May 16, 2015

"Futurization" and Fracking

The scale of futures trading on the oil market--and commodity markets more generally--is a novel feature of the current financial scene. According to the Financial Times, "Daily average turnover has increased from 350,000 futures contracts in 2005, when electronic trading started to dominate, to 1.5m--or 16 times the world's global daily oil demand."  Currently, funds control around 510 million barrels of oil in the New York and London futures markets--"equal to more than five days of global demand, or the combined monthly output of Saudi Arabia, Iraq and Iran, the biggest producers in OPEC." The impact of the shale revolution and fracking on the oil market is well known; less well appreciated, according to David Hufton, an oil broker, is the impact of "financialization." According to Hufton, "Futurisation of oil has been as dramatic in its impact as the arrival of horizontal drilling and fracking . . .  Fracking transformed oil supply dynamics; futurisation has transformed the factors driving oil prices."

David Sheppard and Neil Hume, "Hedge funds loom large in oil price moves," Financial Times, May 15, 2015

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The FT piece contrasts the big movement of macro funds into oil futures with the abundance of oil in the physical market. The supply overhang is also emphasized in the following chart from Britain's Telegraph newspaper. It cites a recent oil market report from the International Energy Agency warning that over supply has reached 2.1 million barrels a day. "Iraq, Libya and Russia are all cranking up output, and Iran is waiting in the wings with an extra 400,000 b/d of quick supply if there is a nuclear deal."

Ambrose Evans-Pritchard, "Epic global bond rout is a QE success story - but it won't last," The Telegraph, May 13, 2015

May 4, 2015

Damn Lies and Government Statistics

A miracle of modern finance is how the markets respond to government reports that are known to be often inaccurate and heavily revised. The inadequacy of the surveys and methods used to compile these reports (especially the market-moving employment report) is often neglected when the markets respond to the release; the “headline number” is all that matters.

One of the most closely watched figures of late has been the weekly oil output numbers released by the Energy Information Administration. The markets have been desperate to know whether the Saudi price war would succeed in flattening the U.S. industry or at least sharply impairing its growth. And yet according to accomplished oil trader Andrew J. Hall, the published estimates are taken from state agencies and lag by several months. The numbers are “essentially an artifice.”

The chart above shows, in orange, the EIA estimates to which all the attention is usually paid, the weekly output figures. It turns out, however, that the agency itself thinks it may have a better gauge. This is represented by the blue line. (I don’t recall having ever previously seen a graphic presentation of this alternative data.) 

Hall believes the recent fall in output as shown by the blue line is very bullish for the oil price, though it might be noted that the adjustments, though showing a steep fall recently, still show production above the normally consulted weekly output figure.

Bloomberg explains the basis of the different methodology:
A more accurate gauge of U.S. output is an “adjustment” the agency uses, which, in addition to the weekly number, adds up changes to how much oil is in storage, how much was used in refineries and how much was imported and exported, Hall said. 
Paul Sankey, an energy analyst at Wolfe Research, also cited the trend in a report Thursday to investors. The amount of production that isn’t accounted for has fallen “dramatically” in the last two weeks, suggesting U.S. daily output may have fallen by as much as 200,000 to 300,000 barrels in April, he said. “That number seems high to us, but it does support the notion that U.S. production is rolling over at present,” said Sankey, a former analyst at the Paris-based International Energy Agency. 
Imports, refinery demand and storage level data all come from surveys the EIA conducts with oil companies. Export data comes from the U.S. Census Bureau. Production data comes from a variety of sources, including state and federal regulatory agencies. In a perfect world, the supply and disposition would equal each other, said Mike Conner, a petroleum analyst at the EIA. But they often don’t, so the EIA uses the adjustment figure to balance it out. “All we really know for sure is the supply components are not enough to make up for the volume on the disposition side,” Conner said. “We don’t know if the error is in field production, imports, refinery inputs or what have you. Different analysts are going to have different interpretations.”
Bradley Olson and Dan Murtaugh, The Shale Boom Has Already Gone Bust—At Least for Now, May 3, 2015, Bloomberg Business 

