Supply Destruction in the Oil Market

–This could be the dip you’ve been looking for. Goldman Sachs released a note overnight warning of “nascent signs of oil demand destruction”. This is another way of saying that when oil costs over $100/barrel, people find a way to use less of it. The Goldman note coincided with a tactical retreat by commodity investors.

–NYMEX crude was down another three per cent yesterday and is now down six per cent in the last two days. It joins oil, gold, and copper in the commodities complex in the correction phase. Some of the wire services report that because high oil prices damage global growth rates, you don’t need to hedge against inflation anymore with precious metals.

–This is wrong.

–These little corrections and pauses in the precious metals bull market are your chance to add to your positions on weakness instead of chasing strength. It’s hard to do emotionally, to buy something as it’s going down. It feels like you’re doing exactly the wrong thing.

–But the important thing to remember here is how committed the U.S. Federal Reserve is to keeping U.S. interest rates low and U.S. bond prices high. Just yesterday, Federal Reserve Board members Janet Yellen and William Dudley both took the airwaves to say the Fed doesn’t consider itself responsible for soaring commodity prices and won’t be raising rates any time soon.

–“These developments,” Yellen said, referring to higher commodity prices, “seem unlikely to have persistent effects on consumer inflation or to derail the economic recovery, and hence do not, in my view, warrant any substantial shift in the stance of monetary policy.”

–Translation: “Screw you even if you’re paying more for food and fuel. We’re keeping rates down for our banker friends whether you like or not. Suck eggs.”

–Of course it’s true that demand destruction occurs when anything gets too expensive for people to buy. But with oil and energy, you also have to consider the effect of “supply destruction” on future oil prices. The world’s largest proven oil reserves are located in a region that seems to be on the verge of redrawing national boundaries for the first time since the Ottoman Empire collapsed.

–You’d think that kind of geopolitical change—once properly considered—would put a floor under oil prices regardless of what’s happening on the demand side. All you have to do is read a headline like “Libya to be a ‘new Somalia’” that appears in today’s Financial Review to get an idea of where things might be headed in North Africa and the Middle East.

–Even if it doesn’t play out the way we’re expecting, we’d still suggest these pauses in a long-term bull market are the right time and place to buy rather than sell.

–We’ll leave it at that today. Your editor has been busy in the archives studying the history of oil concessions in the Middle East. To understand what’s taking place today, you have to go back to the origins of the artificial borders in today’s Middle East. More on that later.

–For today, we’ve nothing to add to our on-going study of the RBA and Nugget Coombs. We did cop a bit of flack for what one reader described as a “meanspirited attack” on another reader. The criticism seemed unfair to us, as we quoted the letter in full and addressed it directly. But life is unfair.

–For the record, our argument against Coombs’s intellectual point of departure is that while it’s motivated by a desire for fairness, it achieves the exact opposite in practice. You can’t evaluate the idea by separating it from what it’s actually resulted in. If the way to make Australia “more fair” or “more just” is to increase control over private life and the economy, it doesn’t achieve what it set out to achieve.

–In fact, the more control the government has economically, the less attainable economic prosperity is for everyone. People end up with more debt, and beholden to a small group of government-backed, anti-competitive enterprises (Telstra, the Big Four Banks). You have corporatism, which isn’t “fair” and doesn’t promote political or economic liberty either.

–The alternative is a strong rule of law, low taxes, free trade, sound money, and secure private property. Those pillars of wealth—not central banks, fiat money, fractional reserve banking, and an intrusive wealth-distributing bureaucracy—are what create wealth. If we forget this or take it for granted as we blunder our way into the 21st century, we’ll squander the biggest advantage we’ve ever had in achieving higher standards of living and a greater quality of life.

–As our friend Ron Manners is fond of saying, “ideas matter.” The idea of using institutions like the Reserve Bank of Australia to set the price of money is just one of many ideas that put more faith in centralised government institutions than in the free market. Let’s call it what it is.

— It eventually leads to pervasive and invasive government…so much so that none of us can really imagine what life might be like in a world where the government wasn’t telling you how fast you can drive, what you can eat, where you can smoke, how much of your savings you’re compelled to fork over to the financial services industry and on…and on…and on…and on…and on.

–Mind you the free market isn’t perfect. We were simply pointing out the best system for creating prosperity is based on economic and political liberty. It doesn’t mean there are no regulations. But it does mean that you have to value individual liberty above an abstract idea of collective fairness.

–We suspect this is what some people find so objectionable to the libertarian idea. It seems selfish, like you’re more concerned over your right to be free than the guy out of a job down the street whose down on his luck and could use some help. And after all, no one likes to hang out with self-centred, egotistical tightwads who are only interested in their net worth.

–Now we can’t speak for all libertarians. No one can. But we’d say that placing liberty as the most important value in a political system doesn’t exclude falling in love, being a good neighbour, liking puppies and sunsets, or having moral obligations to other people in the world.  Life (for most people) is about more than getting rich or being free. It’s what you do with your freedom that counts.

–Yet the growth of government encourages people to subcontract their moral obligations to one another via taxation. You pay your taxes therefore you don’t have to worry about caring for the sick, the poor, the elderly, or the education of your children. That’s what government is for. This has led to “mission creep” by government in the form of numerous wars (on terrorism, on fat, on smoking, on drugs, on illiteracy, on poverty). The cost is high and the victories are few.

–Placing liberty as the highest value in your political and economic order (followed closely by private property) doesn’t mean other things in life don’t matter. It means that only when people are free from material wants (being hungry, cold, and homeless) can they begin to have other, qualitative ambitions in life. We should recognise that some ideas make it possible to lift people from poverty while others almost certainly assure that we’ll all be poor together.

Dan Denning
For Markets and Money Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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6 Comments on "Supply Destruction in the Oil Market"

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Oh…I was of the understanding that taking away liberties was big business these days. You can make a lot of easy money by pandering to peoples fear and emotions.
Who can say no to images of car crashes or lung cancer?….correct! nobody will so the tax or penalty stays in and can get ever higher at eat twist of the screws.


Goldman Sacs…They really know how to work both sides of the street.Their advice is only good for their own self interest and how they can manipulate an outcome.

One of the throwaways in my book that built a vision of the perfect secular world (before tearing it down) had the state providing free accommodation and health services to the poor only in the direct area of the city of their birth and requiring those same people to seek alms for their food and basic living needs. I believe Dan may have made a move in his long held views on competition law and anti trust here but I could also be mistaken on his past position. The Ron Manners view on mining leases and property rights is one… Read more »

I have recommended this book once before from a former industrial editor of The Economist that covers the territory Dan is interested in.

Oil Companies and Governments (An Account of the international oil industry in its Political Environment)

J.E.Hartshorn published 1962


“Your editor has been busy in the archives studying the history of oil concessions in the Middle East. To understand what’s taking place today, you have to go back to the origins of the artificial borders in today’s Middle East…………”

This is why you sign up to AWG. Its exactly what I would be doing was it not for the 7am – 5pm, 6 day a week job.

Keep it up Dan. Love digesting your summaries.


“The Goldman note coincided with a tactical retreat by commodity investors.” – Or rather, it triggered the sell algorithm in the supercomputers doing microtrading from the basements of skyscrapers near the NYSE.

I just wonder how much human investors jump on commentary like this coming from investment houses such as GS. Are they sitting there all day with their finger on the sell and buy buttons? Even day traders, I am sure, are no serious match for the computers.

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