The double dip oil decline is here. On radio and television interviews in October and November last year I suggested that, at some stage, the oil price decline would level off, rebound and then oil prices would decline again. I gave a timeline for that double dip to be somewhere around May/June of this year.
I was off by about a month or so but that double dip is now here. Anyone who follows a market will appreciate that prices do not generally move in a straight line. At each price point there is a dynamic between buyers and sellers, between supply and demand that determines whether the price trend continues or reverses.
In the case of a commodity like oil, there are leads and lags in terms of the requirements of the providers of capital and the establishment of production levels and these take time to play out. That time line usually makes the move in a commodity more extended than a move in, say, a stock on an exchange. The fundamentals of the oil, and for that matter the energy markets (including natural gas), are changing and we would do well in T&T to try to understand those changes as opposed to trying to predict prices.
Back in late 2014 the discussion was all about how low can oil prices go and trying to pick the bottom. I always pushed back against that debate and still do. The bottom line is that oil prices will go as low as it needs to go in order to spark a rebound in price. That is the way market dynamics work.
What is more important than the actual bottom of the market is the vector or the direction of prices and the length of time that prices are likely to move in that direction. Vector speaks to magnitude and it should be clear that the magnitude of the move in oil prices (over 50 per cent down) is quite significant. Oil prices started to fall around this time last year but, even within this calendar year, the volatility in prices from the rebound to the double dip is in the region of 25 per cent.
I would suggest that the direction of the price move is lower for longer. Many were suggesting last year that after the shakeout in the market, oil would begin to firm up and rebound towards the latter part of this year. The reality: there are many different catalysts at play but the base line scenario I would advocate is that prices will stay lower for longer than was originally expected. That base line can be impacted by some exogenous shock, especially one emanating from the very volatile Middle East and North African region but these are not scenarios that you seek to base economic and financial decisions on unless you are wont to speculation.
Lower for longer
Lower for longer means that we must have a fundamental rethink of our economic policies, our priorities and the pace at which we seek to diversify the local economy. We continue to hang our hat on foreign direct investment in the form of industrial plants that use our energy reserves to engage in downstream production for exports. This is the Point Lisas model.
Reflect on the number of plants that have been proposed and promised over the past 15 years and consider how many have come to fruition. We have had everything from natural gas to liquids, ethanol, iron and steel plants, ethylene, plastics, aluminum plants, more methanol plants and the list goes on. How many have actually come to fruition? Ask yourself why? Yet we continue to see promises.
The overall point is that the world has changed but our thinking remains rooted in what worked for us in the 1970s. It was back in 2006 when our national spending was getting into the danger zone that I warned that the reserves to production ratio for natural gas globally was at 60 years. That was at a time when we got zero bids for exploration of new acreage in our attempt to develop our natural gas reserves.
The simple point then: there was increased competition to house these industrial complexes around the world and many are at this time better positioned than T&T. Pay attention to the dynamics in the US Gulf Coast. There you had access to abundant oil and gas supplies and a stable and progressive environment for capital. Add to the mix a cheap and abundant source of labour across the border in Mexico and the scale of the challenge we face to attract quality projects to our shores should be evident.
Global trend
The bigger issue can once again be tied back to global dynamics. If one were to step back you will realise that it is not just oil but the entire commodities complex is in a downward trend. Base metals such as copper, nickel, tin are all down around or about 20 per cent year-to-date. The decline in base metals coupled with the soft oil market speaks to an overall decline in industrial production on a global scale.
This is consistent with a theme I have been advocating for many years. That is, the prospects for global growth in the post crisis scenario have been overestimated and each year we have seen downward revisions to global growth forecasts. This is the fundamental reason why globally interest rates have stayed low for as long as they have.
The point is worth repeating as it gives a context to what is taking place currently.
In the decade 2001-2010 all commodities from gold to oil to copper rallied on the back of significant demand from emerging market economies. The way the global economy is structured, credit is the lifeblood and so the expansion of that decade was fuelled by credit in one form or another. Capacity was developed to meet with the trajectory of demand growth.
Eventually that credit cycle collapsed on itself in the form of the 2008 financial crisis. As credit dried up demand collapsed and it has taken years to kick start the growth cycle. Appreciate that 100 per cent of the demand growth in metals over the past 10 years came from China.
Today, China is facing economic challenges, as it must. No economy goes straight up over a multi-decade period.
Yet, the capacity remains and this means there is the potential for oversupply, which creates downward pressures on prices. I point to a statistic first published by Bill Gates. He pointed out that China used more cement in the period 2011 to 2013 than the United States used in all of the 20th century.
While this statistic is stunning, it can be rationalised, but the point to appreciate is the extent to which China has contributed to global demand even after the financial crisis. With a China slowdown others will have to pick up the slack. Some have pointed to India but with an income per capita one fifth that of China they cannot substitute for any fall off in Chinese demand.
The oil market turned because low rates in the US allowed for risk capital to be allocated to risky shale ventures at an affordable price point. This resulted in an increase in supply. As OPEC, led by Saudi Arabia, maintained its supply levels, prices began to decline on the back of surplus supply.
These declines were exacerbated by the strengthening of the US dollar, as other global economies—in particular Europe and Japan—were weaker relative to the US. As we go forward, the dynamics will likely flip. Demand will remain tepid and so supply will have to fall further to create equilibrium.
As the US Federal Reserve is set to increase rates in September and the US economy stabilises at a growth trend in a two per cent handle, the US dollar is likely to appreciate further against world currencies. That speaks to continued weakness in oil prices and commodity prices, in general.
Let me be clear that the term “weakness” is not a prediction of further price declines but rather it is a suggestion that we are unlikely to revert to the days of US$90-US$100 oil anytime soon. That means we have adjustments to make in T&T.
Lower for longer should be the base case for our medium-term planning horizon.
Ian Narine is a broker registered with the SEC and can be contacted at ian.narine@gmail.com