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Update, May 12: The question of EIA statistics becomes curioser and curioser. The latest was a blast on Monday against the EIA for gross incompetence in its methods of data collection. The EIA, charged oil analyst Philip Verleger, was overestimating U.S. output by as much as 1.6 million barrels a day. The glut the markets had previously identified was seemingly non-existent, a “phantom.”  Verleger was previously on record as predicting that oil prices would fall back to $50 a barrel by the end of the year, a prediction predicated on the existence of a supply glut. So this was a big reversal for him, and it was for oil markets, if true, a very big deal.  

Then today (Tuesday) came a further twist, with Verleger performing a flip-flop and saying it was all a big mistake. According to the FT, Verleger “said economists at the Federal Reserve had examined his calculations and pointed out an error.” “The effect of the error is to change the sign of the Energy Information Administration’s mis-calculation of US crude oil production,” said Verleger. “It turns out that EIA is underestimating US oil output.”

Got that straight?

There follows the Monday story in the FT, followed by excerpts from its Tuesday report. Wednesday may bring further clarification, but it would seem, on the face of it, that the heat of Verleger’s denunciation on Monday seems rather misplaced given his reversal on Tuesday.

A prominent oil analyst has fired a broadside at the body charged with data collection on the US oil industry, saying it has probably overestimated the country's crude output by as much as 1.6m barrels a day.

Philip Verleger, an independent energy economist, claims the US Energy Information Agency (EIA) has "drastically" overestimated US oil production because it uses outdated techniques rather than data from the field,  reports Neil Hume, FT Commodities editor, in London

Mr Verleger said in a report published on Monday:

This is a large variance that could have enormous implications for the global economy. Prices will be higher because the [supply] glut was phantom. Federal Reserve policy could easily have been different had the error been understood.

The EIA, which acts as the statistical arm of the Department of Energy, declined to comment.

Mr Verleger, who runs consulting firm PKVerleger and advised both President Gerald Ford and Jimmy Carter administrations on economic and energy policy, was one of the few analysts bearish on oil before last year's dramatic collapse in prices.

Last week he forecast a further decline in prices, which have rallied sharply since reaching $40 a barrel in January.

On Monday, Brent, the international marker, was trading at $65 and the US equivalent, West Texas Intermediate, was at $59.50.

Mr Verleger said in his report:

The rise in oil prices… has baffled many who believed global stocks were surging. Global stocks would have done so had the numbers been correct.

Analysts say investors should be careful how they interpret US production statistics, in particular the EIA's weekly short-term supply numbers. This is because they are based largely on modelled estimates, not hard supply data from the field.

In a recent analysis of historical estimates against lagged production data, Citi found short-term EIA forecasts underestimated final data by as much as 200,000 b/d over the last year.

Mr Verleger has come to different conclusion but says the EIA's reliance on estimates and "failure" to make contemporaneous accuracy checks of its numbers is a "dereliction" of responsibility on the EIA's part.

He said in the report:  

Rarely if ever had a US agency charged with collecting data made a miscue of this magnitude. The EIA administrator should be dismissed immediately for gross incompetency.

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From the Tuesday report:

The EIA belatedly responded to Mr Verleger's report on Tuesday, saying the claim of a massive understatement of production was extremely unlikely

"Notwithstanding a widely-reported note alleging that EIA's domestic crude production data are probably overstated by 1.6m barrels a day, EIA management and staff are confident in the quality and validity of the agency's production data. Furthermore, EIA's monthly crude oil production statistics, based on official State oil and gas data have been closely aligned with the weekly estimates reported by EIA," it said in emailed comments.

"Turning to the larger items in the balance equation, EIA directly collects data on refinery crude runs, changes in crude oil stocks, and crude oil imports every week. We are confident in the quality of these data. Unless the reported runs data, the stock data, and the imports data are massively wrong, production cannot be overestimated by 1m to 1.6m b/d as alleged," it added.

