“Our ignorance is not so vast as our failure to use what we know.”
-M. King Hubbert
Just ask anybody, there is no shortage of the oil in the world. Or at least that’s the consensus view these days. In the short run, this is clearly correct. But what about in the longer term, say 5 or 10 years down the road?
We’ve been recently reacquainting ourselves with the work of M. King Hubbert and are in the middle of reading, “The Oracle of Oil”, by Mason Inman. Hubbert, as many of you know, is the geologist known for popularizing the idea of peak oil in the United States. He predicted that for any given geographical area, the rate of petroleum production of the reserve over time would resemble a bell curve.
Based on this theory, Hubbert presented a paper to the 1956 meeting of the American Petroleum Institute in San Antonio, Texas, which predicted that overall petroleum production would peak in the United States between 1965, which he considered most likely, and 1970, which he considered an upper-bound case. While his analysis was originally widely discredited, when domestic oil production actually peaked in 1970 Hubbert was very much validated.
In the Chart of the Day today, we look at U.S. oil production going back to 1861. As the chart shows, 1970 has been, so far, the peak in domestic oil production at ~9.6 million barrels per day. Interestingly, 2015 was a closed second with a production rate of some ~9.4 million barrels per day. Clearly, if prices had not started to decline in 2015, drilling and investment would have stayed at high levels and production grown beyond Hubbert’s peak in 2016.
But as it is, production in the United States is on the decline and, as of the most recent weekly data from the EIA, is down about 4.0% year-over-year. Despite this decline, which is largely due to somewhat tepid demand, inventory in the U.S. remains at record levels and is up 10.9%+ year-over-year. Eventually, though, declining production will begin to draw down this inventory.
At that point, investors in energy will likely get all bulled up on the price of oil. In reality, if the last couple of years have taught investors anything, it’s that there is no shortage of supply. And as for Hubbert’s Peak, at least on a strictly linear basis, the peak will likely be blown through in the next cycle of investment in domestic oil production with just a little bit of “Drill baby, drill!”
Back to the Global Macro Grind …
In the shorter term, oil, and really markets globally, are being roiled this morning because OPEC could not agree on production cuts. This fact seems to have shocked almost everyone except our policy team led by former Secretary of Energy Spencer Abraham and former Vice Chairman of the IEA Joe McMonigle who wrote the following last night:
“Since the production freeze proposal was first introduced in February, we have repeated our view in subsequent client notes that "a freeze is not a freeze without Iran." It now seems our mantra is also the official Saudi position from Doha.
Over a dozen oil producers from OPEC and Russia met in Qatar on Sunday to discuss a potential agreement to freeze production at January levels. While Iran made it clear it would not participate in the freeze as it ramps up post-sanctions production, many freeze proponents pushed for an agreement that excluded Iran as a way to support a "positive trend" in oil prices.
But as we pointed out in our Friday preview note on the freeze meeting, "the Saudi's would only support a freeze if all other producers agreed to participate, including and most especially Iran." Based on our analysis, we concluded in our Friday note that "there is no chance Saudi Arabia reverses its position and agrees to freeze production on Sunday."
The deal was dead Saturday morning Riyadh time when Saudi Deputy Crown Prince Mohammad Bin Salman reiterated his position in an interview from King Salman's private desert ranch that the Kingdom would not freeze production without Iran.
So oil ministers left Doha without reaching any agreement creating almost certain downward pressure on oil prices when the market opens on Monday. Oil was already down last Friday as pessimism grew about achieving an agreement in Doha. Any sell off Monday is now about the realization that there will be no agreement at the June 2 OPEC meeting either. The freeze is not a bridge to any future agreement.”
According to the CFTC, longs were adding to their positions into this weekend and long positions were peaking near a 9-month high. As a result, the sell off this morning is not entirely shocking.
Speaking of peaks, or lack thereof, there are a few more to highlight this morning:
- Chinese housing prices clearly have NOT peaked with new home prices up +4.9% year-over-year and increasing in 62 cities;
- U.S. corporate profit margins may have peaked, according to a report from Bloomberg this morning, which shows corporate profits their highest levels in 2014, at 9.7%, and are now closer to 9.0%;
- The NABE highlighted a similar peak this morning with its survey that showed for the first time since the Great Recession more business owners are highlighting declining profits than expanding profits;
- Spanish growth rates may have peaked, as both the IMF and Spanish cut government growth rate forecasts for the first time since 2013; and
- In the global currency markets, the Japanese Yen clearly has not peaked breaking to new 19 month highs this morning as the Nikkei suffers its second -3% daily loss.
The bigger question of course is whether U.S. equities have peaked. In our models, U.S. equities remain in a bearish formation and, all else being equal, we have a hard time seeing them make a move towards a new peak with profit margins in decline. After all, there has only been one time since 1973 when profit margins narrowing by 60 or more basis points didn’t precede a recession.
So . . . Peaking late cycle anyone?
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 1.67-1.81%
Keep your head up and stick to the ice,
Daryl G. Jones
Director of Research