Supply and Demand Not:

Every now and again I come  across snippets that make me wonder if the tenants that have guided us for so long are still with us.

This week I read that oil producers in Texas are drilling very expensive  wells into shale rock formations and then capping them, rather than completing them, so as to store the oil for a time when prices improve. The wells require fracking ( a process of blasting sand water and chemicals into the rock to liberate the oil) It is this very expensive process that had led to the rebirth of the American Oil Industry and the resultant glut in World oil markets. (Every barrel produced in the U.S. displaces a barrel imported from other sources)

Because there is no doubt that the fracking process works this can be likened to building an inventory of product, just as if it were in a tank farm. An investment that will either prove prescient, or remarkably dumb, depending upon continuation of the law of supply and demand as we have known it.

The old way of thinking is that  increasing supply, or potential supply at a time of static demand, will, lower prices rather that increase them.  Apparently these investors believe otherwise.

I believe the rational for their thinking maybe be found in the actions of Central Bankers in much of the world who are pumping money rather than oil into the system so as to artificially lower  interest rates and stimulate their economies.  Problem is, that this action has proved, during the last three years, to increase asset values rather than stimulate demand.

The price of stocks, and real estate has increased, some say to bubble like levels, while the price of commodities in US dollars, has plummeted. (Iron Ore, Coal, Copper, Natural Gas, and now oil) The Baltic Dry Index is at an all time low singling that the demand for bottoms (bulk carriers)  that transport commodities is stagnant.

It strikes me that increased demand must come from China, India, and Indonesia, accompanied by a reduction in supply from major producers if the supply demand equation is to re-aligned. In the case of oil this will require cuts in production by producers of non conventional oil in North America. In the case of other commodities cuts in production by the oligopoly of the giant mining conglomerates.

I believe this will all happen at about the same speed as it has in past supply gluts (2-3 years) and I do not think that global money printing will do much to speed things up.

This does not mean that the value of commodities will not change. I believe that they will, by means of the coming re-alignment of world currencies. China must soon be admitted to the club, as we are seeing with the advent of clearing mechanisms for the Yuan in Britain Europe and Canada. The devaluation of the Yen and Euro will play only a minor role because commodities are priced for the most part in US dollars.

So much as it grieves me (I live in Western Canada) I believe this will all prove to be a case of ‘Plus ca change’