May 3, 2015

The Oil Recovery in 2009: A Precedent for 2015?

The first chart below shows the perambulations of the oil price from the bottom on December 24, 2008 to June 1, 2009. The second chart shows the oil price movement from late January 2015 to the present (May 1). Note that the first chart shows six months, the second chart four, so they do not exactly align.

In both cases, there was a big rally off the lows (December 24, 2009 and January 29, 2015), with rallies failing over the next month to surmount the level achieved in the first week's big rally, then a retest and brief penetration of the lows about six and a half weeks from the original low (February 12, 2009 and March 17, 2015). At that point a rally begins that over the next six weeks sends the price through resistance and up to a new level. Note that the new level achieved is about five or six dollars above the previous resistance (from c. 49-50 to c. 54-55 in 2009, from about 54 to 60 today).

If the past is prologue, we can expect WTIC to meander in May 2015 in the sort of way it meandered from late March to late April in 2009. That is, it would probe support on the downside, sufficiently so to trigger stops, but without breaking through for more than a few hours, followed by rallies that probe resistance on the upside, but which also fail to break resistance (60) over the next month.

The next chart gives a closer look at the price action from March 20 to May 1 in 2009. From the highs to the lows is around 6 to 7 dollars.

The next chart shows the approximate range (from 60 to around 53.5) of the price action I expect over the next month. Historical precedent suggests that the oil bulls will have to wait till June 2015 for the surge above 60, and that bears will have some opportunity over the next month, but they shouldn't get too greedy. That is my (educated) guess.

One should note that there are many differences between the overall financial and energy context in early 2009 and early 2015. The oil bottom occurred about a week after the stock market low on March 6, 2009, when it was apparent that the world economy was experiencing a deep recession (thus crushing oil demand). There is nothing like that economic backdrop today, and still the oil price has recovered (from $42 to $59). On the other hand, the Saudis were attempting to support the price in early 2009, and now they are attempting to suppress it. Despite these differences in context, it is remarkable that the first three months after the initial lows of late 2008 and early 2015 have followed a similar pattern.

Just for the hell of it, two more charts that show the ratio between the Brent price of oil and Euros in 2008-09 and 2014-15. In neither instance were the initial lows (of late-December 2008 and mid- January 2015) retested.

Finally, for a broader perspective, here's West Texas Intermediate from May 1, 2008 to May 1, 2010.

April 25, 2015

More Drilling, More Earthquakes

From the Associated Press:

. . . A series of government and academic studies over the past few years — including at least two reports released this week alone — has added to the body of evidence implicating the U.S. drilling boom that has created a bounty of jobs and tax revenue over the past decade or so.

On Thursday, the U.S. Geological Survey released the first comprehensive maps pinpointing more than a dozen areas in the central and eastern U.S. that have been jolted by quakes that the researchers said were triggered by drilling. The report said man-made quakes tied to industry operations have been on the rise.

Scientists have mainly attributed the spike to the injection of wastewater deep underground, a practice they say can activate dormant faults. Only a few cases of shaking have been blamed on fracking, in which large volumes of water, sand and chemicals are pumped into rock formations to crack them open and free oil or gas.

"The picture is very clear" that wastewater injection can cause faults to move, said USGS geophysicist William Ellsworth.

Until recently, Oklahoma — one of the biggest energy-producing states — had been cautious about linking the spate of quakes to drilling. But the Oklahoma Geological Survey acknowledged earlier this week that it is "very likely" that recent seismic activity was caused by the injection of wastewater into disposal wells.

Earthquake activity in Oklahoma in 2013 was 70 times greater than it was before 2008, state geologists reported. Oklahoma historically recorded an average of 1.5 quakes of magnitude 3 or greater each year. It is now seeing an average of 2.5 such quakes each day, according to geologists.

Angela Spotts, who lives outside Stillwater, Oklahoma, in an area with a number of wastewater disposal wells, said the shaking has damaged her brick home. She pointed to the cracked interior and exterior walls, and windows and kitchen cabinets that are separating from the structure.

