What The Frack? A New World Order Is Here!
It’s well known that the Middle East is a major supplier of ‘black gold’, and that the US is a major importer. Well, until now…
You see, the Saudi Kingdom has just decided to *drop* its oil export price in an effort to ‘take out’ the competitiveness of the new and emerging home-grown US oil boom.
This small step for Saudi is a giant leap for world oil, as evidenced by the correction in oil prices illustrated in the graph on the below. Further drops to below US$70 a barrel are forecast in the near future.
A Little Background
The Middle East has primarily two natural advantages: geographic strategic importance, and oil. You could add in tourism as a distant third (thanks to Dubai), but then again, maybe not. So in regards to economic prosperity, it’s oil, oil and more oil.
A Little BackgroundKuwait and Saudi Arabia, are, by most standards, the most ‘western orientated’ of the Arab nations, and because their future economic prosperity depends on it, have huge political motivations connected with oil exports, and in particular, with oil exports to the US.
Remember the Kuwait oil wells on fire at the start of the Iraq invasion? America to the rescue… Why? Oil, and perhaps the ability to rebuild what they destroyed (thank you Mr. Cheney), and finally a little humanitarian intervention (any weapons of mass destruction been found yet?).
A New World Order
But the oil game has recently and radically changed on two fronts, both of which diminish the importance of the Middle East as an oil supplier and therefore the strategic importance of the Middle East to America. They are:1. The emergence of other oil producing nations, for instance Africa, that have added to world supply, and
2. The fracking revolution unfolding in the US right now.
You may not know it, but the US is now the world’s biggest oil producer, overtaking Saudi Arabia. Really! If you don’t believe me you can click here to read more.
Now, Americans are usually a polite and agreeable bunch when they want something, but they tend to turn the cold shoulder towards you if you are, er, how shall I put it delicately…? Of little future economic interest to them.
What Does It Mean?
The truth will come out in the passage of time, but the short answer is lots! Here are a few off that should happen quickly:
1. Lower fuel costs – not just in the US, but across the world as exports that were targeted for the US seek alternate markets. This in turn will lead to less inflationary pressure as oil is a big component to the cost of living. Already this week the cost of gas in the US has fallen sharply… by as much as 10 cents a gallon.
2. A much stronger American economy and currency. Put away your ‘I Love China’ flag because the era of American dominance might last a little longer yet. Already the US unemployment rate is lower than before The Great Recession, although the stats are a bit rubbery. What isn’t made up is that the floodgates of ‘home grown’ prosperity will open if (when?) the US starts exporting oil (Click here to read more about this!)
3. Less US intervention in the Middle East, with diplomacy being more politically than economically motivated. Who knows, without the need (or perhaps desire) to be the world’s policeman in the Middle East, America might finally get around to repaying some of the colossal debt it’s racked up.
What To Do?
As always, with change such as this there is a massive redistribution of wealth – both macro and micro economically. But let’s focus on you, shall we?If it were me and I owned energy stocks in general (and oil stocks in particular), I’d be reassessing the validity of my investment strategy and my expectations of future performance.
In respect to real estate, the impact will be embryonic until it filters through to personal household finances via a lower cost of living leaving people with more money to justify higher debt. When this happens the natural affordability ceiling on house prices will rise.
Finally, don’t trade in the V8 for an electric car just yet.
In summary, the simple point is this: we live in very interesting times, and this seemingly small pebble – a drop in the price of oil in Saudi Arabia – will result is some rather large and worldwide ripples!
What do you think? Your feedback and comments are most welcome.
– Steve McKnight
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They have dropped their cost per barrel so quickly and easily, it makes me wonder what it actually costs to produce a barrel of oil. We have been fed a bunch of BS about rising oil production costs and in the process we have paid high transport costs that have increased living costs on most of the world. Yet the few that control all of the oil sit back with no moral regard and watch the rest of us struggle.
Thanks for your comment.
At the moment the Saudi drop has only been modest, but the price signal to the market of that move has been significant. I agree about being held to ransom, but until there is a politically and economically viable energy alternative, we can only hope that market forces keep things in check.
Steve
Is this a card that the US has just been hanging onto for a while?
No, not hanging on to as such. More like a ‘behind the scenes fight’ for control, with the Saudi’s finally conceding. Steve
So if oil prices go down and and people have more money in their pocket – they can buy more or spend more which in turn stimulates the economy – then interest rates increase?
Yes, if inflation does not remain within target bands deemed acceptable. This is some way off though, as that spending-led inflation requires confidence which is not apparent at the moment. Steve
U.S. property is quite affordable, may e a goo time to secure a bi of the market.
I’d like to do it through a SMSF, but I’d need someone to guide me through the steps.
