$100 - The New Floor for Crude Oil

The Daily Reckoning U.S. Edition

Home . Archives . Unsubscribe

The Daily Reckoning | Tuesday, December 13, 2011 Stick it on the tab...Industrialized nations to borrow $10 trillion this year, Energy prices still a headwind for any hopes of real “recovery,” Plus, Bill with more on positivists, collectivists, proto- libertarians, and the entire theory of government... ------------------------------------------------------- Secret Photos China Doesn’t Want You To See A new groundbreaking project is threatening China’s global rare earth monopoly. This little-known company’s operations are unlike any other in the world. And could be incredibly lucrative for early movers. Check out this epic story by clicking here.   Darkness Without a Dawn... When a Great Correction Doesn’t Stick to the Script   Bill Bonner Reckoning today from Baltimore, Maryland... The Dow down 167 yesterday. Gold down $48. Nothing to get excited about. The excitement is still ahead. When the Dow cuts through the 10,000 mark and heads to 6,000. Stay tuned... In the meantime, yesterday’s Financial Times told us that the industrialized nations will borrow $10 trillion this year. Next year, the figure should be higher. Where does all that money come from? It’s more than the world’s total savings. Not that we know exactly, but total world GDP is about $50 to $60 trillion. Savings should be about 10% of that — or only about $5 to $6 trillion. So how are the developed nations able to borrow so much? With so much debt turning over, it makes the world financial system extremely vulnerable to inflation...or just a change of sentiment in the bond market. Which makes us wonder. What would happen if the lenders balk? We are, as all Dear Readers know, in a Great Correction. And in a great correction asset prices fall...along with a general fall-off in employment, consumer spending, investment, GDP growth and all the other things that make a robust economy. Demand drops...which typically causes prices to fall (or at least not to rise as quickly as before). There is less demand for credit as for everything else. So, the pool of available bonds falls...forcing up bond prices and forcing down bond yields. Got that? Well, don’t worry if you don’t. Because there’s at least a 50/50 chance it won’t happen that way. So far, the Great Correction has followed the usual script. Bond yields have fallen. Price inflation has generally come down. But demand for credit — as evidenced by the aforementioned $10 trillion government financing costs — is running hot. ‘Typically’ may not matter. Because this is no typical downturn. And it wouldn’t be too surprising if all this demand for credit pushed up bond yields. Wouldn’t that be a drag? And here we find ourselves with a grim, but philosophically amusing, insight. Typically, every cloud has a silver lining. Every glass that is half empty is also half full. And dawn follows even the darkest night. That’s just the way the world works. But what if the cloud has no lining, neither of silver nor of anything else that reflects light? And what if the glass is completely empty? In the normal economic world, low interest rates are the half-full part of the correction glass. A correction comes. Asset prices go down...along with all the other things mentioned above. But interest rates go down too...which make it easier for new projects to clear the “hurdle rate.” At 6% interest, for example, a new project has to return at least 6% to breakeven. Any new investment that won’t produce more than a 6% minimum gain is quickly abandoned. But as the correction drives down yields, to say 3%, all of a sudden a lot more investments begin to make sense. Dawn comes. Lower inflation rates...and lower asset prices...help too. As prices fall, shrewd investor and careful businessmen can put their money to work again. Employees are re-hired. Household earnings recover. Soon, the downturn is over. Both booms and busts are, normally, self-correcting. But leave it to the feds to stop the sunrise. This huge demand for credit from the industrialized governments could drive up interest rates. Imagine what that will do. Already in a slump, households, businesses and investors could find their borrowing costs going up, not down. They could find prices rising, too, especially the prices of energy and food. What a world...a major slump, but with rising prices and rising interest rates! And then, consider what happens next. The feds will err again. They will feel obliged to finance government borrowing themselves. Here’s the Bank for International Settlements, giving us the heads up: The Bank for International Settlements Sunday issued an oblique endorsement of coordinated action by the world’s largest central banks to ease funding conditions for banks. “A freezing of interbank markets in major funding currencies, as during the recent crisis, may require the ability to supply official liquidity in major currencies in an elastic manner,” the BIS wrote in its regular quarterly report.” — MarketWatch It was only a week ago that 6 major central banks announced a coordinated rate cut — expected to juice up the markets. And now all major central banks seem ready and willing to sacrifice the integrity of their currencies in order to protect their bond speculators. This is what we expected all along. But we didn’t expect it so soon. It causes us to revisit our “long, dark road to Tokyo” forecast. You remember our prediction: the US has already followed Japan through one “lost decade.” We figured it would lose another one as the Great Correction drags on. But things could happen faster...and worser. Japan financed its own deficits with its own money. Now, everybody is running deficits. And the amounts to be refinanced are staggering. Bond buyers may balk...or simply be unable to swallow so much debt. Which will cause the central banks to come into the picture — with coordinated money-printing. Instead of going down, bond yields and consumer prices could go up. Think things are bad now? Wait until the economy has to deal with a Great Correction and inflation.   