Happy New Year 2015

Mining in 2015: Copper price topped

What happened in 2014:

The price of the red metal briefly dipped below $3 a pound in March – a near four-year low – on market expectations of a move into surplus after years of deficits.

By the third quarter it was clear mining output and shipments were falling far short of predictions thanks to suspended Indonesia concentrate exports and (surprise, surprise) project delays and production disruptions.

While oversupply fears proved to be overblown, copper is ending the year down 15% near its lowest for the year as uncertainty over Chinese consumption continues to gnaw at investors.

How things could change in 2015:

While not all of it will reach markets, forecast mine output growth through the year of 6% or 1mt and another 800kt in 2016 is still a lot to absorb.

Falling oil, the top input costs for all miners bar those lucky enough to sit on copper oxide, could also have the perverse effect of keeping high-cost mines in the game for longer, further depressing prices.

Too much is being asked of Chile and Peru which together must bring 7.5mt to the table

China’s refined output is racing ahead hitting a record 7.2mt from January-November, up 11.5% year-on-year and more capacity will come on stream 2015.

There’s nothing like a crises to focus minds so Mongolian politicians could even resurrect Oyu Tolgoi’s much anticipated and mammoth phase II while other long shots like Iran – expected to produce 300kt in 2015 no less – returning to the market could weigh on the price beyond 2015.

There is price upside potential: Too much is being asked of Chile and Peru which together must bring 7.5mt to the table in 2015. Codelco’s problems with arsenic, grades, labour and funding are well documented.  And Peru’s new flagship projects like Las Bambas and Constancia still needs work.

Price end-2015:

Not much below $3/lb (and that counts as bullish) and a rising trend into 2016.

All bets are off if…

China State Grid Corp’s $65 billion annual fixed investment budget plus rollover from funds unspent during 2014 finally gets deployed.

Mining in 2015: Nickel price promises much

What happened in 2014:

The metal was languishing at multi-year lows in January but against market expectations Indonesia stuck to its guns and stopped nickel ore from leaving its shores.

Reaction was muted at first – unlike LME-watchers Chinese nickel pig iron producers took them at their word and amassed millions of tonnes of nickel laterite. Tensions with Russia and fears about Norilsk added spice and by May nickel scaled $20,000.

China will run out of stocks of the good stuff soon enough, forcing mills to buy pricier sulphides

Ever-volatile St Nick soon disappointed again and will end 2014 with barely a double digit gain as the Philippines take up the slack, inventories stay stubbornly high and old bugbear, China’s economy, drain investor confidence.

How things will change in 2015:

The Philippines can’t do anything about their grades or their monsoons and China will run out of stocks of the good stuff eventually (as soon as April?), forcing mills to buy pricier sulphides.

Stainless steel growth rates are strong with robust auto sales the US, Europe, and Japan and China’s bumping manufacturing to record 21.4m units.

After a decline of 9% in mining output in 2014, another 6% contraction is forecast for 2015 despite an additional 1–2mt from New Caledonia.

Everything nickel had going for it in 2014 will only become more evident during 2015.

Price end-2015:

Not over $20,000, but that may be too pessimistic

All bets are off if…

Indonesia – even partially – lifts its ore export ban (don’t worry, won’t happen).

Mining in 2015: Zinc price with zing

What happened in 2014:

Zinc became the darling of the mining world, reaching a near three-year high mid-2014.

The four-letter metal benefitted from falling stockpiles and expected supply cuts due to the scheduled closures of among others Australia's Century and the Lisheen mine in Ireland with a combined output of 600kt.

By September doubts were creeping in and the metal’s stellar run began to look as if it could’ve been too much too soon as mothballed mine restarts were fast-tracked in North America and new capacity were planned everywhere from Sweden to India to Mexico and Peru.  

Zinc will end the year up single digits only, but that’s no mean feat into the teeth of a rampant dollar.

