When Goldman Sachs makes a prediction about the price of an asset, you can never be sure if it’s a self-fulfilling prophecy or a psychological investment operation exercised by an elite trading team. Is Goldman calling for US$100 oil by 2011 because it’s already long oil? Or is it just early on the trade in predicting that oil demand will recover faster than oil supply will grow and that the result will be higher prices this year and next?
Goldman’s oil analyst Jeffrey Currie is referring to what we termed last year, “The Long Aftershock.” It refers to the 2007 oil price crash sowing the seeds for the next oil bull market. Currie says his analysis leads to the conclusion that, “By 2011, the [oil] market is back to capacity constraints…The financial crisis created a collapse in company returns which has significantly interrupted the investment phase.”
You can’t find oil that you’re not looking for. And the oil price crash-along with the credit crisis-wiped out the exploration budgets of major oil companies. Obviously, in a free market this would be self-correcting. Higher oil prices would attract more investment and new exploration. All things being equal, more people would look for oil. More people would find it. More people would produce it. And supply would again match demand.
But life is not a textbook. And finding oil and producing large deposits of oil cheaply is not an academic exercise. The ‘Peak Oil’ theory is often deliberately mischaracterised by its opponents as concluding that the world is “running out of oil.” But that’s not the case.
The world is running out of cheap, easy-to-find, inexpensive to produce, and easy to refine oil. There is plenty of oil. But is it “economic” oil? Well the answer to that is no! Whether it’s political risk (where supply is artificially tight because of regimes unfriendly to U.S. or Western interests), or it’s just several miles under the surface of the ocean, finding and pumping oil to meet the world’s 85 million barrel per day demand is not an easy task.
This is why both the investment newsletters we publish – Diggers and Drillers and the Australian Small Cap Investigator – recommend energy shares. These are, as we we’ve described them, call options on scarcity. Because they’re shares, they give you the leverage that comes with exploration companies. As the projects are “de-risked” – drilling confirms the existence of economic deposits – the share prices (in theory) rise.
Of course it doesn’t always work out that way either. When you’re dealing with unconventional energy projects (like Kris Sayce does in ASI with LNG and coal-seam-gas) or more conventional energy projects (like uranium and “tight” natural gas, as researched by Alex Cowie in D&D), companies can still fail. Or commodity prices can fall, altering the underlying assumptions of the project.
But hey, that’s what makes small caps and resource stocks so lucrative. No one knows who the winners and losers are going to be. You can generally be sure that there will be more failures than successes. But if you do your homework and sometimes get lucky (as Alex and Kris have done lately) the returns on offer are a lot more compelling than, say, government bonds.
By the way, some of our colleagues think Peak Oil is absolutely loony. They claim that the world needs energy, not oil, and that markets work. If, for example, oil gets too pricey, we’ll just get our energy from a cheaper substitute like say, uranium.
That’s all well and good, provided there’s an easy substitute. For example, if the chicken parma isn’t on the menu at lunch today, we’ll probably go with a tuna baguette, or perhaps a sushi roll. Calories are calories.
You can’t run an internal combustion engine on uranium, though. True, you can build a transportation system based on electric/hybrid cards. But the network to build them and support them – based on nuclear power plants rather than oil – takes time and money to build, assuming it’s as efficient as oil. In the case of oil, there’s nothing easy or cheap about substituting for it and getting as much versatility, transportability, and energy returned on energy invested in producing it.
But somebody should try it.
Enzo Raimondo of the Real Estate Institute of Victoria says the State Government ought to double the first home buyer’s grant here from $7,000 to $14,000. As the representative of an economic sub-group that benefits when the government slops money into house prices, we’d expect nothing less. It’s a bit surprising he didn’t ask for an even bigger grant, to be honest. Or a check made out personally to each and every real estate agent in the State, paid by the taxpayers of course.
The State grant is set to expire in June. The Federal grant, as you know, has already expired. And Mr. Raimondo raised the spectre of more damage to the market. He cited the 18.6% decline in loans made to Victorian first home buyers in November. Obviously, if we don’t give people more money, they’ll stop buying houses.
None of the grant schemes make homes more affordable, of course. They just get built into the price, raising the general price level. This benefits existing homeowners, builders, and state tax collectors. But we can’t see how it makes housing a more affordable financial decision for first buyers.
If anything, it just saddles first home buyers with more debt. And at a deeper level, it tells everyone else that buying a house is something you should do whether you can afford it or not. You owe it to yourself. And the government will help you get what’s yours by giving you other people’s money.
What a ludicrous and stupid public policy. The grants have pushed people into the market at the bottom of the rate cycle. Whether or not you agree the price cycle has topped is actually irrelevant. The government is supporting prices through intervention. Take that away and what direction do you expect prices to go?
By the way, why is it that immigration is always expected to be bullish for house prices? True, people have to live somewhere. But why is it a) assumed that immigration policy is settled (there will always be heaps of new people coming, and b) immigrants are either cashed up enough to buy a house or have sound enough credit to get a loan from the bank?
In any event, we don’t want to get into housing again. But tomorrow, we’ll take a look at the government’s latest plan to transfer the liabilities of the banks directly to the public sector (your pocket book). As always, the scheme is pitched as a public benefit to boost confidence in the soundness of Australia’s banks. The reality may end up being quite different.
for The Daily Reckoning Australia