"There's been no doubt in my mind what's causing them," Spotts said. "Sadly, it's really taken a long time for people to come around. Our lives are being placed at risk. Our homes are being broken."

Yet another study, this one published Tuesday in the journal Nature Communications, connected a swarm of small quakes west of Fort Worth, Texas, to nearby natural gas wells and wastewater disposal.

The American Petroleum Institute said the industry is working with scientists and regulators "to better understand the issue and work toward collaborative solutions."

The Environmental Protection Agency said there no plans for new regulations as a result of the USGS study.

"We knew there would be challenges there, but they can be overcome," EPA Administrator Gina McCarthy said Thursday at an energy conference in Houston.

For decades, earthquakes were an afterthought in the central and eastern U.S., which worried more about tornadoes, floods and hurricanes. Since 2009, quakes have sharply increased, and in some surprising places.

The ground has been trembling in regions that were once seismically stable, including parts of Alabama, Arkansas, Colorado, Kansas, New Mexico, Ohio, Oklahoma and Texas.

The largest jolt linked to wastewater injection — a magnitude-5.6 that hit Prague, Oklahoma, in 2011 — damaged 200 buildings and shook a college football stadium.

The uptick in Oklahoma quakes has prompted state regulators to require a seismic review of all proposed disposal wells. The Oklahoma Corporation Commission, which regulates the oil and gas industry, has ordered dozens of disposal wells to stop operating or change the way they are run because of concerns they might be triggering earthquakes, said spokesman Matt Skinner.

"There are far more steps that will be taken," Skinner said. 

Last year, regulators in Colorado ordered an operator to temporarily stop injecting wastewater after the job was believed to be linked to several small quakes.

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Alicia Chang, Scientists Convinced of Tie Between Earthquakes and Drilling, AP, April 23, 2015. For a scientific study with neat graphics (h/t/Desdemona), see Causal Factors for Seismicity near Azle, Texas, Nature Communications, April 21, 2015:

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Update, May 17, 2015:  It's good to learn that the oil and gas industry takes this problem seriously and wants to find out more. On the industry reaction, see Benjamin Elgin, "Oil CEO Wanted University Quake Scientists Dismissed: Dean's Email," Bloomberg Business, May 15, 2015

April 23, 2015

New Global Temperature Records

The following temperature map from Bloomberg shows the hottest start to a year on record. "Results from the world's top monitoring agencies vary slightly. NOAA and the Japan Meteorological Agency both had March as the hottest month on record. NASA had it as the third-hottest. All three agencies agree that the past three months have been the hottest start to a year."

Tom Randall and Blacki Migliozzi, Global Temperature Records Just Got Crushed Again, BloombergBusiness, April 17, 2015. The piece also includes an illuminating animation recording monthly temperature measures for about 135 years. This is a screenshot of the most recent image from March 2015.

April 22, 2015

The Triumph (Crisis) of American Capitalism

This chart, put together by Andrew Smithers, shows the contrasting rewards to capital and labor over several generations. The blue line (left scale) is profits before depreciation, interest, and tax, as a percentage of output. The red line (right scale) represents employment costs as a percentage of output. After a fairly stable set of relations in the post-World War II period, reflecting the New Deal consensus, a yawning gap emerges in the 21st century. This is not your mother and father's capitalism, it would seem, but a system of political economy very different in salient respects.

The chart helps explain the relative out-performance of US equities as against world stock markets, noted in a previous post. The piece appeared in 2012, so the data is a bit old, but the disparity has probably gotten larger in the last few years. Smithers was bearish on the stock market in 2012 and, assuming mean reversion, believed shares to capital would recede and shares to labor would increase. Since publication on December 26, 2012, the U.S. stock market is up 54%.

The chart appears in an NPR report introduced by Paul Solman, consisting of an interview between Jon Shayne and Smithers, a noted student of financial history.