How things will change in 2015:

When stock levels fell below three weeks’ worth in 2006 and 2007 the price shot up to nearly $4,000

Once sky high stocks on the LME and in China will continue to be drawn down – zinc is especially sensitive to stock levels and when it fell below three weeks’ worth in 2006 and 2007 the price shot up to nearly $4,000.

New mines ­– even in China which has added 225kt capacity every year for the last decade – aren’t opening at a fast enough rate to replenish lost output and meet demand growing at 4% per year.

That said, there are plenty of projects out there and expansions like Glencore’s McArthur River will hit its stride at 370,000tpa in 2015. Refined output from South Korea will jump and projects like Zijin’s 200kt Bayannur smelter will make zinc not all that hard to come by.

Price end-2015:

Well up, but $2,400 seems like the ceiling for 2015. 2016 could have more upside.

All bets are off if…

A stockpile shock panics the market.

The Most Important US Events Of 2014, According To Twitter

When it comes to social networks, Instagram is where the world's best food photographers reside, Facebook is where "cool parents" and ad-clicking robots can be found, while Twitter is where the up to the minute super-informed, sophisticated intelligentsia hides. At least according to Twitter. So what did said sophisticated audience find to be the most important and talked about American events of the year? The following infographic from Echelon Insights gives the answer:

The top 10 US stories of 2014 were:

1. Ferguson
2. Midterms
3. Ebola
4. Israel
5. Iraq
6. Russia/Ukraine
7. Sterling/Clippers
8. Guns
9. Obamacare
10. Marijuana

What is more interesting is that the top 2 most talked items were defined as such by Liberal Activists, where the topic dearest to Conseratives' hearts, Guns, was only 8th in the combined ranking.

Which begs the question: while the media may or may not have a liberal bias, it does appear that the main talking points in at least media distribution outlet are set by those a liberal bent. Maybe simply because they have far more time to retweet and engage in meaningless Internet debate?

Meaningless internet speculation aside, here is how 2014 progressed through the eyes of Twitter users.

Gold Held In NY Fed Vault Drops To Lowest In 21st Century After Biggest Monthly Withdrawal Since 2001

Exactly one month ago we observed that, as expected in the aftermath of the Netherlands' shocking and still not fully-explained gold repatriation from the NY Fed, the amount of foreign earmarked gold on deposit with the Fed had just experienced a 42 ton withdrawal: the single largest outflow of gold held at the NY Fed in over a decade, going back all the way to 2001. This had brought the total amount of YTD gold withdrawals from the NY Fed to a whopping 119 tons: the most since the Lehman collapse.

However, because this total was insufficient to cover just the Dutch repatriation of gold from the NY Fed (which amounted to 122 tons), we knew there would be more activity when the November data hit. Sure enough, earlier today the Fed reported the total amount of earmarked gold (or gold "held in foreign and international accounts and valued at $42.22 per fine troy ounce; not included in the gold stock of the United States") for the month of November: at $8.184 billion, this was a $60 million drop from the previous month (or it would be at the $42.22/ounce "price"; at market prices the value of the withdrawn gold is about $1.7 billion).

In actual tonnage terms, this means that in November some 47.1 tons of gold were withdrawn from the NY Fed, bringing the Fed's total earmarked gold to just 6,029 tonnes: the biggest single monthly outflow going back to the turn of the century. This is also the lowest amount of gold held at the NY Fed vault located at 33 Liberty street (and just across from the even bigger vault located at 1 Chase Manhattan Plaza) in the 21st century.

But even more notable is that with the November data, we now know that all of the Dutch repatriated gold is fully accounted for.

Which brings up a far more important question: net of the Netherlands withdrawals, there is some 44 tons of extra gold that has been also quietly redeemed (by another entity). The question is who: is it now the turn of Austria to reveal in a few weeks that it too, secretly, withdrew some 40+ tons of gold from "safe keeping" in the US? Or was it Belgium? Or did the Dutch simply decide to haul back some more. Or did Germany finally get over its "logistical complications" which prevented it from transporting more than just a laughable 5 tons in 2013? And most importantly, did Germany finally grow a pair and decide not to let "diplomatic difficulties" stand between it and its gold?

