Sunday, 22 July 2018

On OPEC, fracking and inflation

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Anthony Peters suspects central banks are watching Vienna closely.

I wrote a few weeks back that I couldn’t see how one can trust an equity market which was rallying despite the surrounding fundamentals but concluded that there was money which needed to be put to work and that the lack of alternative asset classes with interesting return profiles and manageable volatility would most probably keep stock markets underpinned.

I see no reason to diverge from this view. On the back of this year’s performance, a sell-off, corrective or otherwise, would surely not significantly impact the impressive returns. In just two days, the CAC has shed 3.02%, the Dax 1.93% and even the Dow has given back 1.14%. This is all chicken-feed in the context of the sell-offs in June, August and again in September and following a period of incredible buying which still sees the Dow some 1,200 points or around 7½% higher than it was in early October, a technical correction has been nothing less than urgently called for.

In other words, “nillus panicus”.

Crude reasoning

Meanwhile, oil ministers are converging on Vienna for the opening today of the 164th Ordinary OPEC Meeting. The younger generation will most probably not think too much of this but to my age group which can remember when OPEC ruled the world post-1973. We will all remember the oil taps being turned off after the Yom Kippur war as well of the chin-bearded Sheikh Ahmed Yamani, the acceptable face of OPEC, explaining to the West that it no longer determined how and at what price oil would be traded.

In a way, the all-powerful cartel worked fine until Iraq and Iran fell out and went to war. All the while, the Saudis tried to balance their desire to make as much from their oil as they could while not strangling Western industry and thus killing the golden goose.

The fractious relationships between various OPEC members made sure that things never got boring but the balance of power, when push came to shove, always seemed to be with the producers and not with the consumers of black gold. The isolation of Iran and Libya and the two Gulf Wars with their impact on Iraq kept supply reasonably tight while enhancing the power of Saudi Arabia to be the balancing factor in the supply and demand equation. Whether WTI was trading at US$10.35 pbb (Dec 1998) or at US$147.27 pbb (Jul 2008) OPEC looked to be more in control of the prices than anyone else, even if it wasn’t.

Not all that much water has flowed down the Arabian wadis since then but things have moved on. America’s love affair with fracking has completely shifted the balance of power on the production front and subsequently on the political one too. For the first time in forty years, Washington is no longer a hostage of Vienna. Despite the West’s efforts to export its idea of democracy to the Middle East in the same way in which the Middle East has been shipping oil, so America’s reduced reliance on their oil will inevitably lead to a concomitant decline in political engagement.

That’s fine and dandy for Uncle Sam but it leaves Europe somewhat in the cold. Although some exploratory fracking has taken place across the European continent, there is little evidence so far that recoverable reserves will be economically viable. With US engagement declining, the EU will fairly rapidly need to take the reins into its own hands and formulate and execute a geopolitically sensitive energy policy which goes beyond simply plastering the continental countryside with wind farms and calling for the universal legalisation of gay marriage and introduction of paternity leave.

Oil analysts had already called a decline in oil prices for 2013 which proved to be wrong. Expecting it for 2014 is possibly just as tricky. With Iran beginning to come in from the cold and despite the loss of output from Libya, there is not tangible evidence that 2014 will see sufficient a glut to bring WTI down to $90.00 pbb, let alone Brent to $100.00 pbb. On the other hand, they could both be in the $70s by this time next year for all I know.

The impact on Western inflation of a significant fall in the oil price should not be underestimated and hence central banks from the Fed to the BoJ will be watching with the greatest of interest. Oil at $70.00 could completely derail the exciting rise in Japanese inflation (did I ever think I’d be saying that?) and blow the socks off Abenomics. Likewise, the ECB is on deflation watch and a precipitous fall in the cost of hydrocarbons would certainly rattle its policies too.

Please don’t expect this particular OPEC meeting to shake the world but energy could easily become one of the major themes of 2014. It would be advisable for all of us to start boning up. 

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