The End of the Age of Cheap Oil

Fuel prices are a lot lower here.

That’s one of the first things I noticed when I first moved to Australia.

While prices for everyday items like rent and food were much higher when compared to Spain, fuel was one of only three things I thought were definitely cheaper. In case you are curious, the other two were golf…and sushi.

In fact, Bloomberg recently run an article on this.

When comparing fuel prices around the world, they wrote the following for Australia:

Australia was one of the first nations to institute a wide-ranging tax on carbon dioxide pollution. It then became the first to revoke one. The country is a gluttonous consumer of fossil fuels and has some of the highest per capita greenhouse-gas emissions among industrial nations. Gasoline is cheap, and people drive a lot.

Australia ranks sixth in the world when it comes to fuel affordability. A litre will set you back only 0.68% of your daily wage. On the other hand, Spain ranks number 27 and a litre will cost 1.75% of a day’s wage.

Remember this next time you complain about high gas prices.

World map of gas prices

Source: Bloomberg

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Yet, to be honest, after living in Australia for almost four years, fuel doesn’t seem that cheap anymore.

The truth is that gas prices have been climbing in recent years after hitting a low in 2016, as you can see below.

Graph of gas prices

Source: Bloomberg

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One of the big stories around the globe today is oil, and where the price is going.

And let me tell you, no one agrees.

Recently, oil prices have been climbing higher on shortage concerns.

In July, Saudi Arabia agreed to pump out more oil ahead of the US midterm elections.

There have been export disruptions coming from Venezuela and the US has sanctioned Iran’s oil exports.  And even though the US wants to limit Iran’s oil exports, it has allowed waivers for some of Iran’s oil trading partners to allow them to keep buying…for now.

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The US has also been increasing production. The US Energy Information Administration (EIA) is forecasting production will average 12 million barrels per day in 2019.

But, with the midterm elections over and the oil market looking well supplied, OPEC may be looking to change its tune.

This from Bloomberg:

The wind changed again in a stormy oil market as OPEC signaled it will consider a return to cutting output next year, potentially making the second production U-turn this year.

‘Amid a summer of rising prices and unprecedented political pressure from President Donald Trump, Saudi Arabia, Russia and other producers had opened the taps. Now, with the U.S. midterm elections over and crude futures wilting in the face of another historic shale oil surge, the cartel will discuss a change of course this weekend[…]

‘If the group, led by Saudi Arabia, does ultimately decide fresh cutbacks are necessary, there are a number of challenges. It will need to once again secure the support of rival-turned-partner Russia, which has less need for high oil prices. There’s also the risk of antagonizing Trump, who repeatedly accused the group on Twitter of inflating prices.

‘Another reversal would seem to be a far cry from the usual OPEC mantra of preserving stability and careful market stewardship. Yet it does reflect the level of uncertainty in a market experiencing huge shifts in supply and demand.

The oil story isn’t over

The big game changer in the oil industry for years now has been US shale oil.

If you are not familiar with shale oil, it is produced through a process called fracking. The way it works is oil companies drill down to where the layers of oil and shale are. Then they pump in water, sand and chemicals to ‘fracture’ the layers of rock and release the oil.

The US has become one of the biggest oil producers in the world with shale oil, and has driven prices down.

Back in 2014, the Saudis tried to bankrupt US shale oil drillers by pumping more oil to lower prices. Their thought was that it was more expensive to drill shale oil so they hoped that the move would send them out of business.

Yet the plan failed.

In fact, even though they succeeded in curbing production, the Saudis took quite a hit on their cashflow.

But, the problem is that shale drillers aren’t making much money.

Why are they not generating enough cash? Well, with fracking, production declines over time.

As the New York Times recently reported, the only reason why they are surviving is because of debt.

´The 60 biggest exploration and production firms are not generating enough cash from their operations to cover their operating and capital expenses. In aggregate, from mid-2012 to mid-2017, they had negative free cash flow of $9 billion per quarter.

‘These companies have survived because, despite the skeptics, plenty of people on Wall Street are willing to keep feeding them capital and taking their fees. From 2001 to 2012, Chesapeake Energy, a pioneering fracking firm, sold $16.4 billion of stock and $15.5 billion of debt, and paid Wall Street more than $1.1 billion in fees, according to Thomson Reuters Deals Intelligence. That’s what was public. In less obvious ways, Chesapeake raised at least another $30 billion by selling assets and doing Enron-esque deals in which the company got what were, in effect, loans repaid with future sales of natural gas.

Record low interest rates has allowed them to take on cheap debt.

Now the US Federal Reserve is looking at normalising the economy. They have been slowly raising interest rates in recent years and are looking at more hikes this year and next.

This could put pressure on already highly indebted shale oil drillers at a time when OPEC may tighten production, the US is looking to crush Iran’s oil exports and Venezuela is in turmoil.

And this could push oil prices higher in the long run. The oil story is far from over.

Best,

Selva Freigedo,
Editor, Markets & Money

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Selva Freigedo is an analyst with a background in financial economics. Born and raised in Argentina, she has also lived in Brazil, the US and Spain. She has seen economic troubles firsthand, from economic booms to collapses and the ravaging effects of hyperinflation, high unemployment, deposit freezes and debt default. Selva now writes from her vantage point here in Australia. She is lead Editor at the daily e-letter Markets & Money. And every week, she goes through each report and research note produced by our global network of trusted advisors to find the best investment opportunities for you in Australia and overseas. She packages these opportunities for you in Global Investor.


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