We should have the official answer shortly, but we know one thing: it sure wasn't Ukraine.

Source:zerohedge

What Are Major Factors to Affect Copper Prices in 2015?

Copper prices posted sharp declines in 2015, with Shanghai Futures Exchange (SHFE) copper falling by 12.92% as of December 26, and copper London Metal Exchange (LME) down by 14.58%. What will be the main factors to affect 2015’s copper prices?

Growing Copper Supply
Most of Chinese futures analysts interviewed by SMM still consider market fundamentals the key factor to impact copper price trends in 2015.

“The oversupply pressure in copper concentrate market will pass on to refined copper market with copper smelters expanding capacity, so we expect a more than 4% increase in copper supply in 2015,” analyst from BOC International Futures told SMM, “while copper consumption growth is expected at only 3.3%.”

Analyst from Minmetals Futures agreed and noted that global copper supply will grow faster than 2014 next year, and the increase in demand will slow down, boding ill for copper price outlook.

Monetary Policies
“On the macroeconomic front, monetary policies in the US and China will garner much attention,” said an analyst from the CIFCO. “Although the timing of the Fed’s first interest rate since QE was not decided yet, market prediction is for the Fed to raise interest rate in mid-2015, and the rate hike is bound to bolster the US dollar index, affecting commodity market,” the analyst added.

“China’s central bank may employ relatively loose monetary policies and pro-growth measures to help with its housing market which experienced a downturn in 2015,” analyst from Jinrui Futures told SMM. The analyst considers it a positive factor for copper market.

Crude Oil
“Copper prices have been largely hit by slumping crude oil prices in late 2014 and any rebound in copper in 2015 will be subject to a bottom-out in crude oil,” said an analyst from Dayou Futures.

China’s Copper Stockpiling
“We expect a 370,000-tonne surplus in global copper market in 2015, but China’s potential copper stockpiling will help ease the glut,” analyst from Galaxy Futures said in an SMM interview lately. An analyst from BOC International Futures expressed his agreement, explaining that the possible copper purchases by China’s State Reserve Bureau will be a wild card.

Other Uncertainties 
Analysts interviewed by SMM also listed a number of uncertain factors, such as volatile yuan’s spot exchange rate arising from any change in China’s foreign exchange policies, possible strikes at copper mines, and the potential El Nino conditions.

Japan Q1 aluminium talks to drag on as buyers refuse higher premiums

 Quarterly pricing negotiations between Japanese aluminium buyers and global miners are set to continue next month as buyers are refusing to pay higher premiums for January-March shipments, five sources said on Friday.

It is unusual for the two sides not to reach agreement before the beginning of the quarter, but the sources said there remains a gap between producers' offers and buyers' bids.

Japan is Asia's biggest importer of the metal, and the premiums for primary metal shipments that it agrees to pay each quarter over the London Metal Exchange (LME) cash price set the benchmark for the region.

For October-December, Japanese buyers mostly agreed to pay a record premium of $420 per tonne , up 3-5 percent from the previous quarter. This year, Major Japan Port (MJP) premiums have risen 64 percent. 

Earlier this month, three top producers asked Japanese buyers to pay record premiums of $435-$440 per tonne for January-March deliveries, up as much as 4.8 percent from the previous quarter, citing higher U.S. spot premiums triggered by solid demand and smelter shutdowns that have squeezed metal supplies, the sources said.

One producer has lowered its offer to $430 while another one had come down to $425 by Friday, five buyer sources said.

"But we still can't make a compromise as spot premiums are lower here and inventories at Japanese ports have built up as suppliers had brought the metal to Japan amid weak demand elsewhere in Asia," a Tokyo-based source at one end-user said.

Aluminium stocks at three major Japanese ports hit a record high at the end of November on rising imports and softer demand.

