Tighter production targets have failed to lift the price of oil

Demand has risen more slowly than at any time since the financial crisis

The Organisation of the Petroleum Exporting Countries, or opec, live in a state of uneasy anticipation. Concern about climate change may mean demand for oil wanes in the coming decades. opec’s power in oil markets is fading fast. On November 13th the International Energy Agency (iea), an intergovernmental forecaster, predicted that by 2030 opec and Russia, an ally, would pump just 47% of the world’s crude. Yet opec has a more immediate problem at hand.

Global demand for oil has been unexpectedly anaemic this year (see chart ). Sanford C. Bernstein, a research firm, estimates that it may have risen by just 0.8%, the slowest pace since the financial crisis. opec and its allies, led by Russia, are due to meet in Vienna on December 5th and 6th. The first question is whether they will announce a new plan to support the oil price. If they do, the second question is whether they will stick to it.

Technically, a plan is already in place. In December 2018 the broadened opec alliance announced a cut in production of 1.2m barrels a day, with the intention of pushing up the price of crude. That agreement has been extended to March 2020. But several opec members, including Iraq and Nigeria, have frequently pumped more oil than allowed by last year’s deal.

Russia was supposed to help opec move into a new era. But the starting point from which it agreed to cut production was unusually high—and output this year has exceeded its quota even so. The country’s oil industry “is really chafing under these production cuts”, says Aaron Brady of ihs Markit, a data and research firm. The result is that Russia’s average daily production so far in 2019, after the opec deal to lower output, is higher than the average in 2018, before the deal was struck. Saudi Arabia has adjusted accordingly. In July and August, for instance, the kingdom cut output by more than twice the amount required by last year’s agreement.

But such efforts have proved insufficient to lift oil prices. On the face of it, they should have been buoyant. American sanctions have clamped down on exports from Venezuela and Iran, respectively the possessors of the world’s largest and fourth-largest proved oil reserves. Tankers have been seized in the Gulf. Iraq, opec’s second-largest producer, is at risk of being engulfed by protests. Most notably, in September a drone attack knocked out more than half of Saudi Arabia’s production. The loss was more severe than that caused by the Iranian revolution in 1979 or Iraq’s invasion of Kuwait in 1990.

Yet oil markets have shrugged it all off. “In the past such geopolitical tensions gave a boost to oil prices,” says Fatih Birol, the head of the iea. The price of Brent crude has subsided from a high of nearly $75 in April to around $60 today.

One reason is that America’s frackers have continued to pump more oil. The country’s daily output in September was 12% above last year’s average. It is also because economic growth has slowed, with oil demand suffering not just in Japan but in India and South-East Asia, where it was expected to grow strongly.

Next year economic growth may tick up. Investors are pressing American shale companies to reduce spending and boost profits. That would result in flatter production and, in turn, help nudge prices higher.

But new supply elsewhere looks set to push prices in the other direction. ExxonMobil is ramping up production off the coast of Guyana. Brazil’s attempt to auction new offshore leases this month was a failure—supermajors, such as ExxonMobil and bp, declined to bid. Yet investments already made offshore mean that by 2021 Brazil’s crude production may be 18% higher than this year, according to ihs Markit.

Norway will also see a surge in output. Notwithstanding its announcement in October that its sovereign-wealth fund would sell its holdings in oil exploration and production companies, the country itself is expected to increase production markedly in the coming years. Its state-backed energy giant, Equinor, said in October that Johan Sverdrup, a giant new oilfield in the North Sea, had begun producing crude.

The broadened opec alliance must now decide whether to hold at the reductions agreed to last year, or to cut harder. The current arrangement may be insufficient to keep Brent crude above $60 a barrel. Yet there may be little appetite for dramatically lower production targets.

Aramco, Saudi Arabia’s state-backed oil company, plans to list some of its shares in mid-December, shortly after opec’s meeting. Any agreement for a big cut in the kingdom’s output would lower estimates for Aramco’s earnings, which would suppress its valuation, points out Neil Beveridge of Bernstein. On the other hand, he says, “the worst thing that could happen to Aramco would be to see the listing go ahead and see the oil price collapse.” This has been a dramatic year on oil markets. December could bring further plot twists. ■

The case for a falling dollar

Why dollars's ascendancy is looking very tired. 

Nobady wants to be called an unthinking optimist. Prospects for the riskier sort of investments are cloudy. The global economy faces numerous threats. Being even mildly bullish can seem a bit unreflective.

