What convinces masses are not facts, and not even invented facts, but only the consistency of the system of which they are presumably part—Hannah Arendt
In this issue
Will the Local Upstream Oil (Exploration and Production) Firms Join the Global Energy Party? Are Higher Energy Prices “Transitory?”
I. Will the Local Upstream Oil (Exploration and Producers) Firms Join the Global Energy Party?
II. Why The Disconnect Between International and Local Markets?
III. Are Higher Energy Prices “Transitory?” The Structural Transformation of the Global Economy Requires Immense Amounts of Capital Investments
IV. Feedback Loop: Supply Disruptions Lead to Power Outages and Vice Versa! Output Cuts Spur Surge in Base Metal Prices!
V. The Cure to Higher Prices is Higher Prices; Seismic Face-off: Slowing Demand versus Supply Disruptions
Will the Local Upstream Oil (Exploration and Production) Firms Join the Global Energy Party? Are Higher Energy Prices “Transitory?”
I. Will the Local Upstream Oil (Exploration and Producers) Firms Join the Global Energy Party?
Figure 1
The price of a barrel of US WTI crude oil has breached the USD 80 level, a 3-year high. It was last quoted at over USD 81. The Brent crude has also gone past USD 84.
Participants of the PSE have frantically been bidding on everything related to index-related issues, except where it matters: Upstream oil issues!
The law of supply tells us that "an increase in price results in an increase in quantity supplied," which means that the present price levels of oil encourage or increases the incentives for exploration firms to seek out new commercial reserves for production.
Proof?
From CNN Philippines, October 14: The Philippines will finally start drilling activities in Service Contract 37, located onshore Cagayan Basin, according to the Philippine National Oil Company Exploration Corporation (PNOC-EC).
And share prices of international upstream oil ETFs are reflecting these!
While share prices of the ETFs of global oil exploration firms, represented by iShares oil and gas (SPOG.L) and SPDR S&P oil and gas (XOP), are exploding in the US and elsewhere, they are being sold here! Incredible. (Figure 1, topmost pane)
Here, share prices of the major players PXP Energy [PSE: PXP], ACE Enexor [ACEX], Oriental Petroleum [OPM], and Philodrill [OV] are at one-year lows! (Figure 1, second to the top window)
In the meantime, there has been some interest in the share prices of low-volume minor players PetroEnergy Resources Corporation [PERC] and Forum Pacific [FPI].
According to industrial service firm Baker Hughes/Tradingeconomics.com, in the US, the number of active oil rigs has risen for six consecutive weeks through October 15, following the plunge to a multi-year low in 2020. (Figure 1, lowest pane)
II. Why The Disconnect Between International and Local Markets?
The Efficient Market Theory (EMH) tells us that prices reflect all available information.
Really? Then why the brazen disconnect? On the contrary, share prices of local upstream oil seem to depict the invalidity of the law of supply. Or, share prices are immune to economics 101!
The thing is, the incongruence between local and international markets signifies a startling revelation of the pricing shortfalls or distortions brought about by the intensive gaming of the domestic markets.
But there is a silver lining.
The current divergence illuminates possible templates about risk-reward opportunities with opulent payoffs. Or market prices will eventually reflect on economic realities.
And mind you, returns for the sector will be different. The high and volatile energy input prices are likely to impact the downstream and utility sector adversely.
As noted last week,
Domestic utilities are likely to suffer from a margin squeeze unless allowed by the NG to adjust selling prices. A profit margin squeeze magnifies the risks of supply shortfalls leading to power outages or rationing, similar to China.
Despite Lower September CPI, Philippine Treasury Yields Soar, Spreads Steepen! Greenflation Implodes the ESG Bubble! October 10, 2021
As of this writing, in the UK, twelve utility companies and two in Singapore have shut or are in the process of exiting their business since prices of natural gas exploded.
The momentum of the iShares Global Utilities ETF (JXI) and downstream iShares Global Energy ETF (IXC) appears to have stalled. (Figure 1, second to the lowest pane)
The underperformance of the downstream and utility sectors could persist should rising prices of oil and natural gas continue.
That is to say, domestic utilities are prone to a margin squeeze.
The same difference applies to coal mining (upstream) and coal-based energy producers (downstream).
