about anything until it affects us, now with gas prices hitting us in the pocket – well someone is to blame. But after you listen to Pickens – he makes some clear and simple points. Sure there are some premium attached to oil and they can all be estimated, dollar risk is about 10-15%, political stability of the region is about 5-15% depending, speculation is anywhere between 5-15%, but at the very end of the day at its intrinsic value it comes down to supply vs. demand.China had made it very clear as they are buying up HUGE sums of oil and futures in EVERY oil producing country – they NEED it – and unlike the U.S. – they do NOT care who they do business with (Iran, Sudan, Venezuela, etc.) additionally they don’t really care about cost as long as they can get it in bulk.
Global consumption is increasing at 2% per year COMPOUNDED – and the Department of Energy predicts by 2025 world oil consumption will increase 35% to over 118 million barrels per day. Maximum extraction on Proven reserves is predicted at around 90 million per day (without any issues) but they are already running very close to maximum extraction (with current problems) and that is around 85-86 million per day. However – consumption on the global scale is 87 million per day. It is simple math – we are consuming MORE than we are extracting.Since there is a lot of talk about oil – I thought I would put a little primer together – please note this is not to justify the current price of oil – but simply explain some basic issues.
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Oil Primer
Recently – in the news there is much speculation as to WHY oil prices are so high. Everything from OPEC is to blame to speculators driving up the price. People didn’t care about oil prices or how HIGH they went, until it hit them at the gas pumps. NOW people need answers and the complexity of how commodities, futures, extraction rates – are too boring or dry for most people to comprehend. They need to point a finger at somebody or a group of people.
Politicians and the media will look at everything except the math – in order to make sense of something. It is easier to believe in a conspiracy or hate a group of people – then it is to swallow the math.
Since Hubbert (a geologist predicted the U.S. peak – extraction vs. consumption in 70s), which lead to an oil crisis in this country – other economist, energy traders, geologist, and government agencies have be preparing themselves for the eventual peak.
There are some facts about oil - which we ALL need to understand before we start making accusations as to OPEC or Speculators that are driving the price.
1. Extraction Rate (currently aprox. 85 million barrels per day) –
Maximum is aprox. 90 million barrels per day Oil is extracted via pressure.
When more oil comes out of the ground – the pressure drops. Water and Gasses are FORCED into the ground to build that pressure back up to extract the oil. All oil wells have a MAXIUM extraction rate. This is simple physics – you just can’t add more holes in the ground to get it out any faster. You also can only increase the pressure to a certain PSI to maintain maximum extraction. Currently the world is running at 95% of maximum extraction on proven reserves.
2. Consumption Rate (currently aprox. 87 million barrels per day)
Global Demand is 2% per year (compounding)
The US has remained relatively flat on oil consumption over the last 3 years. The US makes up about 20% of the entire world’s oil consumption, but is rapidly losing ground to the emerging markets. Global consumption is accelerating – China is increasing at a rate of 5-7% per year. The US Energy Information Administration (EIA) annual report stated that current demand growth shows as 37% increase from 2007 to 2030 to 118 million barrels per day. Most of the demand will come from emerging markets with China and India at the top. World population growth is expected to be double in 2030 of that in 1980.
3. Reserves
Many people think reserves mean some large tank somewhere with gas in it. Actual reserves are just where the oil is underground. Reserves fall into two categories – proven and unproven. Proven means that we know with a fairly high degree of likelihood as to the amount of oil in the ground and with current technology are able to extract it, unproven fall into two sub-categories (possible and probable) – with different degrees of likelihood. All PROVEN reserves have been found in the world over a couple of decades ago. Only unproven reserves have recently been discovered and either the technology to extract it is either not available or too costly. Currently oil is being extracted from proven reserves at 95% of their maximum extraction rate.
SPR – the Strategic Petroleum Reserves are underground caves in the Gulf of Mexico that can store up to 800 million barrels of oil. Currently it has about 700 million barrels. These caves are located near refineries in Texas and Louisiana. The SPR has enough oil to last the U.S. 50-60 days. At the beginning of May, Congress voted to HALT oil shipments (70,000 barrels per day) to the SPR to FREE up supply. Several countries have SPRs – but collectively they are a fraction of what the monthly global consumption rate is.