So whisper it, don’t shout it, but the mood has changed recently for the better. Since the start of October, global equity prices are up by around 7%. Bond yields have risen. There has been a move away from the safe or defensive assets that hold up in bad economic times, towards those that do well in an upswing . Hopes for a preliminary trade deal between America and China pushed the yuan briefly below seven to the dollar last week.

At times like these, thoughts naturally turn to the outlook for the dollar more generally. A weaker dollar would be both a signal and a driver of a broader improvement in risk appetite. The dollar’s fortunes have not yet shifted decisively. But the conditions for it to weaken are starting to fall into place.

To understand why, consider the forces behind the dollar’s ascendancy since 2014. America’s economy, though sluggish by historical standards, has benefited from an ever-reliable engine: the American consumer. The euro-zone, by contrast, responded to its sovereign-debt crisis by saving more. Its surplus savings, together with those generated in Asia, must find a home. America’s high-yielding bonds and modish technology stocks have made it the go-to place for global savers. Capital inflows drove up the price of dollar assets. America’s net investment position—the foreign assets its residents own abroad minus what they owe to foreigners—went deeper into the red (see chart).

As industry slumped and trade faltered this year, America still looked the best of a bad lot. But the scales are tilting against the dollar. Global manufacturing may have bottomed out. The purchasing managers’ index for industry compiled by the global economics team at JPMorgan Chase rose for a third month in October. Growth in output is barely positive, but an improving trend in new orders alongside falling stocks is a sign of a turn in the manufacturing cycle. The improvement is halting. Jobs-rich service industries are still slowing, so it is too early to expect better gdp growth. But hopes are growing of a pickup in 2020, driven by economies beyond America’s shores.

This matters for the dollar. Synchronised global gdp growth opens the door for investors to move capital out of America’s expensive dollar assets to where assets are cheaper, says Hans Redeker, a currency strategist at Morgan Stanley. Moreover, interest-rate cuts this year by the Federal Reserve mean that the dollar is now receiving less support from elevated bond yields. Central bankers in other places are disinclined to relax policy further. The European Central Bank’s governing council, for instance, was divided on the decision in September to cut interest rates and restart quantitative easing.

A shift in global capital away from America would be a particular boon to emerging markets. A fall in the dollar would make it easier to service their foreign-currency debts. It would also ease local credit conditions, thus helping gdp growth. For investors, emerging markets are where the value is. Equity markets are cheaper. Bond yields are higher. Currencies have scope to make up the ground they lost earlier this year and in the slump of 2013-16.

Apart from such trouble spots as Argentina, Chile and Turkey, emerging-market currencies have started to rally against the dollar. Still, the euro is the gauge by which many people judge the dollar’s vigour, or lack of it. And it has been stubbornly weak. Sentiment is coloured by the travails of Germany, the currency zone’s largest economy, which only narrowly avoided a technical recession (two quarters of declining gdp) in the six months to the end of September. But the euro at least seems to have found a floor. And if the world economy gathers strength the euro will eventually rally.

That is still a big if. Another breakdown in trade talks between America and China could lead to a renewed slump in global manufacturing and business spending, and kill off any incipient dollar weakness. Other political risks—the protests in Hong Kong; the Democratic primaries in America—are looming larger. And after a longish expansion, the world economy is lacking vigour. But the dollar’s stint at the top of the currency pile is looking tired, too. People are already whispering. The noises may soon get a lot louder.

How machine learning is revolutionising market intelligence

The business of gathering market-sensitive information is ripe for automation

The Thames seems to draw people who work on intelligence-gathering. The spooks of mi6 are housed in a funky-looking building overlooking the river. Two miles downstream, in a shared office space near Blackfriars Bridge, lives Arkera, a firm that uses machine-learning technology to sort intelligence from newspapers, websites and other public sources for emerging-market investors. Its location is happenstance. London has the right time zone, between the Americas and Asia. It is a nice place to live. The Thames happens to run through it.

Arkera’s founders, Nav Gupta and Vinit Sahni, both have a background in “macro” hedge funds, the sort that like to bet on big moves in currencies and bond and stock prices ahead of predicted changes in the political climate. The firm’s clients might want a steer on the political risks affecting public finances in Brazil, or to gauge the social pressures that could arise as a consequence of an austerity programme in Egypt. It applies machine learning to find market intelligence and make it usable.

For many people, the use of such technologies in finance is the stuff of dystopian science fiction, of machines running amok. But once you look at market intelligence through the eyes of computer science, it provokes disquieting thoughts of a different kind. It gives a sense of just how creaky and haphazard the old-school, analogue business of intelligence-gathering has been.

