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CNN on The Long Recession

One of the themes I have been hitting during my recent presentations concerns the oil price risk hanging over our heads. My hypothesis goes something like this. The days of huge supply excesses in the oil production world are over. Those 5 million barrel per day supply cushions of 10 years ago kept oil prices low, and fairly stable. As the excesses shrank we began to see increasing volatility and prices steadily climbing. Higher oil prices have historically caused recessions. We are currently in a recession, albeit one in which high oil prices weren’t the primary cause. (More on that at the end).

But, oil supplies were already tight prior to the recession. The recession has lowered demand, and at the moment we find that we again have a fair excess of oil production capacity. As global economies strengthen, that increases the demand for oil. One of the things I have been pointing out in my presentations is that U.S. oil demand dropped by 1.2 million bpd over the past four years, but demand in India and China increased by 1.9 million bpd over that time period.

Therefore, it won’t take long for the capacity cushion to shrink and for oil prices to spike up again, putting us back at risk for recession. This was the basis for my essay The Long Recession – and I think it helps explain why oil is back up to $80. This is going to make for a long recession, and one in which the attempts to recover will trigger the higher oil prices that tend to bring on recession in the first place. It is a merry-go-round that we need to get off of, but it won’t be easy.

CNN has a story out today that covers this theme:

Forget $100 oil. $80 oil is a problem

NEW YORK (Fortune) — Are cash-strapped American consumers on for another date with energy price misery?

The U.S. economy remains weak and one in six Americans can’t find enough work. Yet oil prices have risen steadily this year. A barrel of crude costs $79 and change, more than double its price at the end of 2008.

That could complicate recovery in an economy that, despite the tumult of the past two years, remains as consumer-driven as ever.

I think “complicate recovery” is putting it mildly. We have to recognize the economic danger posed by being so dependent upon something that has the potential to swiftly bring the economy to its knees – and that is also in high demand by countries like India and China.

The story also points to the role oil prices played in bringing on the recession:

And though it’s futile to single out any one trigger for the recession that started at the end of 2007, the downturn didn’t start in earnest until consumers’ energy budgets breached the 6% mark in November that year.

As energy prices soared and incomes came under pressure, Americans first stopped buying pickup trucks and then deserted the local car dealer altogether. Car sales plunged in the spring of 2008 before falling off a cliff with the collapse of Lehman Brothers that September.

“The price of oil played a bigger factor in the recession than people seem to be remembering,” Hamilton said.

I would argue that the U.S. would have been pushed into recession eventually even without the subprime mortgage crisis. There are also a number of people who would argue that high oil prices led directly to the recession; that it was oil prices stretching family budgets which led to people not being able to pay their mortgages. Regardless of which theory is true, it is a historical fact that spiking oil prices have caused economic slowdowns, and over the past year oil prices have doubled. It is tough to see an easy way out.

In closing, I am still traveling for a couple more days (writing this from a small library in Oklahoma), and as I mentioned in the previous post I am about to miss my wife’s birthday for the 4th year in a row. So I want to wish her a Happy Birthday tomorrow, and at least this year I will be home only one day late. Plus, I will be arriving in Hawaii with our two Miniature Schnauzers that we had to leave behind when we moved to Hawaii. She doesn’t feel too bad about me missing her birthday, because the reason is that I had to take a detour to Texas to pick up the dogs. So, she is going to be reunited with “the pups” after three months apart (this is a result of Hawaii’s tight restrictions on importing pets) – and I think she feels that’s a great birthday present. At least I hope she does, because I didn’t get her anything else. Now that I think about it, I should go shopping…

November 18, 2009 Posted by | economics, oil prices, recession | 79 Comments

Brazil Flexing Its Muscles

A couple of years ago I was thinking about the possible fates of various nations in a world in which depleting oil reserves begin to have a very strong impact on oil prices. I had visions of $100+ oil and eventually $5-10 gasoline, which would place a crushing burden on the U.S. economy.

Of course higher prices will motivate people to conserve (and will contribute to recession), and then you may find yourself in a situation in which the supply/demand balance once again tips toward excess supply (as we found ourselves in as oil approached $150/bbl). Prices fall. The economy starts to recover. What happens then? Prices rise, putting the brakes on recovery. This is what I postulated in The Long Recession. Today I saw that someone else had weighed in with the same general thesis:

Oil prices mean perpetual recession

“The US has experienced six recessions since 1972. At least five of these were associated with oil prices. In every case, when oil consumption in the US reached 4% percent of GDP, the U.S. went into recession. Right now, 4% of GDP is US$80 a barrel oil. So my current view is that if the oil price exceeds US$80, then expect the U.S. to fall back into recession,” wrote Steven Kopits, managing director for U.K.-based energy-consulting and -research firm Douglas-Westwood LLC in New York.

Long recession, perpetual recession – the idea is the same. If demand starts bumping back up against supply because economies are heating back up, it will be very tough to dig out of a recession for very long for countries that rely heavily on oil imports. Maybe we aren’t there yet. Maybe we have another cycle to go. But I see this as a very plausible scenario.