4. Reserve LIFE – how much oil based on CURRENT extractions.
This becomes rather skeptical – because we must rely on the country telling us the TRUTH as to their PROVEN oil reserves. Recently it has been revealed; via classified documents that Kuwait has overstated their proven reserves by as much as 50%. Regardless – if we hold these reserves to be accurate – then most oil fields look to have about 75-100 years left.
However – these numbers are extremely suspect as OPEC continues to RAISE the amount of proven oil reserves. Mexico, Russia, and the US are at 10-20 years of oil in their production reserves.
5. OIL is not GAS
The U.S. has a refinery capacity issues – we can only refine the oil at a certain rate – just like extraction. This has traditionally been a bottle neck in this country and we have not built any NEW refineries in the last 20 years. It takes time to convert oil into the other products we need. Remember the SPR is OIL – not GAS!
Time to start focusing on the BIG PICTURE and stop worrying about the minutia and blame game!Like will all commodities – the basic math is about supply vs. demand, nothing more, and nothing less. Oil is a soft commodity – meaning that once it is used you can NOT reuse it or resell it. It is also a depleting commodity – with a finite supply. These two facts are inescapable.
Additionally – regardless of media stories – if we just stick to what we ACTUALLY know – we can draw some simple deductions from the above information.
1. Extra Supplies
The SPR only has enough oil to last us 50-60 days in a crisis. There are NO secret warehouses of gas. That means the global pretty much consumes what it extracts on a daily basis (give-or-take a few thousand barrels). It’s sort of like living pay-check to pay-check. You might be up this month, but next month you could be short. Extra supplies can be used up in a couple of days. So what we have today may NOT be here tomorrow. Any talk about extra supplies is fairly silly – when it is obvious (even with the SPR being utilized) we would be out of oil in a few weeks. You also might hear a story about a couple of tankers hording oil, or a warehouse with oil – compared to the daily consumption rates of oil – even in this country – that tanker or warehouse would be dry in a day.
2. Consumption
We continue to ignore what happens in the Global world until it hits us in the pocket book. Rogers, Buffet, Ross, Pickens, and other billionaire investors have been talking about China and the Bull Run in commodities for the last 5 years. They have already been on the train and making billions. However, we lazy Americans hear the sound-bite and change the channel. For most of us are NOT investors in commodities. We don’t care. But WAIT it is now affecting me at the gas tank. Now we take notice.
China has been growing at an accelerated rate for the last 5 years. Same is true with India and other emerging markets. These countries have been slowly shifting from exporters of raw materials to importers. Cement, Steel, Copper, and OIL – more recently soft commodities (like Rice, Wheat, etc.) they are booming populations, booming manufacturing, booming cities. It is not stopping. They have taken first manufacturing jobs from the U.S., then service jobs, and now commodities. It is not going to stop.
We cannot argue that the math of global consumption WILL and HAS eventually out-paced extraction rates. Even the EIA has predicted a doubling of global population growth by 2030. That population growth is NOT happening in the U.S. it is happening in China and elsewhere. Same is true with consumption – while ours has been flat – theirs is growing at 5-7%.
3. Peak Oil http://en.wikipedia.org/wiki/Peak_oil
No one denies (for the most part) including the U.S. government and several oil producing nations that oil is a finite resource, that it can only be extracted at a certain rate, and that we will eventually hit maximum extraction. The debate is WHEN it will happen. Information from the top geologist and scientist and oil experts were pooled for a paper (Hirsch Report) for the U.S. Energy department in 2006 to predict when maximum extraction would happen. They run from 2006 – 2020. Most of the predictions were for 2010.
4. The U.S. Government KNOWS
The U.S. Government had the Energy Agency investigate the oil concern – including the above mention predictions for peak oil (extraction vs. consumption). The government is VERY concern – and the document prepared for the government clearly states the concern in the opening remarks.