"We don't mind continuing negotiations until late January," one buyer source said.

Two other buyer sources, however, said they were getting closer to settling at around $425 while another source at a trading house said he heard some deals had been done at $425.

Most Japanese buyers are expected to take next week off for New Year holiday and return to work on Jan 5.

The quarterly pricing negotiations have been carried out between Japanese buyers and miners including Rio Tinto , BHP Billiton and Alcoa .

Global aluminium premiums are expected to reach record highs by mid-2015 on a supply deficit in the United States and Europe, according to a Reuters survey.

$ 1,200 gold price the new normal ?

After closing 2013 at $1,205 an ounce the price of gold jumped out of the starting gate, rising consistently to reach a high of $1,380 in March.

But the metal failed to consolidate gains during the summer doldrums, falling to a near four-year low November 6 at $1,143.

The recovery from there was swift and gold is heading into the final week of 2014 basically where it started the year.

Gold 2014's highs and lows were 20% or $237 apart, making it the quietest year since 2008. Last year it was 40% or $488 – gold's most volatile 12 months since crazy 1980.

Gold miners' problems are only exacerbated by falling by-product credits

The subdued trading in gold came despite potential market shocks including the slide in oil, the rampant dollar and a variety of geopolitical shocks during 2014.

The gold price is the most sentiment-driven of all commodities, but fundamentals still do matter.

And cost of supply may now be providing that elusive price floor gold bulls have been looking for since 2011's record high above $1,900.

As this chart by metals consultancy GFMS and Thomson Reuters shows towards the $1,100 mark, 60% of the industry would be loss-making on an all-in basis.

Gold miners' problems are only exacerbated say the authors by falling by-product credits, such as silver and copper which are down roughly one third and 10% respectively from the 2013 average.

Average costs in the industry sits around $1,200 and is falling as miners shelve projects, reduce exploration expenditure, defer or cut back on sustaining capital and a strong dollar helps to contain costs outside the US.

While the price may well fall to $1,100 in the year ahead, multiple quarters of prices at these levels would force loss-making miners out of business and reduce supply, helping prices to recover.

There have been 85 large aircraft disappearances since 1948...

Air Asia Confirms Lost Contact With Indonesia Flight After Crew Asked For "Unusual Route", 155 Passengers On Board on 28.12.2014

China To Launch Yuan Swap Trading With Russian Rubles On Monday

The world was slow to wake up to the new reality in which China is now the de facto IMF sovereign backstop, as Zero Hedge described two weeks ago in "China Prepares To Bailout Russia" when we noted that a PBOC swap-line was meant to reduce the role of the US dollar if China and Russia need to help each other overcome a liquidity squeeze, something we first noted over two months ago in "China, Russia Sign CNY150 Billion Local-Currency Swap As Plunging Oil Prices Sting Putin."

In fact, it was only this week that Bloomberg reported that "China Offers Russia Help With Currency Swap Suggestion." But in order to fully backstop Russia away from a SWIFT-world in which the dollar reigns supreme, one extra step was necessary: the launching of direct FX trade involving the Russian and Chinese currencies, either spot or forward - a move away from purely theoretical bilateral FX trade agreements - which would not only enable and make direct currency trading more efficient by sidestepping the dollar entirely, but also allow Russian companies to budget in Chinese Yuan terms. It is no surprise then that this is precisely the missing step that was announced overnight, and will be implemented starting Monday.

From Bloomberg:

China will allow trading in forwards and swaps between the yuan and three more currencies in a bid to reduce foreign-exchange risks amid increased volatility in emerging markets.

The China Foreign Exchange Trade System will begin such contracts with Malaysia’s ringgit, Russia’s ruble, and the New Zealand dollar from Dec. 29, it said in a statement on its website today. That will extend the yuan’s swaps trading to 11 currencies on the interbank foreign-exchange market.

