I spoke back in February 2016 about why the $30 threshold was critical in relation to the price of oil and back then we saw why that was indeed the case when the paper price dropped on several occasions below 30 only to rise on the basis of ‘rumours’ that the OPEC nations and Russia were going to cut production levels. Eventually there was agreement amongst the aforementioned to freeze production but we rapidly saw cracks appearing in that notwithstanding that both Iran and Iraq have refused to comply with this undertaking as well as Norway. In the case of Iran they are now pumping 2.5m bpd (barrels of oil per day) at $8pb (per barrel) production costs which is going to impact the desire to raise the price of oil.
There is a belief that at some point OPEC will cut production and exports in order to raise oil prices but only after US companies extracting hydrocarbons go bankrupt due to the current low energy prices. The dramatic fall in prices has caused US shale companies to run out of budgetary surpluses with bankruptcy a certainty for many. When we also factor in that many of the businesses were supported by junk bonds when they default those holding them will experience severe losses too.
Then we come to the loans which will become impaired within the banking sector. There has been moves to fudge the valuation of the balance sheets of banks by removing the mark to market valuation of these assets so they can be assigned the asset value at the time of their purchase as opposed to the asset depreciation we are now seeing for the reasons discussed here. We have seen ratings agencies downgrading some of the largest US energy corporations and evidence of the serious damage that current oil prices are doing to the US sector in particular with many firms already going bankrupt or suffering large downturns in profitability.
Since February we saw the oil price pumped over $50 and currently at around $42. However we are already seeing many oil producers globally selling oil at sub $30 prices so what is the reason to keep the paper price above this figure. In short it relates to the derivative positions held by financial institutions and the expiration of contracts. The need to artificially pump the price against the backdrop of a global oil surplus and the impending capacity of storage facilities being reached was to prevent the risk of serious impairment or even bankruptcy of these aforementioned institutions.
In the end economic reality will win through and we will see the implosion of both the financial institutions and the fossil fuels sector as a whole. We only have to look at comments that Medvedev, the Russian Prime Minister, made last year when he publicly stated that Russia would not be dependent economically in the future on oil and gas. This statement needs to be placed in the context of Russia’s dominant position as a global oil and gas producer. Furthermore at Davos, earlier on this year, Russia reiterated this position by saying that they were undergoing radical economic reforms and that included their dependence on oil.
In addition we continue to see nations divesting out of trading in dollars none more so than in oil producers where Iran are requesting payment in Euros as well as Russia and China who have agreed payment terms in the Yuan. We can expect to see that continue with other oil producing nations going forward.
If we were to surmise what the collapse of the price of oil will do to the major producing nations we can summarise them as follows:
- In the Middle East there are massive deposit withdrawals occurring
- Russia has its own banks and can cope quite easily
- US will uniquely have major bank problems and likely to see some suffer very badly or perhaps even bankruptcy due to this sole consideration
- China is a beneficiary when prices are depressed
- Nigeria will default
- Venezuela and Argentina will survive despite other huge economic issues
- Norway also will have problems as we are witnessing with respect to their sovereign wealth fund
- Iran will flourish given the removal of sanctions and their ability to flood the market with very cheap oil
- Angola will likely be saved by the intervention of China
I have gone on record previously saying that I expect oil to hit $20pb before the financial implosion occurs but it is entirely possible that will happen as a result of a myriad of other factors before that price is reached. However what is certain is that the petrodollar will die and be replaced in the new financial by gold/silver/asset backed currencies to replace the FIAT fraudulent insanity leading to a monetary system which will be fair and create economic stability across the world.