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Hirsch Report http://www.netl.doe.gov/publications/others/pdf/Oil_Peaking_NETL.pdf
The peaking of world oil production presents the U.S. and the world with an unprecedented risk management problem. As peaking is approached, liquid fuel prices and price volatility will increase dramatically, and, without timely mitigation, the economic, social, and political costs will be unprecedented. Viable mitigation options exist on both the supply and demand sides, but to have substantial impact, they must be initiated more than a decade in advance of peaking.
Important observations and conclusions from this study are as follows:
1. When world oil peaking will occur is not known with certainty. A fundamental problem in predicting oil peaking is the poor quality of and possible political biases in world oil reserves data. Some experts believe peaking may occur soon. This study indicates that “soon” is within 20 years.
2. The problems associated with world oil production peaking will not be temporary, and past “energy crisis” experience will provide relatively little guidance. The challenge of oil peaking deserves immediate, serious attention, if risks are to be fully understood and mitigation begun on a timely basis.
3. Oil peaking will create a severe liquid fuels problem for the transportation sector, not an “energy crisis” in the usual sense that term has been used.
4. Peaking will result in dramatically higher oil prices, which will cause protracted economic hardship in the United States and the world. However, the problems are not insoluble. Timely, aggressive mitigation initiatives addressing both the supply and the demand sides of the issue will be required.
5. In the developed nations, the problems will be especially serious. In the developing nations peaking problems have the potential to be much worse.
6. Mitigation will require a minimum of a decade of intense, expensive effort, because the scale of liquid fuels mitigation is inherently extremely large.
7. While greater end-use efficiency is essential, increased efficiency alone will be neither sufficient nor timely enough to solve the problem. Production of large amounts of substitute liquid fuels will be required. A number of commercial or near-commercial substitute fuel production technologies are currently available for deployment, so the production of vast amounts of substitute liquid fuels is feasible with existing technology.
8. Intervention by governments will be required, because the economic and social implications of oil peaking would otherwise be chaotic. The experiences of the 1970s and 1980s offer important guides as to government actions that are desirable and those that are undesirable, but the process will not be easy.
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We can certainly continue to be whipsawed by the media or a politician during the election year. We can easily blame OPEC or speculators. We can easily jump when an analyst tells of their predictions. We can easily read TOO much into this story or that. We can easily look to conspiracies. We can easily fall prey to many things to explain the higher prices of gas. But we can NOT explain away the simple facts of supply and demand – it is just math.
This was coming – we all knew it – so did the government (Hirsch Report). We have entered a new era. While Pickens is making billions on the current rise in crude prices, he just bought a 1,000 wind turbines from GE and is building the largest wind farm in the U.S., he is also investor in natural gas, coal, and solar. He sees the writing on the wall – he is not trying to drive prices higher in some conspiracy – he KNOWS that we are already at maximum extraction and is already making his NEXT investments in energy (Wind, Solar, Gas, Coal) – why does he make billions – because he puts his money where his mouth is and is also the EARLIER pioneer or adopter in new business.Pickens is the premier oil man and when you see the guy that made BILLIONS in oil now investing 100s of millions in Coal, Wind, Natural Gas, and Solar - he is looking out 1 year, 5 years, 10 years and saying we are being FORCED to find alternative energy because we can NOT keep up with consumption. It’s time to stop focusing on the minutia and blame game and start looking at the BIG PICTURE – Supply and Demand.
Oil prices are high and they should and may come down – but that doesn’t change that there is some real concerns about Supply vs. Demand.
No doubt there is weak dollar premium, speculation premium, political risk premium, weather premium in oil prices - but at it's basis we can not deny that supply vs. demand is a growing REAL problem.
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Initial Jobless Claims – declined?
A bright spot after the oil news, Fed notes, and the Moody’s story – the jobless claims fell 9,000 from a revised 374,000 the prior week – reported by the BLS. Some analyst are hoping or maybe predicting that the lay-offs have eased and is showing a sign of relief. But the short-term numbers and revisions are usually more volatile – as they have to weed through the numbers. The 4-week moving average – a less volatile indicator – rose to 372,250 from 367,250 – so while maybe we had a week reprieve the long-term trend seems to be increasing.