A plunge in Russia’s ruble this month to a record low sparked a selloff in developing nations’ assets, leading to a surge in currency volatility. The new contracts come amid efforts by China to increase the international use of the yuan, as the world’s second-largest economy promotes it as an alternative to the U.S. dollar for global trade and finance. Malaysia and Russia are China’s eighth and ninth biggest trading partners, according to data compiled by Bloomberg.

“This will provide companies with better hedging tools, and at the same time, make currency trading more efficient,” said Ju Wang, a senior currency strategist at HSBC Holdings Plc in Hong Kong. “China won’t stop yuan globalization or capital-account opening because of the volatility in emerging market currencies.”

The CFETS is an agency under the People’s Bank of China.

So while the US continues to parade with "destroying" the Russian economy, even if it means crushing the shale industry, aka the only bright spot, and high-paying job-creating industry in the US economy over the past 5 years, Russia and China continue to be nudged by the west ever closer monetarily and strategically, until one day, as we have long predicted, China and Russia will announce a joint currency, one backed by both China's "surprising" gold reserves and Russia's commodity hoard. Then things will get interesting.

Renewed flight from gold ETFs

After a soft start to the week, the gold price jumped on Friday, coming close to retaking the psychologically important $1,200 an ounce level.

Gold's gains since hitting four-year lows early November are close to 5%, but the metal's resilience against a sliding oil price, a rampant dollar, record money flowing into equities and looming interest rate rises has not enticed investors to return to physical gold-backed ETFs.

Holdings in the bellwether exchange traded fund backed by physical gold, SPDR Gold Shares (NYSEARCA:GLD), fell by 11.6 tonnes on Monday, the worst performance in 18 months, and the sales continued in post-Christmas trade.

At the close on Friday holdings in GLD, which represents nearly 50% of the gold-backed ETF market, stood at 712.3 tonnes or 26.9 million ounces, the lowest since September 22, 2008.

Kitco quotes a research note from HSBC pointing to the risk to the gold price of continued ETF outflows:

"If ETF investors begin to liquidate more heavily, gold may be in for another round of declines," according to HSBC but the investment bank is not expecting further substantial selling during the holiday trading period.

After a positive start to December, this week's outflows have put GLD back in the red for the month with 5.3 tonnes of net redemptions.

The performance so far in 2014 is dismal with investors pulling just over 85 tonnes from the trust although outflows have slowed substantially from the 552 tonnes pulled from GLD in 2013.

Holdings in GLD peaked in December 2012 at 1,353 tonnes or 43.5 million ounces.

In November Barclays noted the risk to the early money invested in the dozens of listed gold-backed ETFs across the globe.

Almost 900 tonnes (700 tonnes on a net basis) were acquired between $900 – $1,000 an ounce.

If the gold price were to fall to $1,000/oz, an additional 100 tonnes would become cash negative according to the UK bank.

Ruble Rallies 34% After Biggest Russian Intervention In 5 Years

Since the Russian Ruble troughed at almost 80 RUB/USD, it has rallied an impressive 34% erasing most of the dramatic devaluation of December. However, as The CBR just announced, this 'strength' came at a price. Russia burned through $15.7 billion of reserves in the week ending Dec 19th - the biggest percentage weekly drop in reserves since Jan 2009, leaving reserves below $400 billion (still a significant amount) for the first time since Aug 2009. While CBR explained much of this will come back as repo trades mature, Vladimir Putin turned inward, blaming the government for "defects" in restructuring the economy.

The Ruble has soared in the last 2 weeks...

On the heels of the biggest intervention in almost 5 years...

•  
• *RUSSIAN INTERNATIONAL RESERVES FALL $15.7B IN WEEK TO DEC. 19
• *RUSSIAN INTERNATIONAL RESERVES AT $398.9B
• *BANK OF RUSSIA SAYS DROP IN RESERVES MOSTLY DUE TO FX REPO
• *BANK OF RUSSIA: FUNDS USED IN FX REPO WILL RETURN TO RESERVES
• *RUSSIA RESERVES ALSO FELL ON REVALUATION AS USD GAINED VS EURO

But, as Sputnik news reports, it's not just external factors, Putin points his finger internally...

