Buy the Loonie?

This should bode well 

Reuters

For this...

CFR

Seems like a contrarian idea. Canada has a housing bubble in certain cities. Oil prices are hurting three of ten provinces. Debt is expanding and economic growth has been weak. Yet the Economist Big Mac Index and the CFR Mini-Mac Index has the CAD (or Loonie) as undervalued against the USD. 

The Economist Big Mac Index has the CAD undervalued by 10% and the CFR Mini-Mac Index by 20%. Strong commodity flows could be forecasting a rally.

Honestly I hate the idea so much I think the trade will probably work. 

2017 Recession?

There is no clear signal for a 2017 recession as of yet. There are some warning signs, such as a potential peak in light truck sales, but recessions have a weird habit of happening around Presidential elections. This year with the dislike of both candidates its possible Americans talk themselves into a recession.

Ed Yardeni

Atlanta Fed Sticky CPI

The Atlanta Fed publishes what they refer to as the stick price consumer price index. It is described as:

"The Atlanta Fed's sticky price consumer price index (CPI)—a weighted basket of items that change price relatively slowly"

Atlanta Fed

This metric does not look deflationary and is near its post financial crisis high. My gut feeling is that most consumer spending is more like this metric than the chain weighted CPI.

US Economy, Recessions and one of my Favourite Indicators

I believe light truck sales is one of the best economic indicators. Few people buy pick up trucks because they want one, most are bought for work and those that do usually work in blue collar jobs and if they have the funds to purchase a new truck the economy is doing well.

St. Louis Fed

Other than the double dip recession of the early 1980's, light truck sales peaks out at least 1 year before a recession. Now this indicator is not a timing model, as in when it peaks sell everything and buy canned food and ammo, but when the sales peak followed by the trend line being broken, historically it is a good idea to begin to watch the economy for other indicators. 

Are truck sales peaking? 

The Re-emergence of the Peak Oil Argument and the Emergence of a Free Market in Oil

The Peak Oil argument refuses to die. Today it has morphed into the Peak Conventional Oil argument. There are parts of the argument I agree with such as any finite resource will eventually run out, either due to regulation or over production, however, this is not what is happening right now. 

Humans are pessimistic for anthropological reasons. Life has been hard. Pessimism is even believed to be genetic, however, explaining the current woes of the oil industry by using the Peak Oil argument fails Occam's Razor. There is a simpler explanation found in economics 101, the adjustment of an oligopoly dominated market to a free market. 

Econ 101

In a free market the quantity produced would be Qc and price Pc and in an oligopoly the price would be Po and quantity Qo. If the price is managed the perfect amount above the marginal cost curve it deters new entrants, but should demand expand too quickly and prices rise fast enough there is an incentive  for new entrants to enter the market. 

This is what happened between 2000-2011. The demand from emerging markets expanded faster than the oligopoly could increase production, leading to prices that rose far enough above the marginal cost of production enticing new entrants to the market. This was coupled with a technology advancement in gas production (no oligopoly and no managed price leading to greater incentives to adopt technology and not just free ride on cartel prices) which was transferred to the oil side of the energy sector and reduce costs on what had previously uneconomic sources of oil.

Oil Demand

To attempt to regain control of the market the oligopoly flooded the market to eliminate the high cost producers. However, by doing this the dominant oligopoly producer had to act as a monopoly producer and destroyed the cartel partners. While this was going on the new entrants and the free riders from the oligopoly produced market began to reduce costs and threaten monopoly producers ability to return to a managed market. What is happening is the emergence of a free market in oil. 

Below is my response to an article entitled "The Oil Industry Faces a Grim Future?"

I disagree. I believe this analysis is incorrect.

What happens to a market when prices are held above the long run inflation adjusted cost for extended period of time? You get surpluses. What happens when you get surpluses? Prices decline. What happens when you get price declines? Inefficient companies (and in this case countries) go bankrupt. This is all economics 101.

Prices are not low, they are within on standard deviation of the long run inflation adjusted prices per barrel. The 2006-2011 prices were historically high on an inflation adjusted basis.

The long run mean inflation adjusted price of a barrel of oil from 1946 (Post war period) in 2015 dollars is $41/barrel, since 1980 it is $51. The price is barely below the mean of the last 36 years and above the mean for the past 70 years. This mean is also biased to the upside due to cartel behavior. A free market, like the one that is developing would have had a lower inflation adjusted price.
The low price narrative that is continually being repeated is to disguise poor capital allocation decisions, the inability to control costs and the reluctance to adopt technology.

Currently what is happening is that producers who were able to free ride on inefficient and cartel behavior are being forced to adjust a free market in oil. In a few years costs will be lower for those that survive and those that cannot reduce costs they will disappear.

The energy business has historically been slow to adopt new technology and methods. This forced adjustment to a free market will accelerate the adoption of technology. Directional drilling was first used in the 1930s but only adopted in 2000s and wells have been fracked since the 1940s, the AAPG released a paper in the 1950s discussing the first 10 years of this practice. It took 70 years to combine the two. No other industry would survive adopting technology and change this slow. The only reason why is 100 years of oligopoly (Texas Railroad Commission followed by OPEC).

Because prices were held above the marginal cost of production due to the cartel effect producers were to free ride and be inefficient. This is essentially no different than what the automakers had to adjust to when the Japanese gained market share in the 1980s. But to claim costs are low is incorrect and forecast dire straits ad infinitum bears the semblance of the predictions of the end of the US automakers in 1980.

Further using the peak oil declining EROEI argument also ignores history. When Col. Drake drilled the first well into a “conventional” reservoir in the 1860s the EREOI was very low, maybe negative. However, over time the EREOI improved. To compare “unconventional” production or oil sands today versus conventional wells in Saudi Arabia that have had continual, but slow technology improvements over the past 70 years is to assume that the EREOI is static and not dynamic. EREOI for oil sands has improved since the 1950s, and unconventional EREOI has improved just in the past 5 years. Unless you can tell me what the return on energy will be for a SAGD project when they begin using microwaves to reduce bitumen viscosity and eliminate the need for natural gas, then the EREOI argument is a strawman. It is like comparing baseball players of today versus the 1890s, fun over a drink but a waste of time.

Some historical perspective is required in analysis. The issue is not that prices are low, poor capital decisions were made when prices were historically high. The world is not ending. The sector is fine. All that is happening is the normal transition from a cartel dominated oligopoly priced market to a free market. Its economics 101.

Charts of the inflation adjusted price of a barrel of crude oil http://inflationdata.com/Inflation/Inflation_Rate/Historical_Oil_Prices_Chart.asp
http://www.macrotrends.net/1369/crude-oil-price-history-chart

Spare Capacity vs. Above Ground Storage

A lot has been made about the large above ground oil inventories. The EIA publishes an update on this weekly. As you can see the above ground storage is well above the 5 year range.

EIA

However, spare capacity (or below ground storage) has been shrinking. 

JWN

Further this Wall Street Journal article suggests that the inventory levels are not abnormal for this point in the cycle.

Wall Street Journal

Maybe the market is tighter than people realize?

WTI Commitment of Traders Report

There seems to be an interesting development on the WTI COT report. You have producers increasing their longs while open interest is increasing.

Not sure what it means but some producers could be buying their hedges back.

CME Group