The problem with measuring unemployment benefits is the discourage worker issue. After 18 months – if those people have NOT found a job then they are DROPPED from being counted as unemployed, they are relabeled as “Discouraged Worker” and then tossed into Never-Never Land never to be counted again. Traditional methods of measuring unemployment’s prior to the last couple of decades of methodology change has it more in line with 12%. Yeah – that seems ridiculously high – but maybe that only seems high because we are so used to hearing it low for several decades. However, you maybe be able to label people to include them into the job numbers (temp, part-time – what next volunteer and illegal migrant workers?) or exclude them from the unemployment (Discouraged workers) – the fact remains no matter what label you put on them it just can’t change the math.For now we just have to extrapolate how many are falling off the unemployment vs. how many are signing on – Damn those Discourage Workers!
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Futures Pre-Market
The futures seemed flat – but then started losing ground – then popped with the declining jobless claim numbers – but are now flat. While the price fluctuations are not big in the pre-market – they are still no doubt volatile. Expect to see Arb traders sideline and let the opening determine itself. After yesterday’s moves and news – I don’t think anyone is willing to leg long or short.
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Support / Resistance
Pull back to short-term resistance. Yesterday I mentioned that if the INDU broke 12800 it would probably see 12600 as a short-term support and guess what we halted the slide right at 12600. The other indices also broke down through their short-term supports as well. This is a basing and testing area – a place to be careful getting long or short.
INDU 12600 / 12800 (12600 is a very short-term support and need to hold today otherwise the next area is about 12,250. This is not a place to load up in one direction or another – just make sure to have some positive Gamma and let the market MAKE you profit in either direction.)
NDX 1950 / 2000 (While I think 1950 could be short-term support and we could see a small rally off it back towards 2k – I don’t think we will rally above 2k but rather see serious resistance there. This is a trader’s area for action and investors should be hedged and not take a position. I think if we don’t HOLD 1950 then look out below because 1900 is easily in the cards.)
SPX 1380 / 1400 (If we break the 1380-85 area of support then 1360 and possibly 1340 could be visited. I think any rally will struggle at 1420 if it can break through 1400. Again – you better have all your long hard assets hedged. We could rally but it will be tough going.)
RUT 720 / 740 (720 is just a short-term low shoulder area that you could trade around – but don’t get naked long expecting a long-term rally going forward. Sure we could hit 720 and bounce – but it is more than likely not breaking through 740 any time soon.)
We had a great 2 month rally from the bottom. The market gave longs the opportunity based on optimistic to get OUT of those longs or roll-up your hedges. But the economy is continuing to face hardship which we can NOT ignore. Hedge those positions!
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Conclusions
I think Moody’s got a lucky break with the Oil and Fed Note news – well I guess the stock didn’t after it got whacked. But probably one of the biggest stories this year has been pushed onto the back burner – so at least CNBC and other news agencies are not focusing on it – for now. Regardless – it still put the hurt on in the financial sector and also other credit rating agencies (McGraw the parent company of S&P got hit from the news).
I also heard some crazy if not foolish buy recommendations in Airline companies because the stocks have been so beaten up. Hello – can you say Jet Fuel. These companies are getting squeezed and just came out of bankruptcy – anyone thinking they are a great buy here – well I have a new condo development in Miami beach to sell you. If the billionaires like Buffet – say NEVER buy an airline company – that is good enough for me – specially with oil climbing.
Oil got a huge jolt that last few days and yeah – could pull back, but do NOT go looking for a major crash or correction. A pull back to $100 would mean more buyers will step in. Airlines, Energy companies, Shipping companies have been buying more futures than spot price to get in front of the rally – any pull back will see these companies jump right in to protect (hedge) the future price of oil. Expect volatility in oil maybe 100-150 range and that will also inject huge volatility in the market. If oil pulls off 10 points in the day the market will act euphoric and rally 200 points - but do NOT get caught up in that.
Expect volatility in the market – maybe not as much as in the DNC convention – but this is the Year of Volatility!
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