External Advertisement Threat to America and You! The impending replacement of the US dollar by China’s Yuan as the world’s reserve currency is only the first of many signs of a far greater disaster awaiting America. Click here to view a special presentation about this disaster — and how you can protect yourself and your assets from the massive economic devastation it threatens. The Daily Reckoning Presents $100 — The New Floor for Crude Oil   Chris Mayer In the midst of the news about the EU crisis, it’s worth pointing out that oil prices have quietly crept back over $100 a barrel. West Texas Intermediate is $102 as I write. Brent crude, which many argue is the more important figure, is $111. This is remarkable given how weak the global economic recovery has been. Also of interest is the fact that the price of crude oil has been trending higher, even while the prices of most other commodities have been drifting lower. The US is the world’s largest consumer of oil. It’s not growing much. Yet there oil sits, with a three-figured handle. I think it is a sign that challenges on the energy front will prove more stubborn than in the past. One day last week, I found it interesting that the main two financial dailies I read every morning both featured special pullouts on energy. The Financial Times report had a number of good nuggets: This is the first year the average oil price is $100 a barrel. In real terms, it’s the highest oil price since 1984. US consumers are on track to spend $200 billion more on oil this year than in 2010. Exxon Mobil’s capital spending budget for the first 9 months — $26.7 billion — was a record. Supply is tight; production from non-OPEC countries (such as Russia) has been disappointing. The US is an exception. It is reversing a four-decade decline in production and imports are down to 50% of consumption, instead of 60% as recently as 2005. (Canada is increasing production, too.) Tight government budgets are leading to lower subsidies for alternative energy. The brunt of this will be felt most acutely in Europe. China is the exception; subsidies for alternative energy have actually increased there. The nuclear renaissance is still a long way off. One article discussed the various phase-outs going on around the world. There is a new enthusiasm for LNG tankers. Consider the portrait these bullets paint. To me, they speak to the challenge in producing enough energy to make a dent in prices. There are also some opportunities in these bullets — producing good old- fashioned oil still looks to be a good business. The Wall Street Journal called its report “Big Oil Heads Back Home.” Some main points: Oil is shifting its attention from the Middle East to the West — oil sands in Canada, deep-water oil in Brazil and the Gulf of Mexico and shale oil in the US. By 2020, shale oil and gas will make up a third of US production, which could shift power away from OPEC. (The Saudis are worried.) Smart grids are coming. There was an article about energy- monitoring devices and other means to increase efficiency and save money. Interesting article on Churchill County in Nevada, which is enjoying a boom in geothermal energy. Biofuel companies are getting into other markets, selling stuff for skin care and beauty products. (Biofuels, like other renewables, are in trouble.) US battery companies are having a hard time trying to survive as they get strong competition from overseas and the adoption of electric vehicles remains slow. Townsville, Australia, plans to lay a cable to take hydropower from Papua New Guinea, some 600 miles away. How China slowing its nuclear program over safety worries is creating opportunities for some firms. How “clean coal” is a boon to companies selling filters and other means to reduce emissions. This report was more focused on the ways in which people are changing their behavior, about how people are figuring out new ways to create energy and to get it where it needs to go. It’s also more about the frontiers of energy and how they will contribute meaningful slices to the pie. It also makes me think about how energy is as much about place as it is about any particular source. In Nevada, they can tap geothermal. In Australia, they are trying an innovative way to tap a river in Papua New Guinea for hydro-power. You can’t really say geothermal is a great energy source. It is in some places, yet it won’t work in others. Ditto, hydro-power. But these stories show you how innovative people can be. And they show you how things can happen that no one would’ve guessed even a handful of years ago. I mean, US oil and gas production up enough to threaten the Saudis? That would’ve been a