III. Are Higher Energy Prices “Transitory?” The Structural Transformation of the Global Economy Requires Immense Amounts of Capital Investments
Rising energy prices are "transitory," assures the mainstream experts. How? Because the reopening of the supply lines will ease the bottlenecks.
Figure 2
The sardonic caricature of Santa Claus on gift-giving provides a nifty but somewhat accurate explanation of why transitory meme misleads. (Figure 2, topmost window)
To be clear, based on proven reserves, the world is not running out of coal.
But the current surge in prices is about mounting scarcity of available reserves.
According to the 2021 Coal: Statistical Review of World Energy of the BP plc, the decrease in coal production was larger than demand in 2020. From 2009 to 2019, reserves grew by a razor-thin margin.
The crux lies in the mounting mismatches between energy production and demand. A mishmash of factors has hampered the production of hydrocarbons and coal. These include caps on price, investments, and production due to green policies, the unsustainable baseloads of alternative energy, geopolitics, weather, substitution, the realignment of the economic structure in response to the pandemic and the attendant policies, labor displacements, and shortages, supply and transport bottlenecks and more.
Falling investments in energy extraction have led to lower output. (Figure 2, middle window)
Aside, other factors matter too.
For instance, Norway's hydro energy sector is experiencing a power crunch as water reservoir levels fall to their lowest in more than a decade. It is an example of the influences of weather, substitution, and limits of supply. (Figure 3, lowest window)
In the meantime, a combination of factors contributed to the spike in energy demand: Massive money supply growth from credit expansion, the reopening and restructuring of the economy, weather, aggregate bailout policies from both the central banks and the central governments through fiscal stimulus, and more.
Simon Black of the Sovereign Man* provides a perspicacious narrative of the dramatic and sudden transformation of the global economy.
Demand: The rapid, dramatic and critical shift towards digital B2C (business to consumer model). [all bold mine]
Global shipping demand surged last year in ways that had never been seen before. Suddenly, instead of efficient supply chains shipping goods to large marketplaces (like retail and grocery stores), consumers wanted everything delivered to them.
While the total volume of shipping was largely the same (or even less) than previous years, the number of individual shipments increased dramatically.
In other words, instead of a single large shipment to a store or supermarket, companies were making thousands of tiny shipments to individual consumers.
This meant more trips… and more packaging. More cardboard boxes. More plastic wrap. More plastic containers. More Styrofoam.
And the prices for all of these materials has spiked.
Supply: Massive dislocations and bottlenecks in the supply network as a result of the lagged response to the deep recession.
Supply has fallen. Last March when a number of wood pulp producers went out of business, no one noticed and no one cared. But it turned out that more than 10% of all North American paper capacity vanished, practically overnight, just before demand started to surge.
And this capacity cannot be simply turned on again with a flip of a switch. It takes a lot of effort to resurrect a bankrupt factory, to re-hire and re-train workers. (We’ll get to the worker issue in a moment.)
It’s a similar trend around the world– foreign factories have closed, and those that remain open are struggling to retain workers and operate under strict COVID protocols. Manufacturing efficiency is way down as a result, so they’re not producing enough supply to keep up with demand.
Then there are the actual shipping problems– the crazy delays, especially on the West Coast of the United States, that prevent container ships from delivering their cargo.
*Simon Black, Three bizarre reasons why inflation is here to stay Sovereign Man, October 11, 2021
Analyst Jeff Snider of the Alhambra Investment** eloquently provides a specific example: The Food industry.
The food supply chain had for decades been increasingly adapted to meeting the needs of two very different methods of distributing food products; X amount of capacity was dedicated to the at-home grocery model, while Y had been set up for the growing penchant for eating out (among the increasingly fewer able to afford it). Essentially, two separate supply chains which don’t easily mix; if at all.
Not only that, food distributors can’t simply switch from one to the other. And even if they could, the costs of doing so, and the anticipated payback when undertaking this, were and are massive considerations. McKinsey calculated these trade-offs in the middle of last year, sobering hurdles for an already stretched situation back then:
Moreover, many food-service producers have already invested in equipment and facilities to produce and package food in large multi-serving formats for complex prepared-, processed-, frozen-, canned-, and packaged-food value chains. It would be highly inefficient to reconfigure those investments to single service sizes.