ANDREW SMITHERS: All output is for somebody’s benefit, either those who work for the firm (the labor share) or those who provide the capital (the profit share). Labor’s share has never been lower or the profit share higher. These shares of course add up to 100 percent, before the government has taxed both labor and capital.

JON SHAYNE: What do you think has caused labor’s share to fall below its average to a new historical low, and capital’s share to rise to the higher highest peak ever?

ANDREW SMITHERS: The change in the way company managements are remunerated has been dramatic in this century. Salaries have ceased to be the main source of income to senior management, with bonuses and options taking over. There has been major change in management incentives and it should not cause surprise, though it evidently has to most economists, that management behavior has changed. The current incentives discourage investment and encourage high profit margins.

This is dangerous for companies’ long-term prospects as it increases their risk of losing market share and reduces their ability to reduce costs. It is very damaging for the economy, but it maximizes the income of managements. Senior management positions change frequently, so if management wish to get rich, they have to get rich quickly. I am not alone in this diagnosis. A recent report from the Federal Reserve Bank of New York comes to the same conclusion from a theoretical analysis as I have come from data analysis.

JON SHAYNE: How do bonuses today encourage profitability above investment? I guess you mean that they are tied to changes in earnings per share, or return on capital, rather than to the growth of companies’ output?

ANDREW SMITHERS: Yes, the current way in which managements are rewarded is perverse from an economic viewpoint. Adam Smith pointed out that some characteristics of human beings such as greed, which are often unpleasant at a personal level, can nonetheless bring social benefits. But this is not necessarily the case under current remuneration systems; greed is increasingly the cause of harm rather than help to the economy.

JON SHAYNE: On the graph, do we know how much of labor’s share represents what managers earn? If their share has gone up over the decades, through stock options and the like, which I believe is the case, then the average worker is getting even a bit less than it looks, correct?  

ANDREW SMITHERS: Yes, there have been two major changes. First, the share of output which goes to all employees has fallen to its lowest recorded level. Second, the proportion of total remuneration that goes to the higher paid has shot up. Both of these changes have been bad from the viewpoint of the average worker. The result is that current management reward systems are producing both economic damage and social disquiet. . . .

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Paul Solman, Capital Wins, Labor Loses, But Andrew Smithers Says It Can't Go On," PBS Newshour, December 26, 2012

April 18, 2015

The Most Important Chart in Finance

The following chart shows a ratio between the SPX (the S&P 500 US stock index) and the MS World Index (an international equity index that excludes the U.S. market). It shows the dramatic disparity between the U.S. and foreign equity markets since the financial crisis and the ensuing Great Recession. As the separate price indices in the two panels below show, the world index is barely above the level it reached in 2000, whereas the S&P 500 long ago surmounted the twin peaks of 2000 and 2008. The chart supports the general conclusion that international stocks are a better bargain than domestic stocks.

The ratio turned on or about January 1, 2015, and has barely looked back since.

Apart from the overall disparity in valuations suggested by the chart, there are additional reasons for thinking the ratio line will continue trending lower. One is the collapse in oil prices, which disproportionately benefits big oil importers (Europe, Japan, China, India). Another is the turn of world central banks to quantitative easing. QE may or may not be healthy for the overall economy, but it has undoubtedly been very, very good for U.S. equity investors. The U.S. Federal Reserve purchased $3.75 trillion of debt in its various QE programs. Observers called it the "Bernanke put," meaning that the Fed had put a floor under the stock market, but it might more justly be thought of as the "Bernanke call." The effect was to send U.S. equities into the stratosphere. The end of the U.S. program and its embrace by others (especially the Bank of Japan and the European Central Bank) is another spur to relative outperformance by the world index as against U.S. equities.

The headwinds facing U.S. equities, after so steep a climb from the pits in March 2009, are also suggested by the following chart, prepared by Absolute Strategy Research, and unveiled in a recent interview conducted by John Authers of the FT with Ian Harnett of ASR. (This is a screen shot from that interview.)