It was a few years ago JDV, and while it is still cheap by many standards, the fall in the AUD makes it less attractive. For the risk to reward, and entry, exit and compliance costs, I would look to get exposure to the US economy or US property other ways. Talk to a financial adviser and see what they say. Steve
This is issue of dropping oil prices is thought provoking.
Dropping oil prices can only be good for the Australian standard of living as that means less of our money will go overseas for buying fuel and the cost of producing Australian goods will drop making us more competitive for exporting as well as saving us some costs of living.
The main reasons for this reduction in oil cost is that the US economy is in a bad way and the oil frack business is required to help the US economy.
These desperate times for the US, and recent development of the fracking technology, answers the question why the oil price is low now and not before.
The Arab oil producers have got no choice but to accept the lower oil prices and they need to sell as much oil as they can to maintain the revenues they have got accustomed to receiving. This further helps push oils prices down.
Australia is in the same boat with iron ore and that’s why our iron ore producers have to throw as much iron ore onto the world market at possible even if that means sinking the iron ore price. We aren’t competitive in any other industry except maybe agriculture and farmers have been in desperate situations well before most other sectors of our economy. That’s why we have to export live animals and turn a blind eye to the barbaric 3rd world slaughtering practices.
China and Korea are doing the same with dumping cheap manufactured products. Korean products already beat European products in both quality and price. The Europeans have started to drop the costs of their manufactured goods to compete with the Chinese and Koreans.
The European economies are basket cases as they aren’t competitive in anything except manipulating figures to fool themselves into thinking they have great economies. Australia is doing much the same – our claimed unemployment rates are total bull. All we get from our government is lies and spin and promises of higher taxes and the shutting down of vital manufacturing industries.
Australia would already be in a major recession and having major deflation if it wasn’t for the low interest rates and US quantitative easing. That lever has been pulled as far as it can go as it has pushed assets prices (shares, bonds and realestate)to a point where they are getting overvalued and ready for a drop (or crash). Sydney and Melbourne prices can’t keep going up based on expectations of continued price increases while rents are dropping. This is why the reserve bank is worried about those markets.
Investing strategies now need to be based on the strong possibility of recession.
Thanks for your interesting post.
Although confidence continues to be uncertain, there is no doubt in my mind that the US economy has improved massively since 2009. It’s still in a bad way in respect to debt, but jobs are being created and spending is recovering. The real test is when the Fed takes its foot off the accelerator and we see how well the economy coasts on its own.
What is the better performing world economy at the moment?
– Steve
Well “The News” it’s all over Europe,
Obama is doing Reagan …it worked with..(against)Soviet Union
and (hopefully) will work with Putin
Would be interested to know more about this as I haven’t heard that angle…
Interesting article and comments.
I suppose we can say the same about China imposing a tariff on coal imports. Soon they themselves will be self-sufficient in coal production.
This gets back to that dilemma, international business v/s globalisation. Which is more beneficial? Maybe globalisation wasn’t the answer to the world’s economic problems looking back in hindsight.
Don’t get me started on our poor macro-economic reforms. For Australia to continue to prosper we need to keep and increase the number of jobs in Australia not outsource them.
Cheers, Geoff W
Amen. I’ve written several posts about the political leadership vacuum in Australia. Our standard of living is high, but it is sustainable? Steve
Steve what are your thoughts on commodity option trading of HOF15 heating oil at this time. Currently trading at $2.48. Historically trends up this time of year with demands of Nth America and Uk during winter. There has also been a fair bit of news on a below average winter temps and the threats of attacks on oils supplies in middle east from isis, that will put high demands and shortages on this oil.
With what you have said about USA oil prices would this be to risky to take out call options expiring Dec 26?
Cheers Greg
Hey Guys,
It is good news for the US and the possible long term export of US oil.
However, as the Saudi’s have lived off oil revenue for decades ( if not several generations ) without paying any income tax, I’m sure they have a few cards up their sleeves. I’m sure they will not just roll over and let the US be the world leader in oil. Either they will find a way to produce oil even cheaper , and / or they will invest in alternative energy sources such as electric cars. Either way ,the future is open .
Overnight OPEC decided to leave production unchanged, and this has caused oil prices to fall further. Here’s a good article to read (it has a great little video in it):
http://www.theage.com.au/business/mining-and-resources/australian-energy-stocks-origin-and-santos-to-be-annihilated-after-opec-decision-says-credit-suisse-analyst-20141128-11vqx2.html
Could have done well shorting oil since you wrote this. Oil was trading then at $78.65 per barrel. Last month’s low was $26.34. Today it’s trading at just over $36.
Good summary! ;-)