It’s going to happen sooner than you think. You’ll casually stroll to your post box, not expecting the shock inside. And then you’ll open your electricity bill and see that it’s double or even triple what you normally pay. There won’t be any good reason for it. It won’t be because you’ve used more power, or because someone’s running a dance club out of your living room while you’re away at work. It will be the result of specific failures to avert a perfectly predictable crisis.
Today’s Markets and Money will take up where yesterday’s left off: the looming spike in the price you pay to keep the lights on. No matter how much oil and gas Australia has, waiting to be extracted through new technologies that are changing the world, the energy crisis is headed your way like an Italian train under Mussolini: on time and with precision.
But before we get to the needless crisis that no one in politics wants to talk about, let’s pay homage to the financial markets. The Australian share market shook off its fear of Fed ‘tapering’ and rallied 1.5% yesterday. It was a brave performance. And in the US, the Dow Jones Industrials and the S&P 500 have railed for four straight days.
Not even a note of caution from the International Monetary Fund (IMF) could rain on the parade. For the fifth time since late last year, the IMF revised down its estimated growth rate for 2013. This time it was from 3.3% to 3.1%. The Fund’s chief economist, Olivier Blanchard, said that, ‘After years of strong growth, the BRICS are beginning to run into speed bumps.’
Duh. Really, statistical revisions to global growth models are meaningless. The only real issue here that bears on stock markets is where growth is going to come from. Is it the emerging markets or is it the developed markets? The IMF is worried that China’s effort to rebalance growth will hurt commodity exporters. It’s also worried that less US stimulus will accelerate capital flows away from emerging markets toward the US.
Basically, the IMF is worried about everything, but still managed to generate a forecast of three per cent growth. That seems like the sort of forecast a bureaucracy would make; safe, conservative, useless, and capable of being revised in either direction. But maybe it’s also a testament to fundamental cheerful optimism of human beings, without which none of us would get out of bed in the morning.
If you’re watching the oil markets, though, you may have noticed an internal contradiction. Oil prices are rising at the same time that global growth forecasts are not. Geopolitical tensions (Egypt) and concern about future supply are partly to explain. But demand certainly isn’t a factor. Yet the price rises all the same.
A barrel of West Texas Intermediate (WTI) crude is going for around US$104 these days. What’s more, the spread between WTI and Brent crude is now below $5 for the first time in two and half years. WTI has temporarily ‘decoupled’ from Brent thanks to increased US oil production from shale oil plays. We’ll see how permanent this semi-recoupling is. But first, take a look at the chart below.
The chart tracks the S&P energy sector fund (NYSE:XLE) over the last ten years on a weekly basis. The fund is made up of integrated (upstream AND downstream) US oil giants like Exxon Mobil and Chevron. But it also has oil service companies like Schlumberger in the mix. In fact 20% of the fund’s holdings are in equipment services. It’s a proxy for the US energy industry.
So what does the chart tell you? Well, the US energy sector fund is near an all-time high. What’s driving it? Is it higher oil prices? Higher US growth expectations? Or is it like 2008, when oil became the fashionable way to speculate on higher equity prices?
It’s not obvious why oil prices should rise because equity prices are rising, especially when the rise in equity prices is simply inflation in the price/earnings ratio (no real improvement in underlying earnings, just higher stock prices). Without any rational explanation, then, we’ll have to chalk it up to the return of headless chicken trading.
Despite the ETF-generated noise in the market, there IS a serious energy issue for Australia right now. And as we mentioned at the head of today’s letter, you’ll be hearing about it in your post box soon enough. But you needn’t take our word for it. Just listen to Incitec Pivot’s James Fazzino, who decided to build a $940 million ammonia plant in the US state of Louisiana because of cheaper energy (thanks, again, to the technology which made the shale boom possible).
‘There is a train coming down the track and where we are going to end up is a train wreck, and it is not just industry that will be affected,’ Fazzino told the Australian Financial Review. ‘Consumers are going to find their gas prices triple as well.’ That is not a misprint.
The US gas boom has reduced natural gas prices there to about $3/gigajoule. By comparison, Australia is exporting LNG at about $10/gigajoule. That would be fine if the only people paying $10/gigajoule were the export customers buying gas from Aussie natural gas producers. But soon enough, industrial and residential users will find themselves paying similar prices.
The trouble is that while Australia is about to become the world’s largest exporter of LNG, domestic gas consumers are going to have to pay export prices for natural gas, if they can find it. LNG is sold under long-term contracts. The coal-seam-gas (CSG) from Queensland is already ear-marked for customers in Japan, Korea, and China.
Fazzino reckons higher natural gas prices could cost 200,000 jobs in industries where gas is a major cost. Australia will lose even more manufacturing and industrial jobs due to artificially imposed higher energy costs. And the country will completely miss out on the chance to create petrochemical jobs that use cheap gas as a feedstock (the Saudi and American plan).
The politicians are ignoring the fight. Industry (natural gas users) want LNG production reserved for domestic users. Producers want to sell the gas on the global market at the highest price. But surely the best solution is to produce more natural gas. That lowers prices for domestic users and creates jobs. It will also, undoubtedly, create more carbon dioxide emissions. But even this will warm the planet and prevent a coming ice age.
But the train wreck is coming, thanks to poor regulatory foresight. New South Wales is all but closed to further unconventional natural gas development. And it will take a lot more drilling before the Cooper Basin is able to ramp up production enough to make a difference in supply and bring prices down. Mind you, that still leaves Cooper Basin energy stocks as the single most exciting sector in the Aussie market, in our view. At least that’s some consolation for the pain of higher utility bills coming your way soon.
for Markets and Money Australia
From the Archives…
Central Bankers in Driving Seat
5-07-13 – Greg Canavan
China’s Economic Rebalancing and the Impact on the Australian Economy
4-07-13 – Greg Canavan
Gold Market Rhyming
3-07-13 – Greg Canavan
How Low Can the Gold Price Go?
2-07-13 – Bill Bonner
No Real Economic Recovery Without “Hitting Bottom” First…
1-07-13 – Bill Bonner
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