surprising prediction not too long ago. Yet it’s happening. These stories also show how political energy is. Everywhere. Government policy has a big impact on the energy mix pursued. Big subsidies for solar, particularly in Europe, essentially built that industry to a point it would never have reached without the help. But now, with austerity measures and tight budgets, a shift in policy can destroy it. An energy investor has to keep an eye on a lot of things. Technologies change. Consumer patterns change. Government policies change. But the overall backdrop is pretty strong for the producers of energy. The most powerful evidence is the most obvious: Amidst all the turmoil and slow growth in the big markets of the US and the EU, oil is over $100 a barrel. Regards, Chris Mayer for The Daily Reckoning Joel’s Note: Even for a non-energy investor, understanding the dynamics of the sector can be critical to assessing opportunities that may or may not present themselves in other areas of the market. Energy sits at the base of just about everything and, for many companies, it is a fixed cost that is nearly impossible to get around. Without energy, not a whole lot gets done, in other words. That goes for primary, secondary and tertiary industries. So, how does $100 per barrel oil impact the rest of the market? How does it impact “recovery” hopes for the western economies? How does it impact specific sectors of those economies and the profitability of individual companies within them? Chris’s next Mayer’s Special Situations alert is due out in three days. In it, he combines the kind of top down macro-analysis you see above with the fine-toothed comb due diligence you’d expect from a top notch value investor, to bring you opportunities that escape most people’s radars. If you’d like to ensure you’re on his private mailing list before the next alert, be sure to let us know today. Here’s how.   Chris Mayer’s Special Situations Presents... 4 Times More Oil Than The Bakken? North Dakota’s booming Bakken oil reserve has created plenty of overnight millionaires. But now a revolutionary new technique — created right here in the US — could produce up to 4 times as much oil as the Bakken... And potentially mint an even bigger wave of millionaires in the process... So what exactly is it? Just Click Here Now For The Full Story.   And now back to Bill Bonner, with the rest of today’s reckoning... On the Uses of Government   Bill Bonner “The Divine Right of Kings” was a theory of government that held water. But you had to put the water in the right container. You had to believe in God. You had to believe that He gave out job assignments. You also had to believe that He didn’t mind when His employees and agents made a mess of things...or even when they contradicted His own orders. Looking at the history of the monarchs who were thought to have been given this divine authority, you would have to conclude that God was either a very tolerant task-master, or a very negligent one. Adultery, murder, thieving, lying — there was hardly one of God’s commandments they obeyed. As a theory of government, the ‘divine right of kings’ would have been okay had it not been for the kings themselves. Some were reasonable men. Others were tyrants. Many were incompetent, largely irrelevant and silly. Taken all together, it was very difficult to believe that they had been selected by God, without also believing that God was just choosing His most important managers at random. Kings were not especially smart. Not especially bold or especially timid. Not especially wise or stupid. For all intents and purposes, they were just like everyone else. Sometimes smart. Sometimes dumb. Sometimes good. Sometimes evil. And always subject to influence. Towards the end of the 18th century, the ‘divine right of kings’ lost its following. The church, the monarch and the feudal system all seemed to lose market share. The Enlightenment had made people begin to wonder. Then, the beginning of the “Industrial Revolution” or the “energy revolution” made them stir. In 1776, Adam Smith published his “Wealth of Nations,” arguing that commerce and production were the source of wealth. Government began to seem like an obstruction and a largely unnecessary cost. Its beneficial role was limited, said Smith, to enforcing contracts and protecting property. The school of laissez-faire economics maintained that government was a “necessary evil,” to be restrained as much as possible. The “government that governs best,” as Jefferson put it, “is the one that governs least.” Government was supposed to get out of the way so that the ‘invisible hand’ would guide men to productive, fruitful lives. Smith thought the arm attached to the invisible hand was the arm of God. Others believed that not even God was necessary. Men, without central planning or God to guide them, would create a ‘spontaneous order,’ which would be a lot nicer than the one created by kings, dictators or popular assemblies. This theory of government, such as it is, leads to what we know of today as “libertarianism.” Libertarians argue about how much authority the government should have. They scrap among themselves over what the government should do and how big it should be allowed to get. But all libertarians agree with Jefferson. And all agree that the governments in the world circa 2011 are much too big. Here at The Daily Reckoning we