First off, I want to first make a few comments about a prior post. I had written earlier this year that Dubai was an example of the ticking time bombs of oil rich Middle Eastern fiefdoms. It's telling that CNBC is likely top ticking the Middle Eastern oil economies by recently shooting their show from the United Arab Emirates state of Abu Dhabi or Dubai or both. There is significant precedence for CNBC to be embracing particular businesses or investment strategies as they are peaking. That happened in 2000 with technology, in 2005 with housing and in 2007 with private equity amongst other examples. We saw CEOs within these businesses made to be TV rock stars during these tops as the media fawned over them. Mind you, oil is in there too. Now, it is sovereign wealth funds and the respective emerging markets that are getting their time in the spotlight with these interviews. Specifically for this spotlight it is oil rich sovereign funds. I didn't actually see which state(s) were interviewed but I did see three interviews with UAE officials. Or should I say members of the royal families. I do not like any hint of royalty and consider it a sellout that a media supposedly committed to free markets is embracing a "banana republic". Royalty reeks of societies that limit personal freedoms. A little like the U.S. ruling class today. A joke. The U.S. situation will take care of itself regardless of who wins any political elections. Why? Because free markets most often determine politician's economic actions and much of their economic legacies and not the other way around as is generally believed. As a society we generally want to give the credit to one person sitting in a small office in Washington for determining the fate of a $14 trillion economy with quadrillions of moving parts. Or, should I say politicians have the ego to take the credit. Nothing wrong with a healthy ego but what was that leadership quote from Lao Tzu a few posts ago? I digress.
Back to Dubai and Abu Dhabi. I could never have dreamed of the massive excesses that are being undertaken there. A state with a little over one million residents is building an airport to support traffic of 125 million visitors? Wrong cycle to be betting on never ending consumption and real estate folks. Anyway, two major messages came across in those interviews. One, there is massive malinvestment in consumption oriented sectors which we talked about. Two, there is a desire to buy anything American due to a tremendous confidence in the American economy. I'll address that one before the end of December. But, I'll just say that I have confidence in democratic economies as well. Yet, that in no way translates into confidence in equities or most any other asset class for the foreseeable future. They aren't even remotely the same thing. Just a reminder of how volatile the world's petroleum producing economies are likely to get before we move on to the post.
As I've written before, one of my favorite stocks this cycle has been Valero. (As an aside, I also wrote on here that their top notch CEO Bill Greehey and its executive team were dumping stock like there is no tomorrow in 2006. More so than at any time in Valero's history. That fact is long forgotten by oil bulls. As is the fact that Greehey was a regular guest on financial television.) I don't really look at Valero's specific movement on a daily basis but at key turning points, I've strapped my trading system onto the stock and made commentary that I was bullish or bearish on its movement. The last buy signal I wrote about yielded a 60% return over a handful of months. Valero was not just a great investment this cycle but a great stock to trade. The key word is "was".
There is no doubt the investment world loves the oil story. Universally more so than they loved technology in 2000. Because the technology theme was limited mainly to the U.S. and the oil story is a global one. Bigger story=>Bigger bubble? The whole world believes the oil scheme perpetuated this cycle and investors everywhere are participating in it. Who could deny the increased energy demand needed to fuel international growth? Talk about a crowded trade. Likely the most crowded trade in history. Just remember one important fact. The world has never seen synchronized growth like this before. As I wrote earlier this year, the last time we had a comparable synchronized global growth environment, we saw the worst recession and largest stock market decline since the Great Depression. We will likely not see this type of synchronized environment again for quite some time. Maybe decades. Those metrics depend on many factors but so far the global economic environment isn't even close to supporting another cycle like this. My point? Expected future energy demand is likely to be very erroneous. Yes fundamentals do matter. Of course, we wrote this last year when everyone was jumping for joy and convinced there was no stopping global growth.