The Activity Surprise Indicator gathers all the economic numbers published daily and measures them against expectations. With the exception of the labor market numbers, says Harnett, disappointments have proliferated at a rate not seen since 2011 (the time of the last big correction in the U.S. stock market). The driving force has been the collapse in the oil price (penalizing the energy sector) and the rise in the dollar (the latter impairing the earnings of U.S. based multinationals.)

Authers, "US earnings season--correction ahead?" Financial Times Video, April 13, 2015


Here's another look at the disparity between U.S. and world equity indexes. EFA is the etf for the EAFE index, which covers developed markets in Europe and Asia. EEM is the etf for the stocks of emerging nations. The first chart shows the SPY:EFA ratio, the second the SPY:EEM ratio.

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Update, 4/26/15: Underlining the disparity in valuations as between U.S. and international markets is the following statistic from Barron's: "Even when smoothing out the most recent bull market—which the Shiller CAPE (cyclically adjusted price/earnings) ratio does by averaging 10 years’ worth of earnings and adjusting for inflation—U.S. stocks seem pricey. The S&P 500’s CAPE ratio is 27, well above its median of 16. The rest of the developed world, meanwhile, averages a CAPE ratio of 17, below its median of 22.5, according to Research Affiliates." Chris Dieterich, International-Focus ETFs Beat U.S. Counterparts, Barron's, April 24, 2015. 

For a thorough examination of issues associated with global stock market valuations, see numerous entries in the excellent blog Philosophical Economics, especially this one from August 2014.

Here's another look at an index of economic surprises, this one compiled by Bloomberg (Matthew Boesler, "The U.S. Economy Hasn't Disappointed Analysts This Much Since the Great Recession," April 23, 2015, Bloomberg Business)

April 16, 2015

OPEC Revenues on Roller-Coaster

A new report from the Energy Information Administration shows net oil export revenues for OPEC over the last 45 years. The graph excludes Iran, noting difficulties in estimating Iran's earnings. Oddly, the EIA seems not to include Iranian data for the entire 45-year period; they would have done better to make an estimate for the last few years than to eliminate Iran from the whole series.

Despite this omission, the graph speaks volumes. It shows the return of the energy crisis in the last decade, outdoing even the first great go round in the 1970s. It gives a vivid picture of the explosion in energy prices from $10 a barrel in 1998 to $145 a barrel in the summer of 2008--inducing shocks that played a significant role in precipitating the Great Recession. The figure also shows how volatile the energy sector has been over the last ten years. Two spectacular rises, two spectacular falls, all in less than a decade.

OPEC oil revenues also have played a key role in shaping the US current account balance, especially in the last decade. The following graph from the Council of Economic Advisors (November 2014) shows that the current account balance had two great lurches downward in the 1980s and 1990s. Then it fell yet further the following decade, driven especially by the increasing price of oil.

After 2010, the current account balance would have headed back down were it not for the shale revolution in America, which added 4.5 million barrels per day of new production in four short years. Now, with the price of oil falling by fifty percent over the last six months, there have been corresponding improvements to the US current account. But though the effect of the price collapse on the US balance of payments has been dramatic, its effect on US oil production remains very uncertain. Most forecasts foretell a stoppage of growth, not a decline of production. We shall see.

April 14, 2015

Cities by the Sea

From the February 2015 National Geographic, a graphic showing potential costs to coastal cities from rising sea levels.

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Gideon Mendel, "Drowning World," National Geographic, February 2015, 126-27.

California in Your Future

So it used to be said. Whatever happened in California would later happen in the United States. What happened in the United States would then happen in the world. As a Coloradan, I should like to say: Say it ain't so. 

These graphics from Bloomberg gave the incredible scale of California's epic drought and heat wave. The first shows temperatures well outside the range of recent experience: 

The next chart shows a drought measure called the SPEI, which takes account of both rainfall and heat. In weather charts, as in stock charts, it's generally not good to be on the bottom right of the panel. That means you're toast. 

