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Is the Russian bear back in his cave?

bearrussThe Ukraine had been the topic on everyone’s lips for over six months. Today, nary a word is written about Russian’s plan to annex that nation. You can thank declining oil prices for that.
While most of the west rejoices over the recent precipitous drop in the price of oil, the story is quite different for the largest producer of fossil fuel energy, Mother Russia. That’s right, Russia, and not Saudi Arabia, leads the world in energy production. As such, Russia depends on energy for 16% percent of its gross domestic product, 52% of total Federal revenues and 70% of all exports. And that was in 2012. Since then the numbers are even higher.
As the price of energy continues to decline, so does the Russian currency, the Ruble. It has dropped by 26% in the last year and just today fell another 1.3%. In the first half of this year alone the Russian economy contracted by over 10% and that was before the brunt of the oil decline occurred. Russian officials estimated they will lose $90-100 billion a year based on oil’s decline.
Officially, the Russian Economic Ministry cut their forecast for GDP in 2015 from 1.2% to -0.8. The Russian people are going to feel that bite with real incomes falling by 2.8%. This will be the country’s first recession since 2009. At the same time, the inflation rate is expected to rise from 7.5% to 9%. In an effort to combat rising inflation their central bank is hiking interest rates at the same time to almost 10.5%, further hurting economic growth.
Earlier in the year, the prospects for the Russian economy were already looking fairly anemic, thanks to Putin’s adventurism in Crimea. In retaliation, U.S. and European sanctions have now begun to bite. By Russian forecasts, those sanctions will cost the country $40 billion this year. They have also effectively closed off global capital markets to Russian banks and corporations. As a result, investment has dropped off a cliff as uncertainty, combined with a lack of security, has devastated corporate Russia.
On December 4th, Putin addressed his government ministers and parliament with a mix of sophisticated economic plans to liberalize the economy and good old fashioned nationalism that would have made Hitler proud. Of course, he blamed the west for everything from Russia’s current economic woes to annexing Crimea and Ukraine.
It was interesting that he barely mentioned the continuing war in Eastern Ukraine. It appears that the declining oil price has damaged Putin’s plans far more than the economic sanctions instituted by the west. Was it a fortuitous coincidence that energy prices started to decline this year just as Vladimir Putin began to marshal his forces for a move into Ukraine?
Readers should remember that the Kingdom of Saudi Arabia, which is getting the blame for not supporting oil prices, is a key U.S. ally. What better way to hamstring Russian adventurism than to hit them where it really hurts via oil? Notice too, that both the administration and congress has been silent about this recent energy rout, although theoretically, declining oil prices hurts our burgeoning shale industry and American efforts at energy independence.
I say let the oil price fall until it doesn’t. Let the markets determine the fair value of energy and hopefully, in the meantime, bankrupt the Russian bear.

Investors should look east

American investors tend to focus almost solely on their own markets. While every nuance of each day’s developments is debated ad infinitum, short shrift is usually given to what is happening overseas. For example, can you tell me how the Chinese stock market has fared this week? read more…

The truth behind Black Friday

The disappointing 11% decline in brick and mortar retail sales on Black Friday took Wall Street and Corporate America by surprise. Excuses vary from the holiday shopping fad has run its course, to people just wanted to be with their families on Thanksgiving. Don’t believe it. read more…

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OPEC’s oil ploy

OPEC’s oil ploy

Over the last four months Americans have received an early Christmas present. The price of oil has dropped precipitously, benefiting both corporations as well as the consumer. But that could be a two-edged sword for this nation.

Brent crude, the global oil benchmark in the futures market, has declined 23% since its June price of $115/bbl. Today it is trading below $83/bbl. providing an enormous windfall in cost savings for all of us. The retail price of gasoline has dropped 15% during the same time period to a national average of $3.17/gallon. Every one-cent decline in gas prices equals about a $1 billion drop in energy spending, according to economists. So we have all just received what amounts to a tax cut that has gone directly into our pockets.

That’s the good news. The bad news is that many of the same economists believe the reason prices have fallen so quickly is the deteriorating state of the global economy. Slower growth equals less demand for oil, all things being equal. As such we find ourselves with an oversupply of oil.

Now usually, OPEC, which controls the lion’s share of oil production worldwide, would begin to throttle down the amount of oil produced per day. There would be meetings and all the disparate members of this energy cartel would decide what cut backs are necessary in order to prop up energy prices. This time around no such agreement is contemplated.

Instead, Saudi Arabia, the energy colossus, has been quietly telling the oil market that they would be quite comfortable with even lower prices for an extended period of time. Behind the scenes, they have said that $80/bbl. for a year or two would be just fine with them even though that level of pricing would hurt all OPEC members, and some more than others. Venezuela, for example, is in such bad shape that oil at that level would probably force the country into bankruptcy.

So what, you might ask, is the reason for this change in strategy?  OPEC recognizes that a new competitor is emerging in the form of United States energy independence. Readers may be surprised to learn that the U.S. has emerged as the number one oil producer in the world, even as it maintains the same spot in energy consumption. We can thank new technology, such as oil and gas fracking, for the turnabout in our energy prospects.

OPEC competitors would like to slow the rate of production here at home, thereby reducing our competitive edge. The best way to do that is by lowering prices. As prices drop certain sources of energy such as fracking and tar sands become less economical in comparison. Industry experts figure that a drop to $75/bbl. in oil would begin to curtail drillers and producers from developing additional fracking wells. The fracking industry has become much more cost sensitive since the early days of 2003. There has been so much capital sunk into the cost of expanding this output that any price change in oil impacts the bottom line much faster.

Investors are well-aware of that risk which explains why many energy stocks have dropped 25-30% over the last month. By keeping prices low for a year or two, OPEC could effectively gut much of the growth in energy production here at home.  I suspect that is their game plan going forward.

There are other negative implications if OPEC succeeds in their plan. The U.S. oil and gas sector has added over 400,000 jobs since 2003. Some estimate that another 1-2 million jobs have been created in construction, manufacturing and transportation to support our drive for energy independence. As a result, although the cost savings in energy consumption might contribute a 0.03% gain to GDP growth, the hit to Americas as a result of a decline in the energy sector could be far greater.

 

 

 

Are we there yet?

 

No, is the short answer to that headline. The S&P 500 Index needs to test 1,905 or thereabouts before all is said and done. You might ask why. read more…

Wash, rinse and repeat

 

The dollars running, stocks are falling, bond prices are jumping while commodities are tanking.  Welcome to another week in the financial markets. Expect more of the same in October. read more…

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Bill Schmick was born in a blue-collar neighborhood of Philadelphia, just a few blocks north of “Rocky Balboa” territory where most of his Catholic schoolmates grew up to be either cops or criminals. He narrowly escaped both professions by volunteering to fight in Vietnam as a U.S. Marine... Read More

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