Myopic vs. Strategic Thinking
By Chris Puplava, February 25, 2009
Before getting to the heart of today’s article I’d like to first provide the following definition below:
- Unable or unwilling to act prudently; shortsighted.
- Lacking tolerance or understanding; narrow-minded.
- Lack of discernment or long-range perspective in thinking or planning.
The above definition aptly describes the policy of President Obama towards one of the greatest suppliers of oil to our country, Canada, as President Obama is leaning towards putting pressure on reducing emissions from Canadian oil sands production.
US President Barack Obama has signaled that Canada's oil sands industry should not be granted an exemption from strict regulations to limit emissions of greenhouse gases.
His stance could add to the already high costs of developing this vast resource which is increasingly regarded as one of North America's most secure sources of energy…
"What we know is that oil sands create a big carbon footprint," Obama said in a television interview with the Canadian Broadcasting Corporation Tuesday. "I think that it is possible for us to create a set of clean energy mechanisms that allow us to use things not just like oil sands, but also coal. The United States is the Saudi Arabia of coal, but we have our own homegrown problems in terms of dealing with a cheap energy source that creates a big carbon footprint."
Canada is the biggest foreign supplier of oil to the US, and in recent years a growing share of that oil has been derived from the oil sands region of northern Alberta which are estimated to hold a massive 173 billion barrels of oil.
About 780,000 barrels of oil per day are produced from the Alberta oil sands and exported to the US. Canada currently sells about 60% of its oil sands output to US refiners…
The recent steep fall in oil prices to current levels of around $40 a barrel have already had a big impact on plans to expand Canadian oil sands production.
Canadian bank TD Newcrest calculates that around 600,000 b/d of new output, originally scheduled to come on stream by 2010 or 2011, has been postponed.
The cost of oil production from tar sands is one of the most costly means of producing oil, that and deep water drilling. The collapse in oil prices is making production from the Canadian tar sands less economical, and slapping emissions controls and other regulation will only raise the cost for Canadian oil exporters to the U.S. The article mentions above that roughly 600,000 b/d of new production that was supposed to come on line over the next two years has been scrapped, and slapping regulation on Canadian oil producers will likely lead to even further cut backs in new production plans.
While the goal of reducing the carbon footprint is a noble venture, Obama’s policies are likely to have unintended consequences. For example, who’s to say that instead of spending billions to meet possible future regulations on oil sands production that Canadian oil exporters don’t simply export their oil to China or other oil-starved countries?
When we eventually pull out of this economic mess we do not want to do so with a crippled oil industry. It will take years to bring new production on steam while demand can rebound much faster, leading to insufficient supply to meet reviving demand from emerging markets that will push oil prices up quickly. With oil production projects already being dropped left and right, one of the worst things we can do prior to an economic recovery is to alienate our top suppliers.
Canada is currently our number one supplier of crude oil, surpassing Mexico in late 2005 as Mexico’s giant Cantarell oil field is in decline. Internal demand coming from the Middle East is eating into their export levels, which can be seen with declining exports from Saudi Arabia even before world economic growth collapsed in 2008. Furthermore, Hugo Chavez, no fan of the U.S., is diverting more of his exports to China. These trends can be seen in the figure below that shows exports from our top four oil exporters peaking between 2006-2007, and rising oil demand coming from oil export countries.
Source: CIBC World Markets
In stark contrast to the U.S. policy shift of alienating the top crude exports to our country, China is acting more like a vulture and opportunist by utilizing the economic crisis to its advantage with their sizable foreign exchange reserves, picking off the weak to their advantage as the following articles illustrate.
With the world suffering through a major credit crunch, China has suddenly gone shopping. Beijing said Friday that one of its big state-owned banks, China Development Bank, agreed to lend Petrobras, the Brazilian oil giant, $10 billion in exchange for a long-term supply of oil. That investment came after similar deals were signed this week with Russia and Venezuela, bringing China's total oil investments this month to $41 billion…
Venezuela got a $6 billion loan from China and agreed to increase its oil exports to the country, bringing China's total investment in the country to $12 billion. In Brazil, China signed a $10 billion "loan-for-oil" deal that guaranteed the country up to 160,000 barrels a day at market prices.
And in Beijing this week, Prime Minister Wen Jiabao met his Russian counterpart after China agreed to loan Russia's struggling oil giant, Rosneft, and Russia's oil pipeline company, Transneft, $25 billion in exchange for 15 million tons of crude oil a year for 20 years.
"This is heavy energy diplomacy," said Philip Andrews-Speed, director of the energy policy center at the University of Dundee in Scotland. "If you need money you go to where the money is, and today, China's the place."