are sympathetic to this point of view. Not that we are libertarians. We just don’t like anyone telling us what to do. But libertarianism is hardly a theory of government. It makes little attempt to explain why government is what it actually is. In fact, it is purely prescriptivist day-dreaming, focused on what government ought to be. In theory, a government ought to be small, say the libertarians. Government ought to mind its own business, they say. It ought to sort out disagreements between members of the public...and protect the public from wrongdoing. It ought to have not to drain the resources and productive output of one part of the population for the benefit of another. But so what? Who cares what the libertarians want? Throughout history, government has operated in pretty much the opposite fashion. The insiders who get control over the police power of the state use it to promote their own agenda. Sometimes it is an apparently selfless agenda. Adolf Hitler, for example, took little wealth for himself. Nor did Stalin raid the public treasury for his own benefit. Instead, each worked long and hard in the interests of his people. (It would have been better if they had been on the make for money. It might have distracted them.) Whether the insiders want money or power hardly matters. If they seek money, they take it from the outsiders — those, by definition, who neither control nor are favored by the insiders. If they seek power, that too must be taken from someone. The outsiders pay, every time. While the proto-libertarians focused on how much harm an activist government could do, the utilitarians, positivists, and collectivists turned their attentions to how much good it could do. According to John Stuart Mill and Jeremy Bentham, a government should provide the “greatest good to the greatest number.” Again, this was not a theory of government, it was merely an idea about what government should do. And a dumb idea, at that. Who knows what is ‘good’ and what is not? Only God...or people themselves. Since God keeps his own counsel, only the people can decide. But how? They can only decide if they are allowed to choose for themselves — how they will spend their time and their money. And the only way they can spend their time and money as they wish is if they are given the liberty to do so, which takes us back to libertarianism, the very creed to which the utilitarians, positivists and collectivists opposed themselves. They wanted an elite to decide what was ‘good’ for the masses. Which, of course, is what really happens. The elite insiders decide what they want. They call it ‘good.’ More to come... Regards, Bill Bonner for The Daily Reckoning ------------------------------------------------------- Here at The Daily Reckoning, we value your questions and comments. If you would like to send us a few thoughts of your own, please address them to your managing editor at joel@dailyreckoning.com Changing Views on Growth and Economic Recovery More Governmental Insights: Insiders, Outsiders and the Question of Divinity What Happens When the World's Economic Growth Engine Goes Kaput Spain Successfully Auctions Off €4.94 Billion Comparing the US and Eurozone Debts It Begins: Markets Await News from the Eurozone Summit The Daily Reckoning: Now in its 11th year, The Daily Reckoning is the flagship e-letter of Baltimore-based financial research firm and publishing group Agora Financial, a subsidiary of Agora Inc. The Daily Reckoning provides over half a million subscribers with literary economic perspective, global market analysis, and contrarian investment ideas. Published daily in six countries and three languages, each issue delivers a feature-length article by a senior member of our team and a guest essay from one of many leading thinkers and nationally acclaimed columnists. Cast of Characters: Bill Bonner Founder Addison Wiggin Publisher Eric Fry Editorial Director Joel Bowman Managing Editor The Mogambo Guru Editor Rocky Vega Editor Additional articles and commentary from The Daily Reckoning on: Twitter Facebook DR iPhone APP To end your Daily Reckoning e-mail subscription and associated external offers sent from Daily Reckoning, cancel your free subscription. If you are you having trouble receiving your Daily Reckoning subscription, you can ensure its arrival in your mailbox by whitelisting the Daily Reckoning. © 2010-2011 Agora Financial, LLC. All Rights Reserved. Protected by copyright laws of the United States and international treaties. This newsletter may only be used pursuant to the subscription agreement and any reproduction, copying, or redistribution (electronic or otherwise, including on the World Wide Web), in whole or in part, is strictly prohibited without the express written permission of Agora Financial, LLC. 808 Saint Paul Street, Baltimore MD 21202. Nothing in this e-mail should be considered personalized investment advice. A lthough our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investment advice.We expressly forbid our writers from having a financial interest in any security they personally recommend to our readers. All of our employees and agents must wait 24 hours after on-line publication or 72 hours after the mailing of a printed-only publication prior to following an initial recommendation.Any investments recommended in this letter should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.