When I began my career as an institutional equity trader in Canada fourteen years ago, commodity prices where just about to make one of the most fantastic runs in market history. China was rising – and it was hungry. Hungry for the copper that would be needed for millions of miles of power lines. Hungry for the uranium that would power their new power stations. Hungry for the nickel and iron that would create the stainless steel needed for millions of cars and household appliances. Most of all, China was hungry for the lifeblood of modern industry and economic growth: oil.
But there was a big problem on the horizon. According to an army of experts, global oil production had – with an extremely high degree of certainty – reached its peak, just as the dragon of Chinese industry had acquired an unquenchable thirst for oil. The implications were exciting, and frightening. They were exciting, because if you had oil you were bound to become unfathomably rich, and frightening, because if you did not, you would invariably become subservient to those that did.
It was on the back of this dual hypothesis of waning supply and exponential demand that the price of oil made a spectacular run from around $25/barrel in 2002 to almost $150/barrel in 2007.
Now let us take a look at the present day. The price of oil has fallen to around $30/barrel based on what analysts would have you believe is limitless global supply. Moreover, Chinese economic growth has supposedly reached its peak and is thus doomed to terminal decline, which would also derail global economic growth. Surely oil will fall further and a price $10/barrel is not out of the question…
And is one sense, these analysts are right: there is theoretically an inexhaustible supply of oil – just not at $30/barrel and surely not at $10/barrel. This is because it is not economical for the majority of energy companies to produce oil at the prevailing prices.
However, for the vast majority of the world that are not oil producers, lower oil and energy prices are a gift equivalent to a global tax break, and in effect this makes every business not related to oil cheaper to run. This is a good thing, because it encourages commercial activity, which leads to economic expansion.
So let us now compare some assumptions from 2007 to those that we are now hearing in 2016:
– Chinese economic growth will continue to grow at a elevated pace leading to an inexhaustible demand for oil
– Oil supply is in terminal decline
The economic implication is increasing constant demand + low supply = higher prices
But this did not happen…
– The pace of Chinese economic growth is in terminal decline
– Oil will stay in a constant state of oversupply
The economic implication is decreasing constant demand + high supply = lower prices
If markets were wrong in 2007, why should we be so sure that they are right at the current time, especially if they are using inverse, albeit similar logic?
There are those that argue that green energy changes the game and will ultimately reduce our current reliance on oil. They may well be right. However, they would have to concede that it would require a tremendous wave of capital investment in green energy infrastructure to significantly usurp the use of oil over the next 10 years. This would imply that capital would flow from traditional energy producers (hydrocarbons) to green energy generation. However in order to build green energy capacity, you would need to use existing sources of energy. And guess what? Lower systematic investment in oil production accompanied by a sustained period of demand for oil can only lead to… higher oil prices!
I am not calling the bottom on oil. Just trying to dampen some of the hysteria.