The drought is also conveyed in a series of moving figures from 2011 to 2015: here is a snapshot of the last in the sequence:

Explains Bloomberg:
More than 44 percent of the state is now in “exceptional drought” (crimson). It’s a distinction marked by crop and pasture losses and water shortages that fall within the top two percentiles. California has seen droughts before with less rainfall, but it's the heat that sets this one apart. Higher temperatures increase evaporation from the soil and help deplete reservoirs and groundwater. The reservoirs are already almost half empty this year, and gone is the snowpack that would normally replenish lakes and farmlands well into June.  
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Tom Randall, California's New Era of Heat Destroys All Previous Records, Bloomberg Business, April 10, 2015

Higher Mileage

This graphic from Bloomberg shows improving efficiency in the US car and truck market. 

Another shows change in global oil intensity and China demand growth:

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Peter Waldman, "Saudi Arabia's Plan to Extend the Age of Oil," Bloomberg, April 12, 2015

Climate Change and Brain-Eating Parasites

Joe Romm of Climate Progress details the impact of climate change on global health:

It’s a myth there are no big winners from climate change besides fossil fuel companies.

According to one study, global warming is doubling bark beetle mating, triggering up to 60 times as many beetles attacking trees every year. The decline in creatures with shells thanks to ocean acidification “could trigger an explosion in jellyfish populations.” And climate change has helped dengue fever, which spread to 28 U.S. states back in 2009.

Of course, invasive plants will become “even more dominant in the landscape.” And who doesn’t love ratsnakes?

Let’s also not forget brain-eating parasites, which are expected to thrive as U.S. lakes heat up. That parasite — the amoeba, Naegleria fowleri — feasts on human brains like a tiny zombie. As one Centers for Disease Control and Prevention expert warned several years ago: “This is a heat-loving amoeba. As water temperatures go up, it does better. In future decades, as temperatures rise, we’d expect to see more cases.”

But this is just a taste of things to come, as two parasite experts explain in a recent article, “Evolution in action: climate change, biodiversity dynamics and emerging infectious disease [EID].” That article is part of a special April issue of the Philosophical Transactions of the Royal Society B., whose theme is “Climate change and vector-borne diseases of humans.”

“The appearance of infectious diseases in new places and new hosts, such as West Nile virus and Ebola, is a predictable result of climate change,” as the news release explains. The article examines our “current EID crisis.”

Coauthor Daniel R. Brooks explains: “It’s not that there’s going to be one ‘Andromeda Strain’ that will wipe everybody out on the planet,” he said, referring to the deadly fictional pathogen. But he warns: “There are going to be a lot of localized outbreaks that put a lot of pressure on our medical and veterinary health systems. There won’t be enough money to keep up with all of it. It will be the death of a thousand cuts.”

Many tropical diseases are tropical because their insect or animal host prefer warmer climates. A 2015 report on neglected tropical diseases by the World Health Organization (WHO) pointed out that “climate variability and long-term climate changes in temperature, rainfall and relative humidity are expected to increase the distribution and incidence of at least a subset of these diseases.” For instance, WHO notes, “dengue has already re-emerged in countries in which it had been absent for the greater part of the last century.”

The Congressionally-mandated 2014 National Climate Assessmentconcurs: “Large-scale changes in the environment due to climate change and extreme weather events are increasing the risk of the emergence or reemergence of health threats that are currently uncommon in the United States, such as dengue fever.”

“Some of the neglected tropical diseases are no longer strictly tropical,” said Dr. Dirk Engels, the director WHO’s Department of Control of Neglected Tropical Diseases, in a statement.
Certainly there have been major advances in the fight against many tropical diseases, but those are primarily due to medical advances and investments in public health. Such investments remain a top priority in a warming world. But the kind of extreme climate change humanity faces on our current path of unrestricted carbon pollution makes the job harder for all those focused on public health around the world.

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The following is from the introduction to the academic study Romm mentions, “Climate change and vector-borne diseases of humans.”