Natural gas and coal don't have the appeal of oil and I believe much of the appeal is black gold's futures market is very deep and very liquid. No pun intended. Deep and liquid are key characteristics of any market a professional trading organization would want to trade. In addition, oil has international economic appeal because of its demand profile. And, it is a significant hedge against economic uncertainty as is gold. The oil futures market has been a source of enormous profits for professional investors. And, I do mean enormous. Surely tens to hundreds of billions in profits from trading oil. That said, in the last month or so, I posted a link to a survey where financial advisors were most bullish on oil stocks as their favorite investment. Any time Wall Street is in complete agreement, we need to worry. This cycle is has been industrial commodities, Goldilocks, sustainable global growth, inflation worries, yield producing investments, oil
, emerging markets, Apple, Google, hedge funds, derivatives, quantitative trading, Goldman Sachs and China amongst others.
There are many ways to measure sentiment in in the oil futures market. I know a handful of pretty reliable methods but I'm sure oil traders know even more. Let me give you something simple that anyone can watch. It's more anecdotal than scientific so it is not a short term timing method but it is a data point worth watching to determine the health of the energy markets. Energy equity prices typically lead strong futures moves in the oil and gasoline markets. When gasoline stocks exhibit strength and are trending, gasoline futures and oil futures have typically headed higher in this cycle. One of the easiest anecdotal data points this cycle has been to watch Valero. Valero is a proxy for gasoline prices and refining spreads. As the chart above shows, the stock has not followed oil or oil stocks higher in this most recent move. Valero has not produced any type of measurable return for nearly two years as a buy and hold investment. Mostly chop in the stock's action. That is not a good sign in my estimation. Couple this with the generally held belief that higher energy prices translate into higher and higher energy company profits and one should be very careful here. Higher energy prices do not always translate into higher profits. As energy resource supply and demand characteristics change in the technology, equipment, investment and human capital requirements, energy profits come under pressure as the cycle progresses. Then there is economic substitution and reduced demand caused by higher prices. Higher and higher oil does not translate into higher and higher profits. There is a ceiling of peak profits given specific underlying factors.
This cycle gasoline has moved in a repeatable pattern with oil. Some time ago that cycle broke both with the futures market and the equities market. Many times major trend changes take place with subtle changes in market behavior. The oil futures market has surprised me by running nearly to $100 a barrel. But bubbles can always become larger bubbles. And, with fewer and fewer investments working over the last six months, more and more money is likely plowing into oil as it is one of the few investments still working. I believe there is substantial evidence oil is the "technology stock" type of bubble investment this cycle and this decoupled move to $100 could very well be a final run similar to technology in 2000. As market participation narrows in any rally, strength is confined to fewer and fewer winners. This has been the case with oil and not gasoline. And, the participation in the recent futures market rally did not exhibit the enthusiasm I would like to see leading the move to near $100 to be highly suspect.
Regardless of the games played with oil inventory cancellations and other deceptive games of traders, underlying demand for oil related products is very weak in the U.S. Some product demand profiles are at the lowest levels in over a decade or more. That means energy demand is negative in many products. All while we've had a ramp up in production over this cycle. It's time to listen to energy CEOs and scientists in the oil industry as the "experts". Not the traders that the general public listens to on television and in the media. Traders know no more about oil than you or me. In fact, I suspect quite a few know even less. They know how to make money by following a trend and feeding off of the sentiment in an open outcry trading environment. That means down as well as up.
Those in the oil industry have been telling us for years there is plenty of oil while Wall Street's participation in the oil futures market exploded as have prices. We've heard any of a multitude of reasons from traders and Wall Street analysts as to why oil is marching higher. Those include little marginal gasoline refinery capacity to turmoil in the Middle East to China to marginal spreads between supply and demand to peak oil to Nigerian rebels to Chavez chatter and half a dozen other reasons. Most of the reasons given for high oil prices have been transient except for the emerging market growth theme. In other words, increased demand. That premise is going to be severely tested as emerging market growth is going to suffer a very hard landing as we have been discussing since starting this blog.
