Big Fractures Forming in the Oil Market


Political cynicism really knows no bounds. President Trump is proving that right now. I suppose you could say at least he’s honest about it, unlike the rest of them.

Saudi Arabia is causing devastation and starvation in Yemen. We knew this already. Now, its political elite may be involved in the potential murder or disappearance of the journalist Jamal Khashoggi. It may have involved mutilation and torture.

Trump’s response is to emphasize that the country buys a lot of US military equipment, which supports a lot of American jobs.

We’ll leave the morality of it all behind and peer into the future for the only reasons anyone cares about Saudi Arabia in the first place – oil and money.

The Brent and WTI benchmarks are weakening currently. But 2019 is shaping up to be a real doozy on current trends…

Chaos forming in the oil market

Imagine if the current uproar around this causes international sanctions to come down on Saudi Arabia.

That would put it in the same isolation pen alongside Russia and Iran. Oh, and Venezuela is collapsing as a society as well. These are the big exporters that supply the world.

There’ll be some nervous fixed-income investors, too. Saudi Arabia has issued 68 billion in US dollar debt over the last two years. The cost to insure against default is up 30% in the last two weeks.

Chaos here is not welcome at all. It bears reminding that the only country that has any meaningful spare capacity in terms of oil production is Saudi Arabia.

Australia has a very weak flank here. The Australian Financial Review reports this morning that we’re one of the few countries with no strategic reserve, not to mention only about 20 days’ supply of crude and most fuels.

It’s supposed to be over 90.

We also have the chaos in Central America, which bears close watching right now. Mexico is another big producer.

Trump is threatening to deploy American troops and close the Mexican border to stop the flow of immigrants coming from Guatemala and Honduras.

Now, we have news that Mexico’s credit line to the US is being tripled. The Wall Street Journal reports this is a ‘symbolic display’. Coincidence?


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All this is making the third quarter earning reports from the US energy companies some of the most fascinating reading around…

Strains and pains in Texas

You see, for all the words written about America’s energy renaissance, it does contain one problem – the lack of profits. The cumulative free cash flow from the US frackers is a negative US$75 billion over the last five years.

One of the dynamics I’ve been following in my Small Cap Alpha service is the pressure coming to bear on them from their major investors.

The institutional men and women funding the frackers want to see some return on their money.

Higher oil prices and slower production and exploration costs can deliver that to them. However, for you and me, it could take the rosy predictions for US supply down a notch – and the price of oil up.

And we still have the problem of the frackers escalating costs (sand, truckers) and pipeline constraints in the major production area of the Permian.

Stay tuned to Profit Watch over the next few weeks, that’s for sure.

Let me head off one objection, too. You might be worried about slowing trade cutting off oil demand.

Because despite the ructions in the Dow Jones lately, I remain bullish in US growth…

A Christmas rally coming to US stocks

The US banks are the key. I’ll keep it saying it. They keep reporting good numbers – and positive outlooks.

US Bancorp is the fifth-largest bank in America. The latest results show how net income rose 16% on last year. It’s also reporting strong consumer confidence and expects loan growth to go up in the current quarter and next year.

I find it hard to be bearish when banks are reporting these kinds of numbers. By the way, my latest copy of The Economist shows that seaborne trade rose 4% in 2017 and remains on track for another 4% this year.

Here’s something else worth noting. I mentioned earlier in the week that the S&P 500 has been higher after every midterm election since 1946.

Here’s a chart showing the average shape of the market in a midterm election year…

Source: LPL Research, FactSet

We could be shaping up for a similar repeat in 2018 once the uncertainty around it all clears.

After all, US stocks are still growing earnings – including the defence firms, dead journalists aside.


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Callum Newman,
Editor, Profit Watch

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