Analysts have used text data to try to predict changes in asset prices for a century or more. In 1933 Alfred Cowles, an economist whose grandfather had founded the Chicago Tribune, published a pioneering paper in this vein. Cowles sorted stockmarket commentary by William Peter Hamilton, a long-ruling editor of the Wall Street Journal, into three buckets (bullish, bearish or doubtful) and attached an action to each (buy, sell or avoid). He concluded that investors would have done better simply to buy and hold the leading stocks in the Dow Jones index than to follow Hamilton’s steer.

The application of machine-learning models to text-as-data might seem a world away from Cowles’s approach. But in concept, it is similar. The relevant text is sought. Values are ascribed to it. A statistical model is applied. Its predictions are tested for robustness. Of course, with bags of computing power and suites of self-learning models, the enterprise is on a different scale from Cowles’s rudimentary exercise. The endless expanse of the internet means far richer source material. The range of possible values ascribed to it will be broader than “bullish, bearish or doubtful”. And self-learning algorithms can test and retest the combinations that yield the best predictions.

It is tempting to focus on the black-box elements of all this: the language software that “reads” the source text and the algorithms that use the data to make predictions. But this is like judging a hi-fi system by its speakers. A lot of the important work comes earlier in the process. Arkera, for instance, spends a lot of effort finding all the relevant text and “cleaning” it—stripping it of extraneous junk, such as captions and disclaimers. “A good signal is crucial,” says Mr Gupta.

He gives Brazil’s pension reform as an example. The country has 513 parliamentarians. They have social-media accounts, websites and blogs. They speak to the press—Brazil has scores of regional newspapers. All are potential sources of useful data. If you cut corners at this stage you might miss something that even the best statistical model cannot fix later. There is little point in having a cool amplifier and great speakers if the stylus on your record-player is worn out.

Any good emerging-market analyst knows this, too. If you bumped into one shortly after Brazil’s elections last year, he was probably on his way to Brasília to sound out prospects for a crucial pension reform. Without it, Brazil’s public debt would be certain to explode, sparking capital flight. In July a pension bill finally passed Brazil’s lower house. Arkera’s models tracked the leanings of Brazil’s politicians to get an early sense of the likely outcome. It would be hard for an analyst working unaided to mimic this reach, even if he was always on the ground and spoke perfect Portuguese.

Intelligence-gathering is a labour-intensive business. It is thus ripe for automation. That this is happening in finance is also natural. There is a well-defined objective (to make money). There is a well-defined end-point (buy, sell or avoid). Without such clarity of purpose, intelligence is an endless river. It is one undammed thing after another.

The improved mood in financial markets

Investors are shunning safe assets in favour of risky ones

It has been a year of mood swings in financial markets. In the spring and summer, anxious investors piled into the safety of government bonds, driving yields down sharply. Yields have recovered in recent weeks (see chart 1). This is not the only sign that investor sentiment has improved.

In general, safe assets have been sold in favour of cyclical ones. The Australian dollar, a cyclical currency, is up against the yen, a haven for the fearful. Something similar is happening in commodity markets, where the price of copper, a barometer of global industry, has risen against the price of gold (see chart 2).

Equity prices in America have reached a new peak. But what is more striking is the performance of cyclical stocks relative to defensive ones. Within America’s market the prices of industrial stocks, which do well in business-cycle upswings, have risen relative to the prices of utility stocks, a safer bet in hard times. In Europe the stocks of financial firms, the fortunes of which are tied to the business cycle, have risen relative to those of firms that make consumer staples—food, beverages, household goods and so on—which are more resilient in bad times (see chart 3).

Investors have also begun to embrace assets at the riskier end of the spectrum. A host of emerging-market currencies have gained against the dollar since the start of October (see chart 4).

Five Energy Innovations To Transform The World

The term “disruptor” has become an overused phrase that has cheapened the perceived impact that new tech, new processes, new ideas, and new generations have on the world. But there are a handful of true disruptors in the energy industry that may rather unexaggeratedly change the way in which the world works.

The EIA’s chief energy modeler disagrees. “First, there are no technology revolutions between now and 2050, no structural breaks, no technology breakthroughs. Sure, technology can lead us to evolve, prices get cheaper, technology continues to improve, but no breakthroughs, no dilithium crystals,” Daniels said earlier this week at Rice University’s Baker Institute. 

True, the slower changes are much more common. But every now and then, something comes on down the line that surprises us all. In today’s faster-paced environment, and with the next generation of thought leaders stepping up to the plate, combined with the growing need to arrest the damaging effects that some of these energy sources have had on the environment, the race is on to do more, to do better, to do cheaper. 

 But there’s a catch, even with the cleverest of inventions, and that’s that even great ideas struggle with implementation.

