The Market Bomb That Could Blow

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Now here’s something that might have got lost among the chaos of the market yesterday.

The US just placed a total embargo against Venezuela.[1] The old regime change team must be back in business!

This may seem all a bit obscure to us here in Australia. But this is the first full embargo the US has placed in the Western Hemisphere in more than 30 years. It’s a big move.

Trump told US Congress that the Nicolás Maduro regime was illegitimate.

He also called Juan Guaidó the ‘interim president’…despite the fact that the Venezuelan people didn’t vote for him, either.

Hmmm. We know the history of the US government here. It puts out some airy-fairy stuff about democracy, human rights and freedom.

All of it is usually horse manure. Behind the scenes is some other goal…but what?

I have no idea.

The only thing I do know is that a full embargo against Venezuela will drive the country’s oil production even closer to zero than it is now.

That may not seem like a problem in the current environment.

The world seems awash in crude, and Trump isn’t helping the outlook for this by busily driving sentiment and trade into a brick wall.

However, I spent an hour yesterday talking with an energy expert based in Texas.

I can tell you that all this does matter. The world is priming itself for an energy crisis at some point.

The only question is…when?

We like to keep things upbeat here at Profit Watch.

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But we also follow the wisdom of George Soros…and prepare to bet against market narratives that could prove to be false.

Today, that’s a world of no inflation…forever. 

To embark on such a path is to run the risk of looking foolish for a long time…but the payoff is so huge for being right that a few jeers along the way are worth it.

Let’s see some of the problems brewing here. Take a look at the following chart…

Source: Optuma

This is the chart of the SPDR S&P Oil & Gas Exploration & Production ETF from 2015 until now. It’s trading at an all-time low. Margins across the energy business are weak currently.

That means there is very little incentive for the industry to invest for future supply.

Investors neither want the dud returns on offer nor the headache of fossil fuels on their social conscience.

That would be fine…except for the fact that the world still consumes 100 million barrels of oil a day…and this is unlikely to change anytime soon.

We have a further problem. Almost all of the supply growth in the crude business is coming from the United States…mainly from West Texas shale.

This oil is not like that of Iran, Venezuela or Saudi Arabia. It’s much less suitable for the refined products likely to see increased demand in the near future.

That means it’s wrong to think of one ‘oil price’.

There are many different oil prices, in the same way a bottle of Shiraz from the Barossa may trade at a premium to a Chardonnay from the Mornington Peninsula.

We could be moving into a world where shale oil trades at a much cheaper discount to, say, Nigerian or Canadian oil.

Why do you care?

This has the potential to eat into the margins on offer from such firms as Qantas and even Australia’s booming gold miners currently.

Jet fuel and diesel are products that could rise in price because they are not suited to having US shale as a feedstock.

Here’s another thing: US refiners were not built to process the oil that US shale guys are pulling out of the ground.

That means the US needs to export a lot of these barrels.

And Donald Trump keeps antagonising the biggest oil importer in the world…China!

That puts the US energy industry at risk of retaliatory sanctions…and pressures crude prices in general.

That further drives down the return that US energy companies are making now…causing them to cut drilling and staff…which will likely further crimp supply down the track.

See the vicious cycle we are now spiralling into?

Now, it’s possible that Donald Trump causes so much chaos and uncertainty that crude oil and economic growth keep falling.

But that could set the world up to be even more ‘short’ oil at some point.

Rick Rule is a noted commodity investor. He has a line that just because something is inevitable does not mean it’s imminent.

That’s probably the way to think about oil right now. These issues can drag on for a long time.

But they’re vital to watch in today’s environment. There’s US$14 trillion in negative-yielding debt around the world.

Nobody can see inflation anywhere, and doesn’t expect to.

The biggest ‘asymmetric’ bet I can find is something that causes central banks to raise rates instead of cutting them.

The only thing big enough to scare the world on this front is the oil market.

Just remember that US$14 trillion in negative debt is vulnerable to anything that raises inflation expectations.  

That could make yesterday’s market look benign.

So keep your fingers crossed that this bomb never blows.

Best wishes,

Callum Newman Signature

Callum Newman,
Editor, Profit Watch

[1] ‘US Expands Sanctions Against Venezuela…’, The Wall Street Journal, Aug. 6, 2019.

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