One country that I have long felt is very well-equipped to thrive as oil prices go higher is Brazil. In fact, as I was preparing to buy Petrobras last year, I debated whether to instead buy into a closed end Brazil fund called iShares MSCI Brazil Index (EWZ). My reasoning was that as oil prices climb, the Brazilian economy stands to benefit in multiple ways.

There is of course the obvious in that Brazil has very large oil reserves relative to their population size, and their oil production is on the rise. It therefore stands to see cash flow into the country increase as they begin to export oil. I would expect to see consumer spending rise, benefiting many sectors in the country. For countries that wish to replace oil with alternative energy, Brazil is a key provider there as well. There is probably nobody better at efficiently producing ethanol from sugarcane. Their location in the tropics also means they have good solar insolation, improving the prospects for solar power (as well as for biomass, since they also get ample rain). All in all, they are abundantly blessed with fossil and renewable energy.

I saw another story today from MarketWatch that emphasized some of these very points and reminded me why I selected Brazil as a country with a bright outlook as oil production worldwide depletes:

Brazil’s JBS shows a nation on the march

SAN FRANCISCO (MarketWatch) — The Brazilians are coming and they are buying, securing a firm foothold in weakened corners of U.S. agriculture. JBS S.A., the world’s biggest beef producer, just added Pilgrim’s Pride to its empire, speeding the Texas-based chicken producer’s exit from bankruptcy with an $800 million cash payment that will give JBS 64% of the company’s new stock.

JBS is not the only Brazilian outfit feeling its protein these days. The country’s economy is on a tear, much of it fueled by resurgent commodities. It posted surprisingly strong 1.9% GDP growth in the second quarter, making it the first Latin-American nation to emerge from the global recession.

Petrobras (PBR), Brazil’s state-controlled oil company, is in the thick of it. Over the past few weeks, it announced several major new deepwater oilfield discoveries, prompting talk that it might swap some of its bulging reserves for up to $25 billion worth of new shares in the company.

The new found oil wealth augments Brazil’s already booming sugar cane-based ethanol exports and vast hydroelectric supplies. Together, they have put the country in the enviable position of becoming a net energy exporter.

The article goes on to say that the Brazilian stock market is up 60% for the year.

So far, my decision to buy PBR over EWZ has proven to be the correct one. In the not quite 10 months since I bought it, the PBR is up 160%. The return from EWZ has been nothing to sneeze at though, up 117% over the exact same time period. This reiterates my belief that Brazil will be a safe haven in an oil-induced financial storm.

September 17, 2009 Posted by | Brazil, Brazilian ethanol, EWZ, investing, investment, PBR, Petrobras, recession, sugarcane ethanol | 14 Comments

The Long Recession

Sometimes people ask me what I think will happen as a result of peak oil. Well, it depends. We could see alternatives – natural gas, ethanol, GTL, CTL, etc. – fill the gap of falling oil supplies for a while. It just depends on how quickly production falls. But if the alternatives are not up to the task, then I think what we will see – borrowing terminology from The Long Emergency– is The Long Recession. Here’s how it would work.

As economies heat up, demand for oil increases. This puts upward pressure on oil prices, which can ultimately cause a recession such as the one we are in now. Historically, spiking oil prices tend to consume disposable income and lead to recessions. Jeff Rubin, whose new book I recently reviewed, has claimed that four of the past five recessions were caused by spiking oil prices.

In normal cycles, oil companies build up capacity when oil prices are high. A recession caused by high oil prices, combined with overcapacity built up during the price rise, can keep oil prices at bay for a long time. But what if oil capacity can’t be overbuilt, because oil production has peaked? In this situation, oil prices will start to recover just as soon as the economy starts to come out of recession. This may in turn “restall” the economy, leading to a long recession that just repeats the cycle every time the economy begins to recover.

It is hard to say that we are at that point. However, oil prices have recovered quite a bit of lost ground, and have now crossed $70/bbl:

$70 oil menaces budding recovery

At the end of May CNNMoney.com ran a story asking if $60 oil will kill any economic recovery. ‘No,” most analysts said – consumers could shoulder $60 crude, and analysts didn’t see prices going much higher.

Now oil is touching $70 a barrel. Goldman Sachs recently said it sees crude at $85 by the year’s end. With the economy still on life support, oil is drifting dangerously close to being the wet blanket at the recovery’s party.

Hmm. Sounds like what could be waiting on the other side of this recession is…a recession.

There are alternatives that start to become economical with oil at $70 or more. Oil sands, for one. Natural gas vehicles also start to look pretty good at those oil prices. Even GTL, CTL, and BTL stand a chance of being economical if oil prices hang around at lofty levels. But companies – especially oil companies – are pretty risk averse when it comes to predicting oil prices. I doubt any U.S. oil companies are basing future economics on the expectation of > $70 oil. If they were, you would see far greater investments into unconventional energy sources.

June 9, 2009 Posted by | btl, CTL, economics, gtl, oil prices, recession | 20 Comments