But this challenge hasn’t stopped some trendsetters from forging ahead with new ideas. From kinda nutty to astonishing, we have listed some of these true energy breakthroughs here.

#1 California’s Solar Mandate - One of the potentially largest energy innovations is not technology based. Instead, it is a legislation that capitalizes on existing but relatively underutilized technology--solar panels. The tech is there, and soon the legislation will be too--at least in California. Mid-2018, California approved a measure that would require all new homes built in California in 2020 and later to include solar panels. 

It is the first US state to adopt such a bold requirement, which was not without its opposition due to the cost it would burden homebuyers with. This upfront cost, however, will be partially offset by lower utility costs down the line. Longer term, this will affect energy needs in California, which is currently plagued with repetitive blackouts during the windy season for fear of sparking wildfires, which California blames on climate change, or PG&E, depending on which argument suits them on the day.  

The ambitious solar panel requirement is expected to add a cost of almost $10K to each home built, in a state that already has the highest home costs in the country. While this will be burdensome for homebuyers, proponents of the change estimate that it will drastically curb electricity consumption in the state, which contributes 14% of California’s greenhouse pollutants.

How much of a game-changer is this? It will likely spur on other states to follow suit, and not only will it change the amount of fossil fuel-derived energy consumed, it will also ignite a race to develop better and less expensive PV panels, paving the way for an even broader adoption.

#2 Data Management and Digitization - It sounds less exciting than some of the other breakthroughs in energy, but this one has the potential to reap the most benefits for the energy industry. Good data, collecting data, and analyzing that data are essential tools for squeezing out additional gains from all forms of energy. While some in the energy business are focused on moving towards more sustainable energy, others are more practically moving to eek out more gains on existing forms of energy by improving the data.

Arguments for this method of improving the way we do energy are compelling. But data is data, and data is boring--it hardly elicits the same thrill as Musk’s BFR that will change the way we transport people around the world. But even as long ago as in 2017, the IEA’s Digitalisation and Energy 2017 report suggested that digitalisation could save 5% on annual power generation costs. Specific gains can be made through smart drilling, fault prediction through AI, improved AI to sift through seismic images and geology models to improve oil and gas exploration, and predictive algorithms that will allow utilities to better plan for peak usage. 

#3 Thermal Resonator - MIT has come up with a device called the thermal resonator that draws heat from the air around it before turning it into electricity. It doesn’t require sun like solar panels--it actually can sit in perpetual shade. For now this is just generating a small amount of power, but it has the potential to render batteries obsolete.  

#4 Fusion - This one is not right around the corner, and some joke that fusion has been a decade away for the last forty years. But new advances here are being made all the time, and it’s possible that by 2030, it may be a reality. Of all the ideas on this list, it has the greatest potential to change the entire energy industry for good. Fusion reactors can’t meltdown (hello, Chernobyl), don’t create eternal radioactive waste, and therefore will not spark the same public fear that normal fission nuclear reactors have had. 

The International Thermonuclear Experimental Reactor (ITER), funded by the China, India, Japan, South Korea, Russia, and the United States, is probably the furthest along with this tech, and hopes to build the world’s largest fusion device that is expected to be ready in 2035.

#5 PET Recycling - One of the most recent breakthroughs will have an indirect effect on the energy industry, and it is a transformative one. BP is soon rolling out a $25 million prototype plant to recycle PET containers again and again. This is a deviation from the current way of doing things, which has PET bottles landfilled after a single use, or at best, allows for recycling PET bottles just one time. This doesn’t directly apply to energy, but because PET is derived from crude and nat gas, solving the environmental problem associated with PET will go a long way to securing future demand for fossil fuels. This could have a significant but indirect effect on the energy industry by bolstering confidence in this sector which will encourage research and investments into new tech for fossil fuels.

Some honorable mentions include the quantum battery that never loses its charge, the itty bitty battery that can work in the extreme cold, Tesla’s million-mile battery, and a way of extracting hydrogen from oil without releasing greenhouse gases, but the total number of energy developments are far too numerous to count. It is only a matter of which one will be the next breakthrough that will change the course of energy forever.

Gold, Stocks, & Crude: "Oil Is Clearly The Odd Man Out"

At first blush, US stocks, gold and crude oil may seem like 3 very different markets:

• Equity prices essentially measure optimism related to human ingenuity (corporate profits) balanced with fears of equally human frailty (central bank management of long run inflation expectations).

• Gold, by virtue of its 5,000-year track record, prices the desire of market participants to hold physical assets that are no other participant’s financial liability.
• Crude oil prices reflect something akin to the global economy’s blood pressure reading. New technology has shifted this calculus over the last decade, but the world still uses 81 million barrels/day. Demand still matters to that market even if potential supply is higher than prior periods.