Enthusiasm for never ending oil consumption growth is a position put forth by dubious "experts". Indeed we have seen generally rising demand over longer term cycles but don't confuse that with generally rising prices over long periods of time. That has never happened. Ever. China's industrialization has produced enough excess economic capacity across many sectors that it could take ten or more years to work off if their bubble economy pops. Or should I say when. In such an outcome, what implication does that have for energy demand in real estate, manufacturing and other heavy users of energy in China? For other countries ramping up energy sapping industrial and commodity capacity to feed China's expected bull market in infrastructure anticipated to last another twenty to thirty years? I think the trend followers anticipating this type of future demand in China's growth are very exposed to a highly suspect position. Closer to home we now have enough excess oil in the U.S. to bathe in and demand is seriously waning. Games, forecasts and hopes won't prop a market up forever if fundamentals continue to deteriorate. Not just in oil but in any market.
As I've said before, the U.S. has the technology today to relatively elegantly cut its oil consumption significantly. By 30-50% per unit of GDP in thirty years is not an impossibility. The world's scientists will finally break our dependence on oil. It might not happen tomorrow and it might happen in waves but it will happen. And, it will happen regardless of what special interests, lobbyists and politicians want. This is not the 1970s. Because now, there are at least four truths lobbyists and special interests can no longer suppress: A nearly universal concern about our planet; America's desire to not watch our sons and daughters endlessly die in Middle East conflict; A trillion dollars spent every decade protecting U.S. oil interests that could be spent for economic investment or social programs-this excludes current Iraqi war costs; And technology has progressed enough to develop viable alternatives. There was never a truth worthy of sustainable alternative energy in the 1970s crisis. Once prices abated, it was easy for society to forget the pain of high energy prices.
I read something a few years ago that I thought was very telling for those drawing trend lines into eternity for positive oil demand and high oil prices. It stated something along the lines of Germany and France had not increased their oil imports in thirty years due to energy efficiency and independence initiatives. What if the U.S. had actually used the Department of Energy's creation to accomplish the same feat? What if the U.S. and other countries now accomplish this feat on a go forward basis? Or what if the entire globe unleashes science on this problem and what evolves is even more compelling? Now, I can't find that data anymore so I'm going from memory. If anyone has the exact statistics, post it in the comments section and I will move it as an addendum to this post.
Will the world's oil consumption continue to increase over the long term or will oil come under pressure from alternatives and efficiency well before we run out? That is, if we ever would or could run out. That's any easy answer for me. In a society (the U.S.) where efficiency and alternatives haven't received any serious consideration and with massive advances in technology coming, what is the world capable of in the application of energy efficiency and alternative energy sources over the next thirty years? The cumulative consciousness of hundreds of thousands of scientists, engineers, entrepreneurs and companies across the globe is now focused on a major problem and they will not be denied. Why? Because free markets see significant profits and business benefits in energy efficiency and green technologies. Not because politicians want to tax us for being polluters as so many apparently find as an appealing solution in today's environment. Or any other of the well intentioned but misguided ideas of politicos. Politicians ought to get out of the way and let the markets work. Funding for basic research is a constructive role of facilitation governments can play but picking the market's winners and losers is for the market place and business to decide.
I suspect advances in coming decades will be staggering and beyond the imagination of most everyone. Not just in energy sources but green technologies across every aspect of our lives. I can envision some very radical changes to the economy with developing technologies. So much so that nearly every thing I touch or do would be radically changed. And, if one person can imagine it, what will the cumulative consciousness of the global society create? It will likely be an amazing driver of productivity, new business and employment.
In the mean time, the the world's largest energy consumers in Japan, Europe and the U.S. are slowing very rapidly. We could very well be seeing a major peak developing in oil prices. And, while I have no reason to believe this is the ultimate peak, the emerging green fundamentals combined with the negative macro economic fundamentals developing could very well be aligning to support oil's ultimate peak. Forever. Is that the current cycle or something thereafter? Who knows. Regardless of when it will happen, it will happen. We will see oil's involvement in the global economy diminish and at some time, it is plausible if not probable oil will be completely banished from any role in energy consumption. That might take one hundred years or longer to banish oil completely but it will happen.