And if anyone had reconfigured or would because they felt this economic shift might be more permanent:
For food-service producers, the dilemma is around the two- to five-year payback period of new packaging lines. Reinvesting and rebalancing a food-service network for retail is not a straightforward decision. Companies making new investments would be facing a 40 percent or more decline in revenue. And any number of issues could extend the payback period or make investments unrecoverable. Forecasts are uncertain, for example, about the duration of pandemic-related demand shifts, the recovery of the food-service economy, and the timeline of returning to full employment.
So, for some the accordion of shuttered restaurants squeezed food distributors far more toward the grocery and take-home way of doing their food businesses. And it may have seemed like a great bet, or less disastrous, as “two weeks to slow the spread” morphed to other always-shifting government mandates which appeared to make these non-economics of the pandemic a permanent impress.
More grocery, less dining. Forever after.
**Jeffrey P Snider, Retail And Food Sales: If It’s Not Inflation, And It’s Not, Then What Is It?, Alhambra Partners, October 15, 2021
The above showcases importance of the HETEROGENEITY of capital.
Because of the specificity of capital structure that represents specialization to the division of labor, capital cannot be turned on and off like a switch as commonly assumed by the mainstream.
The capital structure as Austrian Economist and Professor Per Bylund explained***,
We assume a market with highly specialized production with a capital structure that is well configured to satisfy consumer wants. As capital is heterogeneous, by which is meant that it “is not an amorphous mass but possesses a definite structure [and] is organised in a definite way” (Hayek 1941, p. 6), the capital structure entails both productivity gains and high costs of adjustment. As the market data change, the existing capital structure will be misaligned to real consumer wants. In this sense, the specialized market place is very fragile to (unanticipated) changes.
Per Bylund, The Division of Labor Is at the Very Core of Economic Growth February 9, 2019, Mises.org
Ergo, the present predicament in the energy supply networks reflects the HIGH COST of adjustments from an existing capital structure not attuned to the drastic and dramatic changes in consumer behavior. Such changes have caused extensive misalignments or maladjustments requiring massive capital investments.
And because of the deficiencies in capital investments in traditional supply, backed by the unreliability of the capital structure of alternative energy, the transition to balance supply with demand takes time.
One should not forget that regime uncertainty from persistent government interventions in the marketplace obscures the economic calculation necessary for capital allocations.
As previously noted,
The concern isn't only the disruption of the economic process flows. The more pressing issue is the ability of enterprises to conduct financial or business calculations under such an uncertain environment.
Such regime uncertainty impairs the ability of commercial establishments to forecast changes in demand productively, which subsequently corrodes their business continuity and expansion plans that translates into resource and labor allocations.
Even more, since politics dictates which and how businesses should operate, the priorities of commercial establishments shifts to regulatory compliance than appeasing the consumers. Or, present conditions skew the economic order from the marketplace to the political sphere.
Of course, like individuals, firms have distinctive traits. Companies that tend to benefit are those with political connections and with easy access to credit. As the weakest links, small and medium scale enterprises are the foremost victims.
And the overlapping interdependence of one node to another affects the entire complex networks of enterprises comprising what is known as the economy. Such escalation of regime uncertainty magnifies the risk environment on a systemic scale, which brings into light the call to action by international shipping and transports groups to restore freedom of movement worldwide.
This account represents the supply shocks presently being experienced around the world.
Stagflation Ahoy! NEDA Chief Says Recovery Will Take 10 Years! Will Surging Global Inflation Escalate Domestic Price Pressures? October 3, 2021
Most importantly, market pricing signifies a sine qua non to reflect the present and future economic conditions and reduced government interference.
Last week, admitting defeat to basic economics, China liberalized or removed its price caps on coal, aside from lifting production restrictions paving the way for increases in available reserves. But increases in reserves come with investments, which means a time-consuming process.
Therefore, the mainstream assumption that reopening solves the supply-demand imbalance represents a grossly simplistic heuristic.
IV. Feedback Loop: Supply Disruptions Lead to Power Outages and Vice Versa! Output Cuts Spur Surge in Base Metal Prices!
In turn, the power outages and volatile energy prices have only been magnifying the factors above, reinforcing a feedback loop that exacerbates strain in the supply networks.