The difficulties in Russia’s economy are not only because of outside factors, including sanctions, but also because the government has not worked out some defects, Russian President Vladimir Putin said Thursday.

“The difficulties that we have run into carry not only an outside factor. They are not solely tied to some sorts of limitations of sanctions or limitations tied with the objective international environment, they are tied to our not working out defects that have accumulated over the years,” Putin said during a government meeting in Moscow.

Putin said the government has taken efforts in order to change the structure of the economy in order to give it a more innovative nature, but said the efforts were below the needed measures.

“Much has been done in this but the latest events have shown that this is insufficient,” Putin added.

Russia is currently facing an economic slowdown, with dramatic fluctuations seen recently in the value of the Russian ruble against the US dollar and the euro.

The weakening of the Russian national currency is attributed to low oil prices. The sale of oil accounts for a significant part of Russian budget revenues. Economic sanctions imposed on Moscow by the West in the wake of the Ukrainian crisis are also cited among the reasons for the economic slump.

During a December 18 televised press conference, the Russian president said that the country's economic situation could begin to improve in the first quarter of 2015, with Russia's economy recovering completely over the next few years.

*  *  *

Still it's not like $400 billion is going to disappear tomorrow - for those proclaiming Russia's imminent default. (CDS imply a mere 5% probability of default over the next year based on 25% recovery assumptions)

Supply plays key role in 2014 global commodity market

The Chief Executive of Glencore one of the world’s top resource company, Ivan Glasemberg, stated that, the demand for the metals hasn't been bad this year.

He added that, the demand for oil, iron ore and also coal is growing, but the price of these materials is not progressing soon enough. He stated that, the reason behind the lagging of price for the commodities is that, the companies including Glencore has been investing largely in their projects, expanding the production, which finally lead to crisis.

Supply of commodities played a key role in the global market of metals this year. It was the judge to determine the winners and losers based on every market, starting from iron ore to nickel . Supply is also the reason why the commodities are performing at the worst for the third consecutive year.

According to the analysts, this trend could continue to follow the market for the year 2015, as none of the iron ore producers and the oil producers are showing signs to decline their rate of production for the next year.

According to the recent report published by the Citi Bank, the analyst stated that, it is too easy to assume that the main problem regarding the commodity market is the global growth of GDP. But actually the problems regarding the supply are the main issue which creates gluts in the market. The worst effect of supply can be seen in iron ore, as the metal has been marked as the worst performing metal of the year.

Iron ore, which is commonly known to be the key ingredient in the procedure of steel making, has declined over 50 percent in its value, which is noted to be five year low, due to the increase in the supply of iron ore, mainly from the mines of Australia. The increase in supply declined the demand of the commodity in the Chinese market.  

World Nickel market ended in 148 kt surplus: WBMS

The latest report published by the World Bureau of Metal Statistics (WBMS) indicates that global Nickel market has recorded a surplus during the initial ten months of the year. As per the report, the Nickel market ended in excess of 148,000 tons when matched with the surplus of 186,700 reported during entire year 2013.

The reported stocks held in the LME at the end of October this year were 124,000 tons higher when compared with the levels during end-2013.

Refined Nickel production from January to October this year totaled 1,593.4 kt. The nickel smelter production during the month of October 2014 alone totaled 167.1 kt, whereas the consumption was 145.1 kt. The WBMS report also states that the Japanese refinery output declined sharply by 2.5 kt when compared with the previous year.

Global Nickel mine production declined significantly on account of the export ban in Indonesia. The ten-month production totaled 1,471.7 kt, nearly 27% down when compared with the production of 2,013.7 kt during the comparable period last year.