China and Russia struck a deal that will give Russian energy firms Transneft and Rosneft loans to increase East Siberian oil field development and production and to connect the Eastern Siberia-Pacific Ocean pipeline to China. In return, China will receive about 300,000 barrels per day of oil for the next 20 years. Russia might have made the deal out of economic desperation as its state-owned energy firms feel the pain of evaporating credit, economic woes and low oil prices…
And the Chinese got a steal: Although not all of the contract’s subtleties are likely out in the open right now, reimbursement for the loan means that the Chinese have purchased Rosneft crude for only about $11.40 a barrel once interest is figured in — about one-third of what Russia’s crude fetches on the open market right now. The Russians have essentially locked the fate of their Far East strategy to the whims of Chinese energy policy, and this is a compromise that could reveal how financially desperate Russia is.
Brilliant, purely brilliant! That is what strategic thinking is called! China, concerned about their U.S. reserves being devalued by U.S. monetary policy, is exchanging their holdings for long-term oil contracts from countries all over the world, locking in oil prices at exceptional levels, like the $11.40/barrel estimate for the Russian deal.
Over the past decade world oil production growth has been roughly stagnant for most oil producing regions, while Russia was one of the few bright spots this decade, though production growth stagnated in the last few years as capital expenditures in the region began to slow. Now with the recent deal inked by China and Russia, China has just secured direct oil access to one of the few oil regions that showed sizable production growth this decade as seen in the figure below, which normalizes exports to 100 at the start of this decade. When world economic growth turns up, which it eventually will, China will have strategically positioned resources to allow their growth to continue, and has done so at rates 92% below last year’s peak and current prices!
Oil Exports Normalized to 100 on 01/01/2000
Probing the Depths of the Bottom
While China may be preparing for the eventual economic recovery, it certainly isn’t here. Looking at the leading economic indicator for the OECD shows that the rate of change has nearly reached the levels of the 73/74 recession, currently declining at a 7.15% year-over-year (YOY) pace. While developed economies were the first to contract, the high-flying BRIC economies are quickly playing catch up as the chart of BRIC industrial production rates shows below.
The economic numbers above illustrate the degree of the economic contraction currently underway but do not tell us when the bottom may be in for crude oil. For this we turn to equities as the stock market serves as a useful discounting mechanism for economic data, and thus oil prices. Perhaps “THE” leading indicator for oil prices may be the Chinese stock market, as the Shanghai Index peaked nearly a year prior to the top in oil prices, and the recent break of the down trend that has been in place since 2007 in the Shanghai Index may be signaling a bottom for crude oil ahead. The 50 day moving average (MA) for the Shanghai index served as rally killers for the past year and has done so for oil prices as well. Coming off the October lows the Shanghai Index has staged an impressive rally, breaking above its 50d MA and now assaulting its 200d MA. A move above the 200d MA on the Shanghai Index would be a major positive for oil as it would signal that Chinese equities were discounting an economic bottom and recovery ahead.
Oil has yet to break through its 50d MA and that would be the first step for oil prices to turn more constructive, and the 200d MA is more than 100% above current prices, indicating we may see a prolonged period of consolidation before oil can move above its 200d MA.
Also hinting at a potential recovery in oil prices is the MSCI Asian Ex-Japan Index, which typically leads oil prices by 210 days. The bottom in the index in October and stabilization may be signaling the same for oil ahead. If the Asian Ex-Japan Index can best its January highs it is likely that crude oil may follow suit and signal that the low is in. Corroborating the MSCI Asia Ex-Japan Index is the Korean Kospi Index, though it typically leads oil and the CRB Index by 168 days (24 weeks).
One final indicator that points to a final bottom in oil is my commodity currency index below that has failed to breach its October lows, and has typically lead oil prices by roughly a month. If the commodity currency index can breach its January highs then we can likely expect oil to break above its January highs of $48.59/barrel, which would also lead to a break above its 50d MA, providing further support that the bottom is in.
While the above indicators point to a potential bottom in crude oil, if a market rally in global equities stalls and then equities breach their prior lows, then all bets are off in terms of the final lows in oil prices. However, if equities continue to move to new highs and rise above their 200d moving averages, then the bottom is likely in for oil. If oil has indeed bottomed then I hope that President Obama not only supports alternative energy, but moves to secure our oil supplies or more and more will be directed towards China’s shores. The U.S. is at a critical juncture in terms of our energy future as Mexican oil production is in decline, Venezuela directing exports to China, Saudi Arabian internal demand cannibalizing its exports, and Canada serving as one of the few promising suppliers to the U.S. If President Obama moves to implement greater regulation on Canadian oil sands, he will likely be shooting the U.S. economy in the foot, and we can expect higher oil prices than what is necessary.
As President Obama has made an about face in regards to statements made about China’s unfair currency manipulation that could spark trade wars, let's hope his counselors can help him do the same with his plan of putting further regulation on Canadian oil sands exports, or we may lose the goodwill of our number one oil supplier.
© 2009 Chris Puplava