Bubble Bubble, Boil and Trouble, Markets Quake and Markets Crumble

oil prices rising, commodity boom?There is talk about the property bubble, and now an oil and gold bubble. Commodity prices have had a massive bull run, so will does this bull still have ground to cover? There is a real possibility the answer is yes… quite so.

Commodities have cycles like any other product, there are cycles such as ‘winter demand’ for oil, or a rise and fall as economies boom and bust, but then there are structural cycles that have to do more with supply and demand. There has been (for instance) a big upsurge in demand for oil but Opec have not increased output in order to meet the demand. The US Economy is slowing down (don’t use the R word!) and Europe is following, so if some of the major markets are starting to slow then what will that do to Oil or other commodities?

Oil prices in Euro’s prices went from €16 to €68 because the Euro got so much stronger against the Dollar, so is the solution to buy from the Iranian Oil Bourse which deals in euros? Supply traditionally rose to meet demand, however Governments are stopping supply and that is a huge issue. Venezuela’s production is down, Mexico’s production is down in the former it was because of political reasons, the latter was due to the dying off of an oil field. However in California there are 30-40 billion barrels of oil off the coast but the US government won’t give access to that energy.

The conspiracy theorists have long believed that the USA want to make sure that they are the last ones on the block with any oil and its hard to doubt that belief, why won’t they drill fuels that are available right there in the USA? They are happy to burn Iraqi Oil that comes from across the planet and to absorb higher oil prices and drive big cars but they won’t tap into the liquid fuel that is right there in their front yard. The US is importing 4m barrels per-day of refined products.

bio fuel, bio diesel, a solution?The only solution that has surfaced is Ethanol and that takes 8 gallons of fuel to to make 9 gallons of fuel, not the solution that it was meant to be. In the mean time not drilling for US oil means that they send half a trillion Dollars abroad for fuel that is available in America. So the structural element of commodities is a big part of what is driving the commodity markets to new dizzy heights. Oil, Gas, and Metals were banger investments for decades, because of this the commodity industries did not invest heavily in operations, now however its all changed, in parts of Australia they can’t find workers for the mines, the waiting time on Tyres for mega-earth movers is a year! The short term answer is to teach drivers to drive more carefully and thus preserve the tyres.

The BRIC nations (Brazil, Russia, India, China) are seeing fast increases in demand for oil, this is another issue that will affect supply because as their needs come on stream it affects the existing supply/demand structure and when you add in that structural element it quickly shows that prices are going to hit a crisis point at some stage.

nigeria: mend (movement for the emancipation of the Niger Delta)In Nigeria the MEND organisation (Movement for the Emancipation of the Niger Delta) are blowing up fuel lines, however, when I flew home from Edinburgh two weeks ago I had the fortune of having a Nigerian driver who was very knowledgeable on oil policy in his home country. We spoke about Ken Siro Wiwa and he then went on to tell me the difference between Shell and Chevron, Chevron build roads in his county which is (in English) ‘Across River’ but Shell don’t do this, they pay tribal chiefs and the chiefs don’t distribute the money so despite the fact that its one of the richest countries on the planet in terms of commodity wealth the inhabitants are amongst the poorest. This imbalance means that people, be they criminal elements, terrorists, or actual freedom fighters (I guess it depends on your perspective) they have a cause that is easily understood, the market effect of this is geo-political risk that again will affect supply on a worldwide basis.

It is a liquid fuel problem, so even the moves being made in renewable’s is not giving the answers we require, because electric cars are still not widely available, the other solution may be to look at cellulose ethanol which would be better than corn ethanol because Corn prices are actually Oil prices, the high corn prices are due to a huge amount of corn being used to make ethanol (fuel) instead of being used to feed people. Cellulose ethanol can be made from non-food materials which is a probably the only sensible way forward for biofuels.

The US government however does have a lot to answer for, the system of taxation is not conducive to a rational and efficient market when it comes to Energy. Why? Because when fuel or energy is sold governments make tax income and that is normally done on a percentage basis so higher prices mean more tax income, this is an issue we are seeing in Argentina where the falling dollar means that the Government created irrational tax bands to keep tax money coming in to their coffers and reduce exports. The result was basically a farmers strike. China may see serious civil unrest before the Olympics due to price increases. In the Philippines there have been price protests, Egypt has outlawed the exportation of rice from April to October in order to guarantee availability of the food as an alternative to wheat. In Jakarta there was an actual riot. In Australia there is a drought and wheat supplies are at lowest since 1979. So take it for granted that food prices are going to keep rising.

nuclear energy: a solution, but not a popular oneGovernments worldwide don’t have a cohesive energy plan, we need more fuel, we need more gas and electricity yet getting a pipeline laid anywhere is next to impossible, we saw this in Ireland already. Drilling will elicit protests, getting planning permission for offshore wind turbines is like pulling teeth and nobody will embrace Nuclear Energy. So the pool of energy will continue to dwindle until at some stage we find a solution that satisfies all parties or that things become so desperate that we are forced to accept anything.

I don’t like sounding all doom and gloom, but this bubble will certainly be an interesting one to watch. How long will it last? My opinion is we will see recovery deep in 2009, I just don’t see how we can outplay all of the factors that have to unwind before then. At that stage we should see the securitization market return, rate compression should be a thing of the past and property (although likely to stagnate for some time perhaps even beyond then) will cease to cumulatively fall. Financials, although the cause of this crisis, could actually be the way out of it from a market perspective, the crisis doesn’t mean there is no cash money out there, its just not where companies want it. The SWF’s (Sovereign Wealth Funds) are actively snapping up good buys and there are long term value prospects in that position if you have the money to do it.

The important thing now is for (and I’m loathe to say this!) some intelligent government and official intervention, if your property price fell I empathize for you, however, if we (the first world) don’t get the food shortages fixed then thousands of people will literally starve, and I sympathize with those unknown masses. The pervading notion must be to save lives before saving corporations, however, if we are in an economy where corporations are not functioning efficiently then it may hinder the ability to get food to the millions that need it, a precarious and daunting catch-22 indeed.

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