Against those differences these 3 assets share one common bond: they are priced in dollars. With rare exception you need greenbacks to buy all of them. On top of that, their units (S&P 500, troy ounce, 42 gallon barrel) do not change.

This combination of differences and commonalities makes a stock/gold/oil relative price analysis a useful exercise. We use World Bank data for each from 1970 – present (email us for the spreadsheet), which has longer run information than just WTI prices, for example. Here is what the latest data shows:

#1: The S&P 500 currently trades spot-on its long run average ratio to gold:

• The S&P 500 trades for 3119; gold is $1,471/oz. The ratio: 2.12.

• Over the last 30 years the average S&P/gold ratio has been 2.07.

• The chart below (1970 – present) shows how the S&P/gold ratio has done an excellent job of spotting when equity market optimism was either too high (1998/1999 at +4x) or too low (2008 – 2012, when the S&P 500 and an ounce of gold went for about the same amount).

Upshot: by this measure the optimism imbedded in US equity prices is at equilibrium with the caution priced into gold markets.

#2: The S&P 500 does, however, trade rich to oil prices:

• The World Bank data uses a blend of WTI, Brent and Dubai prices. The average of those today is $59/barrel.

• That makes the S&P/oil price ratio 52.8.

• This is well above the 30-year average of 32.8, in fact fully one standard deviation (18.9) over the long-run mean.

• The chart below (1970-present) highlights that US stocks have been well above their long run average ratio to oil since 2015, when crude prices collapsed. They are not anywhere near the late 1990s (ratios +80x), however, which saw peak levels of equity market enthusiasm coupled with trough levels of global economic optimism due to the 1998 Asia Crisis.

Upshot: that the S&P/crude ratio has run consistently at 40-60x since 2015 points to a systemic belief that equity valuations benefit from disruptive technology (Big Tech valuations/price gains) but oil prices suffer from the same phenomenon (American energy independence from new extraction methods).

#3: The gold/crude oil ratio is noisy through time, but at current levels the yellow metal looks expensive:

• The ratio here based on the prices noted above is 24.9x.

• The 30-year average is 16.8x, with a standard deviation of 5.8. That puts the current ratio almost 2 standard deviations away from the mean (28.4).

• The chart below (1970-present) shows you have to go back to the 1980s/1990s to find a period where the gold/crude ratio runs reliably above 20x. When it happens, however, it can be just as sticky as the 10-20x band we’ve seen more recently.

Upshot: oil comes up “cheapest” against both gold and stocks, but as with the prior point there’s good reason for that. In this case, no one has figured out how to frack gold deposits just yet.

*  *  *

Summing up: using these simple ratios we find that global capital markets are pretty well balanced between fear (gold prices) and greed (stock prices) but oil is clearly the odd man out. If your inner contrarian says that’s an opportunity, we would advise caution just now. Prior history says it can remain cheap relative to stocks and gold, even without the overhang of technological disruption.

China "Discreetly" De-Dollarizing Amid Ongoing Trade Tensions

Ongoing trade conflicts have forced China to increase financial decoupling between the US. China wants to decrease its US exposure and diversify its reserves away from dollars, according to economists at Australia and New Zealand Banking Group (ANZ).

"The ongoing trade war and geopolitical issues have increased the risk of a financial decoupling between China and the US," Raymond Yeung, Greater China chief economist, wrote in a recent note.

ANZ predicts Beijing will quickly diversify its foreign exchange reserves away from dollars.

"Although China still allocates a high share of its FX exchange reserves to the US dollar, estimated at around 59% as of June 2019, the pace of diversification into other currencies will likely quicken going forward," Yeung said.

ANZ told CNBC that China would likely diversify into British pounds, Euros, and Japanese yen... and gold.

Source: Bloomberg

ANZ believes China is building "shadow reserves" as a way to diversify from the dollar.

"In fact, we believe that the Chinese government has already discreetly diversified its offshore portfolios to include alternative investments," the report said.

Yeung said, "factory-dollar recycling" has contributed to "the global prominence of the US dollar over the past decade. However, if China initiates a convertible standard superior to the fiat-money regime, not only will it gain a market following, but it will also boost the global acceptance of the RMB."

Although the dollar is the world's reserve currency, Yeung warns it could be displaced in the coming decade.

China has spent the last six years, reducing its holdings of US Treasurys.

Efforts of de-dollarization by China could reduce the world's reliance on the dollar by 2030, and at some point, catapult the renminbi into the hot seat.

Remember, nothing lasts forever...