Power outages have magnifying shortages through disruptions in productions.
Figure 3
Not only the upstream energy but the impact has spread to the agriculture and the mining industries. Economic imbalances have prompted US oil inventories to plunge recently. (Figure 3, upmost pane)
In short, the complexity of the economic system has led to chains of events (the second, third to the nth order).
One thing leads to another, as they say. The butterfly effect.
Already plagued by declining CAPEX and falling jobs, power outages have also affected the output of the other segments of the mining industry. (Figure 3, middle window)
For instance, rocketing energy prices have halted the production of Kosovo Ferro Nickel Mining. Surging energy prices driving up mining costs have spurred metal supply cuts. The prospects of magnesium supply shortages from output cuts fueled a price spurt in aluminum. Global copper inventories drop sharply, impelling steep backwardation in prices. (Figure 3 lowest chart)
Figure 4
As a result, surging prices of industrials metals prompted commodity indices to milestone highs. The CRB Commodity Index sprinted to a 6-year high. (Figure 4, topmost pane)
Meanwhile, the London Metals Exchange Metals Index (LMEX) soared to an unprecedented level, this week. The LMEX, according to financialadvisory.com, is a weighted index of six, designated, primary metals which include: Primary Aluminum, Zinc, Nickel, Lead, Copper, and Tin. (Figure 4, middle window)
The spillover from soaring prices of industrial metals has prompted the base metal index, as S&P Metals & Mining Industry Index ($GSPMM) ETF, and the iShares MSCI Global Metals & Mining Producers ETF (PICK), to mount a significant rebound. (Figure 4, lowest pane)
Will the local equivalents mount a significant rally too?
V. The Cure to Higher Prices is Higher Prices; Seismic Face-off: Slowing Demand versus Supply Disruptions
What would upset or derail this streak of surging commodity prices?
The simple answer: the law of supply.
The law of supply holds that "as the price of a good or service increases, the quantity of goods or services that suppliers offer will increase".
If markets are allowed to clear, rising prices will eventually lead to increases in supply and diminish demand.
Stated earlier…
That said, the alternative fix is to constrict demand through conservation. Hence, the de facto policy mix has been to allow the markets to partly clear through higher prices and energy rationing through rotating power outages or brownouts. Likewise, to expand supply by repealing discriminative investment policies against politically incorrect climate-energy investments or permit their reopening.
…
But there’s a catch 22.
Aside from supply disruptions and rising prices, the constriction of demand extrapolates to lower economic growth that magnifies risks of a meltdown in the global credit and financial markets.
Despite Lower September CPI, Philippine Treasury Yields Soar, Spreads Steepen! Greenflation Implodes the ESG Bubble! October 10, 2021
Needless to say, the cure to high prices is higher prices.
Some signs of these have emerged.
Figure 5
Surging CPI has prompted a pullback on consumer and business sentiment as Citi’s Global Surprise Index smashed through the high of 2008. (Figure 5, topmost window)
Some of the major central banks responded by sopping up liquidity.
With the credit impulse of the G3 trending lower, manufacturing output may follow. World container shipping prices appear to have plateaued. (Figure 5, second to the top panes)
China’s slowing credit impulse may also affect demand for commodities. (Figure 5, second to the lowest window) Money supply growth via Real M1 has also been heading south. (Figure 5, lowest right pane)
China’s property sector plays a major role in demand. The property sector accounts for an estimated 30% of her GDP and 62% of household wealth. It also consumes about 20% of global copper and steel supplies or over 10% of the total global commodity supply.
Nonetheless, the over-indebted property sector has been reeling from a slowdown and emerging credit woes, highlighted by the predicament of Evergrande and a string of defaults from some property developers. Expected defaults of property junk bonds may reach a record as sales of existing homes in the top 10 largest Chinese markets have reportedly been down 44% year on year. (Figure 5, lowest left pane)
The point shown is that slowing demand and drastic supply disruptions are in a monumental face-off. Which will prevail?
Again, my closing note from last week.
The imbalances brought about by massive political interventions in the economic system have fomented a transition of one extreme event to another, revealing or exposing inherent weaknesses embedded in the system!
An incredible pendulum swing of tail events!
