How Far Away is an Oil-free Future?

In today’s Money Morning…how far away is an oil-free future?…proper energy policy left in the too-hard basket for too long…supply shortages will mean hardship for many, profits for a few…and more…

Not much to report on in overnight market action…the Dow Jones index and the S&P 500 fell 0.25%. Brent crude was up a bit, while gold fell about US$10 an ounce as its rival, the US dollar, gained strength.

One market I’m keeping a close eye on is energy. Specifically, the price of Brent crude, the international oil price benchmark.

As you can see in the chart below, the price of Brent crude has been very stable over the past few months. Since December, it’s traded in a tight range between US$53/barrel and US$57.30/barrel.


Source: Optuma
Click to enlarge

My view is that it will break higher out of this range in the coming weeks or months. There are a few reasons for this.

There is a sense that the ‘age of oil’ is ending. Oil is no longer hot. It’s all about the coming of electric cars and battery storage technology. Oil will be increasingly obsolete in this newfangled, technology-rich economy — or so the thinking goes.

That Saudi Arabia is selling a chunk of its massive state owned company, Saudi Aramco, gives credence to the view that the golden age of oil is over. The Saudis want to monetise their oil reserves now, before oil loses out to new energy technologies.

But there is an old adage that ‘bull markets climb a wall or worry’. That means that prices rise in the face of obvious reasons as to why they should not. In my view, this is happening in the oil market now.

The other reason I like oil’s prospects is based on cyclical factors. Put simply, oil experienced a massive bear market between 2014 and 2016. When prices fall as much as they did (from around US$115/barrel to around US$26/barrel) it knocks out a lot of investment in future production.

That’s the market’s price mechanism at work. Prices fall to discourage new supply. That happens via companies large and small pulling back on exploration and investment spending.

While such actions don’t have an immediate effect on the market, they do affect future production. And at some point, the market starts to look ahead and see lower future production levels.

But in this case, we have a strengthening global economy that still uses oil as the main fuel for its growth. That means demand will pick up. And in a few years, it will run into constrained supply due to the large cutbacks in investment that occurred during the bear market.

As the Financial Times writes:

Drastic cuts in oil industry investment risk creating a shortfall in supply that by 2020 will expose the market to a surge in prices, the International Energy Agency has warned.

More investment in global oil and gas exploration and production is crucial to ensure future supplies are able to meet growing demand, it added.

The oil price crash that sent prices from $115 in 2014 to below $30 early last year forced international energy companies to curb investment by a quarter in 2015, and by a similar amount last year.

The Paris-based agency said only modest signs of recovery in 2017 meant that it was far from clear that enough projects would enter the pipeline in the next few years to avoid a supply crunch.

I certainly don’t think prices will sustainably get back to US$100/barrel or more. But you could easily see prices rise to US$80/barrel over the course of this year.

More regulatory failure

That’s bad news for Aussie industry, already struggling under high energy costs.

Yesterday, I mentioned regulatory failure had created the housing market monster that the country is now grappling with. Overzealous central banking combined with idiotic state and federal laws channel and reward capital for going into housing regardless of price.

Well, regulatory failure is happening on a massive scale in Australia’s energy market too. It’s been building for a while. But now, all of a sudden, everything seems to be going pear shaped.

Is this what happens when no political leader can assert themselves? When no party captures the imagination of the public or governs for the good of the nation? It’s been a decade now of farcical, acrimonious politics in this country, and the electorate has responded by turning to minor parties.

Which is all well and good, but it makes governing for the benefit of everyone a bit of a nightmare. Instead, we end up with everyone wanting something for ‘me’, not ‘us’.

Over the years, energy policy has gone in the ‘too hard basket’ or the ‘it’ll work itself out tray’ and now we’ve got this…from the Financial Review:

Shell-shocked businesses are reassessing investments and jobs after being slugged by huge increases in their electricity bills driven by the imminent closure of the giant Hazelwood power station combined with hot weather and rising “green” power costs.

Business power retailer ERM Power has reported a 170 per cent hike in electricity contract prices for commercial customers in Victoria and South Australia from two years ago as wholesale prices surge.

There are calls for the government to invest in new coal fired power plants, and others that say (rightly) it should be left to business to make that investment.

But uncertainty over what our long term energy policy is means businesses will baulk at making such large investments. Business needs regulatory certainty, not a political circus.

East coast gas price shock is here

And then there’s the east coast gas market, which I’ve written about before and given you some money making ideas on. The supply issues there just seem to keep getting worse.

It has even been suggested recently that gas exports from Gladstone Island in Queensland be capped so enough gas remains for the domestic market. As the Financial Review reported a few days ago, contract prices are spiralling out of control:

The price shocks being seen by local buyers have been confirmed most recently by the Australian Industry Group. It notes that members have reported prices in offers for new contracts over the past few weeks more than five times higher than levels a few years ago.

While contract prices were around $6 a gigajoule in 2015, up from historical levels of $3-$4, prices rose to $8-$9 over 2016 and by the end of the year reached $11-$12 a gigajoule.

But early this year, prices spiralled further, AiG said, citing manufacturers in Victoria being offered one and two-year contracts with wholesale gas prices of $20 or more.

This is a price shock that could reverberate throughout the economy. It could lead to higher inflation and wrongly force the RBA to raise interest rates. That in turn would put pressure on house prices and impact the economy’s growth engine, household spending.

In other words, a debacle of our own making. Don’t forget, Australia has some of the largest gas reserves in the world. Yet here we are, facing an extreme supply crunch…because we don’t have enough available to use now.

Regards,
Greg

From the Port Phillip Publishing Library

Special Report:Crunch Point at Curtis Island’ How a failed $60 billion gamble by Australia’s three biggest energy giants could pay off big for you… [More]


Greg Canavan is a Feature Editor at Money Morning and Head of Research at Port Phillip Publishing. He likes to promote a seemingly weird investment philosophy based on the old adage that ‘ignorance is bliss’. That is, investing in the Information Age means you have all the information you need at your fingertips. But how useful is this information? Much of it is noise and serves to confuse, rather than inform, investors. And, through the process of confirmation bias, you tend to read what you already agree with. As a result, you often only think you know that you know what is going on. But, the fact is, you really don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. As the name suggests, Greg sees opportunity in a crisis. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines traditional valuation techniques with charting analysis. Read correctly, a chart contains all the information you need. It contains no opinions or emotion. Combine that with traditional stock analysis and you have a robust stock-selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the basic, costly mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Money Morning here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:


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