According to World Metal Statistics-December 2014 published on 17th Dec, 2014, the world apparent demand during the first ten months of the year was 30.7 kt lower year-on-year. The demand for refined nickel was 1445.7 kt during Jan-Oct ’14.

Marubeni says LME aluminium prices may rise towards $2,300 a tonne next year

London Metal Exchange (LME) aluminium prices are forecast to rise gradually in the latter half of next year possibly to as high as $2,300 a tonne as smelter shutdowns and output cuts squeeze supply, Japanese trading house Marubeni Corp said.

"We expect the LME prices to move higher next year as the market will remain tight," Norinobu Ozawa, general manager at Marubeni's light metals section, told reporters on Wednesday.

Marubeni, a major aluminium trader in Japan, estimated the global aluminium market will see a deficit of 387,000 tonnes in 2015, against an estimated deficit of 125,000 tonnes this year. It sees the deficit to widen to 872,000 tonnes in 2016.

Many aluminium producers have cut loss-making capacity or shut down completely in response to low LME prices, high energy costs and a flood of new capacity from China.

"Given the slack LME prices, high-cost producers will be forced to reduce or end production next year," Ozawa said.

LME aluminium prices, which have gained about 4 percent this year, traded at around $1,875 a tonne on Wednesday.

Marubeni forecast that they would be between $1,900-2,300 in the third and fourth quarters next year, moving up from an expected $1,800-2,200 range in the first quarter.

Global aluminium demand is expected to grow by over 5 percent in 2015 and 2016, led by a solid recovery in the U.S. economy and steady growth in emerging countries, Marubeni said.

The trading firm also forecast that the squeeze on supply would lead to higher premiums in Japan next year, predicting the range between $400-480.

Japan is Asia's top aluminium importer and the premiums it pays set the benchmark for the region. This year, Major Japan Port (MJP) premiums have risen 64 percent to record $420.

Earlier this month, major aluminium producers asked Japanese buyers to pay record premiums of $435-$440 per tonne for January-March deliveries, up as much as 4.8 percent from the previous quarter. But no agreements have been made as buyers demand lower prices.

Global aluminium premiums are expected to reach fresh record highs by mid-2015 on a supply deficit in the United States and Europe, according to a Reuters survey. 

Natural Gas Suggests $33 Oil

In the last couple of months, the sharp reversion in oil prices has certainly caught the world’s attention.  While the majority of economists and analysts continue to expect incorrectly that falling oil prices are a positive input to economic growth, the reality is that it is not.  The negative impact to economic growth from the decline in oil prices are quite considerable when you consider that almost 40% of all the jobs created since 2009 have been in energy related industries. 

Furthermore, many of those jobs are in the highest wage paying areas of the country that leads to more consumption and further job growth in other areas of the economy.  In fact, for each job created in the energy sector there are nearly three jobs created elsewhere in the economy.

“What we have here is a failure to communicate.” - Cool Hand Luke, 1967

As I discussed at length previously, the current problem in the energy price is a realization of a supply / demand imbalance.

"First, the development of the‘shale oil’ production over the last five years has caused oil inventories to surge at a time when demand for petroleum products is on the decline as shown below."

"The obvious ramification is a ‘supply glut’which leads to a collapse in oil prices. The collapse in prices leads to production‘shut-ins,’loss of revenue, employee reductions, and many other negative economic consequences for a city dependent on the production of oil.”

$33 Oil – A Return To Normalcy

While the economists and analysts are hopeful for a sharp recovery in oil prices, the current decline in oil prices is nothing more than a return to historical normalcy.  Let me explain.

If you ask virtually any oil and gas professional, that has been around the industry longer than the graduating class of 2000, they will tell you that the historical relationship between oil and gas prices is roughly $8.  The chart below shows the highly correlated history of oil and gas prices until 2008.

