Is Oil Overvalued? Or Are We Just Seeing Temporary Weakness in the Price of Oil. The Economic Fallout
Canadian Oil Sands Prices as an Indicator
In recent months there has been an anomaly between world oil prices and the price of oil coming out of the Canadian Oil Sands. Because of transportation issues Canadian heavy oil has been receiving less value than the world price of oil. They say that this is a temporary anomaly and perhaps it is so. But this differential is but an indication of weakness in the price of oil everywhere.
If demand for crude oil were growing rather than moderating, the differential for Canadian Oil Sands crude would be far less.
The Price of Oil Has Weakened Recently
However the price of oil everywhere in North America continues weakening - just a bit each week. From February 2012 until now, there has been a gradual but consistent weakening in price. Perhaps that hasn't translated into cheaper gas at the pumps yet, but any chart will show a decline in the price of crude oil. This price weakening is perhaps a result of economic weakness, or more oil flowing from Iraq, or perhaps demand weakness, or seasonality. But however you wish to interpret this, oil is reaching new recent lows.
Oil is Trading at the Lowest Price of the Last Eighteen Months
Some traders see the weakness as a leading economic indicator, and as oil prices hit their lowest levels in over a year and a half, it's a sign that global growth is facing some serious headwinds. With the fiscal cliff in the USA looming as a result of budgets constraints hitting the USA in the New Year, and persistent European troubles that never seem to go away, the energy markets seem to be confirming an inevitable economic downturn.
Yet, others see the decrease in the price of oil as a very positive sign.
A Longer Term View on the Price of Oil and the Effects
We wrote a few months ago, on the long term future price of oil. To summarize our comments, there is a revolution coming in terms of energy availability in North America.
The new Fracking methods, combined with the enormous new fields of natural gas being discovered in which for the first time, the gas is recoverable, have made gas very plentiful in North America. The "normal" pricing curve has become a thing of the past. We still have 'experts' calling for the recovery in the price of natural gas (read price increase) but the reality is that the price of gas has a new and lower trading range - at a price that makes the use of natural gas very economical.
Add to this the fact that there are now more oil reserves in North America than there were at the height before the Peak Oil Theory came into vogue. This does not include the ever expanding production coming from the Canadian Oil Sands.
One thing is for certain. There are massive changes coming that will affect the USA position in the world, the value of the Canadian dollar, efficiency and productivity in North America. If the price of crude oil continues to weaken, energy prices will continue to moderate, resulting in lower costs in North America and that will result in higher productivity in North America. This will make the USA much more competitive in manufacturing.
If the export of crude from the Canadian Oil Sands is at a lower price, less export dollars will be flowing back to Canada, resulting in a weaker Canadian dollar, and an increase in productivity in Canada when costs are compared to other countries. This will also mean a lowering of living standards somewhat. The changes will be significant.
The supply side of the equation of crude oil supply and demand, will be strengthening even more. The following commentary about unexpected new sources of supply coming on stream, add further to the supply side of the equation, and will further weaken prices.
The Vanishing North - The Melting of the Arctic
In the June 16, 2012 edition of "The Economist", is a very interesting article which I urge readers to look at.
Positive Economic Effects of the Disappearance of the Arctic Ice
Some comments included in that article are pertinent to this discussion. I will quote some here - "Arctic governments are starting to see a bonanza in the melt. The Arctic is stocked with minerals......hitherto largely inaccessible, including an estimated 30% of undiscovered reserves of natural gas and 13% of undiscovered oil reserves."
How these so-called experts can quote percentages on "undiscovered deposits" is beyond me, but that is a subject for another day. Further quote - " .... oil companies are flocking north...".
The Price of Energy is About to Fall
What we have here is a long term trend that looks to change the economics of the world.
If you think that you are secure in your investments in the high dividend paying former gas and oil trusts, think about the long term effects of the dramatic increase in the supply of energy and the expected continuing drop in the cost of that energy (oil).
One Thing is Certain - The Future is Uncertain
In a short blog like this, it is not possible to examine the effects of this coming change, but let me at least mention some of the topics.
Is production of oil from the Canadian Oil Sands too expensive to compete in the new paradigm?
Is productivity in the US about to improve radically because of the lower cost of energy?
Is the diminishing flow of money to the Sheiks of the Middle East going to change the value of the US$?
Will the focus of the US military cease being on overseas oil supplies?
And many more similar questions.
The real issue, is the timing of these coming changes.