Oil, Ideology, and World War III

Greetings all!

You may have heard something over the past few weeks about a little drop in the price of oil or some such thing. I’m pretty sure a couple of the financial news outlets mentioned it…about eighty times an hour.

Yeah, oil’s a thing. I’ve already written about some of the links between the oil market and stock prices, but that black gold can influence the currency markets just as much, if not more.

For example, let’s take a look at the currencies of two countries in whose economies oil plays a significant part; Canada and the U.K. According to WorldsTopExports, oil represents about 10% of the U.K’s exports and around 19% of Canadian offerings.

Back in October, the USD bought only about 1.28 Canadian Dollars, but that figure had reached 1.47 by January. During the same period, the British Pound went from 1.55 USD to only 1.40. Clearly the slide in oil revenues from Canada’s tar sands and the U.K’s North Sea fields is having some effect on the CAD and GBP.

So we’ve traced possible causality links from oil prices to other markets in which, as traders, we might also be interested, such as equities and currencies. But let’s see if we can get a better jump on these markets by sailing upstream along the great rivers of causality. Specifically, let’s move outward in our concentric circles of analysis to look at some economic drivers of oil prices, and then at some real-world factors behind those economic drivers.

As I’ve been arguing in several of my recent posts, the economy consists of people. So if we want to anticipate what the economy will do next, and how that will affect the markets we trade, we must consider what’s making those people tick. This involves looking at factors in that messy outermost circle of analysis.

But first we need to make a stop in that middle circle; economic analysis. Price is a funtion of supply and demand so let’s look at each in turn. Oh, and by the way, this is meant to be more of an illustrative example than an exhaustive analysis, so go easy on the comments about how I left out this or that factor.

Supply

Clearly the U.S. fracking revolution represented a major new source of supply as the rig counts increased in places like the Bakken, Permian, and Marcellus shale plays. The thing about this kind of supply though is that it operates according to classic economics in a kind of negative feedback loop with price.

Price goes up and drillers pile in because North Dakota’s where it’s happening baby! That creates too much inventory at Cushing, Oklahoma though, so the market price drops as merchants try to free up space. Then it’s sad times in the oil patch as we’ve seen recently with companies dropping their rig counts, laying off workers, or even going belly-up. That leads to a lack of supply, causing price to rise, and round and round we go.

We have another supply story in the Middle East. First, there’s the Iran nuclear deal which removed sanctions from Iran, creating the potential for additional supply from that country. We also have the Saudi’s refusing to cut production. Every time there’s a rumor of a deal with OPEC, speculators run up the oil price a bit, only to watch it tumble again when it’s clear that there’s no deal and that the Saudis will keep on pumping.

Demand

On the demand side, the story seems to be one of a slowing global economy, exemplified by fears of what I like to call the Great Fall of China. The latest manifestation of the global slowdown is the spreading popularity of the coolest new toy on the block, negative interest rate policy (NIRP). Meanwhile, the Chinese stock market is tanking, despite Beijing’s efforts to stabilize it. Fun!

Let’s get real

But all of these supply and demand factors still place us in that middle economic circle of analysis. So by all means, let us sail onward to that outer circle where real people are thinking about and acting upon the world. Let us consider why…

Why was there a fracking boom in the U.S.? Why was there a deal with Iran? Why aren’t the Saudis willing to cut back production? And why is China imploding, if in fact that’s what’s happening?

In this capitalist’s view, the answers to these questions are based in the ideologies and agendas of those holding power in each environment.

According to eecworld.com, the U.S. fracking boom really got started in 2003, and received a boost when the technology was exempted from the Safe Drinking Water Act by the Bush administration in the Energy Policy Act of 2005. The equation is simple. Less regulation equals more innovation.

Contrast this with the situation in China, where an oppressive communist regime runs a top-down command economy which includes the building of massive ghost cities in which no one lives. It’s like creating jobs by having half the population dig holes while the other half fills them in. Everyone’s employed, but everyone ends up starving to death too. Lovely. This doesn’t pass the Gilligan Test, and it’s not sustainable. More on China in a future post.

Now fast forward to the Obama administration’s handling of the Iran deal. The deal went forward even in the face of blatant provocations by Iran; missile tests, constant anti-American rhetoric, the use of captured U.S. naval personnel for propaganda, and even renunciations of major parts of the deal itself. Why? Because President Obama is a narcissist who’s desperate for some kind of historical legacy. The Affordable Care Act is falling apart, so no joy there. Libya? Syria? Nope, those are a total mess now. Russian reset? Yeah right. So Iran (and Cuba I suppose) ended up being his remaining hope of doing something that didn’t end in disaster. We’ll see about that…

Finally, what’s motivating the Saudis to keep pumping oil even though it’s already selling at a lower cost than the barrel it comes in? One common theory is that they’re trying to undercut the U.S. shale producers, but I don’t buy it. That’s because they must know that these U.S. drillers can pull their rigs out of mothballs and start back up at the drop of a hat. Even if some go out of business, others will come in to fill the void once price moves back up. The Saudis understand basic economics a lot better than many in the media do in my estimation.

No, this has to do with something else, and I think that something else is the escalating proxy war going on between the radical Sunnis of Saudi Arabia and the radical Shiites of Iran. Lining up on Iran’s side are the Russians and their puppets in Syria, the Assad regime. We can put Al Quaeda and Hezbollah on that team too for good measure, along with the pro-Shia elements in Iraq. And let’s not forget the Yemeni rebels. On the Saudi side, we have the other kingdoms and emirates, Turkey, their pals in ISIS who are supplying them with oil for resale through Istanbul, and we’ll throw in the Muslim Brotherhood as well. Oh, did I leave out the U.S.? That’s because the Obama administration seems to be both at war with and allied with elements from each faction at the same time. Go figure.

Anyway, even though the U.S. is confused, the Saudis aren’t. They would be very happy to hurt Russia and Iran economically. And what’s a major revenue source for both of those states? Yep, oil. Saudi Arabia is betting that they can stay solvent a lot longer than either Russia or Iran, and they’re driving the price of oil down as a weapon in a war of survival.

So getting back to fundamental analysis, my point is that keeping an eye on who’s in power around the world and understanding what those people want can give the attentive trader a significant advantage. Anyone who was watching the regulatory decision on fracking in 2005, or understands the unsustainable nature of the Chinese system, or perceives the desparation in the Obama administration for a legacy, or anticipated the use of oil as an economic weapon could have seen the coming crash in oil prices and acted accordingly.

That’s enough for now. Until next time, keep an eye on world events, and…keep pipping up!

 

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