Not surprisingly, the divergence between oil and gas prices came to fruition in conjunction with the massive interventions by the Federal Reserve, which lowered borrowing costs enough to sufficiently provide for funding of higher cost shale exploration.  As Yves Smith recently stated:

“The oil and gas sector is capital intensive. Drillers have borrowed phenomenal amounts of money, which was nearly free and grew on trees, to acquire leases and drill wells and install processing equipment and infrastructure.Even as debt was piling up,the terrific decline rates of fracked wells forced drillers to drill new wells just keep up with dropping production from old wells, and drill even more wells to show some kind of growth.One heck of a treadmill. Funded in part by junk debt.

Junk bond issuance has been soaring as the Fed repressed interest rates and caused yield-hungry investors to close their eyes and take on risks, any risks, just to get a teeny-weeny bit of extra yield. Demand for junk debt soared and pushed down yields further. And even within this rip-roaring market for junk bonds, according toBloomberg,the proportion issued by oil and gas companies jumped from 9.7% at the end of 2007 to 15% now, an all-time record.”

With an excess supply now realized, particularly as global demand continues to wane, oil prices are now returning back towards their historical long-term relationship. 

If we assume that natural gas, which has been trading around $4 per BTU, has already returned a more normalized supply/demand range this would imply that oil prices have further to fall. The chart below is an extrapolation of the current West Texas Intermediate Crude price forecasted into 2016 on a monthly basis.  It would currently require a decline in oil prices to $33 per barrel to return the WTIC/NatGas ratio back to its historic spread of $8.

As T. Boone Pickens notes in his interview, the main supply / demand divergence is in the process of returning back towards equilibrium particularly in light of the deflationary forces that exist on the global landscape. While it is certainly feasible that we could see a sharp “snap back” rally from the recent plunge in oil prices, it is likely an opportunity to reduce energy exposure in portfolios before the next leg lower.

Just as a reminder, the last time oil prices fell 50% from their peak was in 1985-86.  Oil prices then stayed at those levels until the turn of the century.  The rebalancing of supply and demand could leave oil prices at lower levels for much longer than the majority of analysts currently believe. Considering that oil production related states have done the majority of the work related to the current domestic economic recovery, such an outcome could derail the hopes for a continued economic revival.

NatGas Crashes Most In 10 Months As Polar Vortex Arrival Delayed

Natural Gas prices are down over 11.5% in the last 2 days, falling to their lowest price since January 2013, as a familiar tale of excess production in the face of ebbing demand looms large. As WSJ reports, BNP Paribas' Teri Viswanath notes "the delayed return of cold weather has simply curbed all buying interest," and this was exaggerated by technical selling as the market broke previous support around 3.50. Ironically, given its detrimental impact on GDP, Macquarie points out, "it is increasingly apparent to us that weather will need to bail the market out again this winter - otherwise prices could see material downside during the spring and summer months."

Moar tax-cuts, more discretionary spending!! oh and less employment, capex, and EPS for Oil & Gas stocks...

As The Wall Street Journal reports,

Natural-gas futures slid to their lowest prices this year and entered a bear market Friday, as investors come to grips with surging production that is beginning to push the U.S. toward potential oversupply.

...

“The delayed return of cold weather has simply curbed all buying interest,” said Teri Viswanath, natural-gas strategist at BNP Paribas in New York. “Unseasonably warm weather that persisted through the month of December now necessitates extreme weather conditions to avoid a (gas supply) surplus.”

Analysts said Friday’s selling was partly driven by technically driven trading as the market broke through levels where it previously rebounded.

...

Though the U.S. has begun to draw on natural-gas stockpiles for fall and winter heating needs, continued booming production from U.S. shale fields is helping to replenish supplies. As a result, withdrawals from storage have been smaller than average, and the U.S. has begun to erase a supply deficit that has persisted most of this year, after outsize demand from the severe winter last season dragged stockpiles to an 11-year low.

...

“It is increasingly apparent to us that weather will need to bail the market out again this winter—otherwise prices could see material downside during the spring and summer months,” Macquarie Bank said in a research note. “At this point, winter weather will determine just how low prices can go.”