This theme issue arose out of our perception that while it is widely recognized that an important impact of climate change on human health is likely to be via effects on vector-borne disease (VBD) transmission, the complexity of the biological and non-biological susceptibility modifying pathways by which such effects arise and combine to influence transmission is less well understood. This has made reliable appraisals of the potential effects of climate change and variability on VBDs complicated and represents a serious problem in developing more robust tools to assess the risk of climate change affecting VBDs in populations residing under different social and geographic contexts. This issue thus aims to provide not only an up-to-date synthesis of current knowledge of, and key research in, the impact of various individual components of climate change (biological, non-biological, evolutionary and economic factors), but also, crucially, to reveal and highlight the need (and potential means) to address the effects of multiple factor interactions, nonlinearities and human reflexivity if we are to develop and establish a more rigorous agenda for future research, including the provision of useful informatics for informed public health policy-making, in this important area of climate change studies.

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April 1, 2015

Sinopec: Peak Diesel in China Coming Soon

A new report from Bloomberg conveys surprising forecasts from Sinopec, whose chairman predicts a peak in diesel and gas consumption in China:

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China’s biggest oil refiner is signaling the nation is headed to its peak in diesel and gasoline consumption far sooner than most Western energy companies and analysts are forecasting.

If correct, the projections by China Petroleum & Chemical Corp., or Sinopec, a state-controlled enterprise with public shareholders in Hong Kong, pose a big challenge to the world’s largest oil companies. They’re counting on demand from China and other developing countries to keep their businesses growing as energy consumption falls in more advanced economies.

“Plenty of people are talking about the peak in Chinese coal, but not many are talking about the peak in Chinese diesel demand, or Chinese oil generally,” said Mark C. Lewis, an analyst at Kepler Cheuvreux in Paris who has written on how oil companies should broaden their activities to produce all forms of energy. “It is shocking.”

Sinopec has offered a view of the country that should serve as a reality check to any oil bull. For diesel, the fuel that most closely tracks economic growth, the peak in China’s demand is just two years away, in 2017, according to Sinopec Chairman Fu Chengyu, who gave his outlook on a little reported March 23 conference call. The high point in gasoline sales is likely to come in about a decade, he said, and the company is already preparing for the day when selling fuel is what he called a “non-core” activity.

That forecast, from a company whose 30,000 gas stations and 23,000 convenience stores arguably give it a better view on the market than anyone else, runs counter to the narrative heard regularly from oil drillers from the U.S. and Europe that Chinese demand for their product will increase for decades to come.

Rising Forecasts

“From 2010 to 2040, transportation energy needs in OECD32 countries are projected to fall about 10 percent while in the rest of the world these needs are expected to double,” Exxon Mobil Corp. said in a December report on its view of the future. “China and India will together account for about half of the global increase.”

Exxon expects most of that growth to be driven by commercial transportation for heavy-duty vehicles, specifically ships, trucks, planes and trains that run on diesel and similar fuels.

BP Plc’s latest public projection for China, released in February, sounds a similar note. “Energy consumed in transport grows by 98 percent. Oil remains the dominant fuel but loses market share, dropping from 90 percent to 83 percent in 2035.”

The oil companies aren’t alone in their view. The International Energy Agency in Paris, the adviser to 29 governments including the U.S., forecasts China’s oil demand is most likely to increase at least through 2040.

Slowdown Signs

But signs of China’s energy slowdown are already evident. Diesel demand declined last year, and growth in crude oil consumption has shriveled. Crude use is projected to rise about 3 percent this year, less than half the rate of the total economy.

Also, China’s political leadership is trying to wean the economy off debt-fueled property investment and old-line smokestack industries, shifting toward services and domestic-consumption led growth.

Sinopec itself is already planning for the time when its primary business isn’t selling fuels but consumer goods at its shops and filling stations that blanket the nation.

“In the future, fuels will become a non-core business of Sinopec,” Fu said on the conference call. “Petroleum or oil and gas will continue to be a major energy source in the future, but they won’t be the only source, more emphasis will be put on our new energy and alternative energies.”

* * *

Timothy Coulter, “China’s Fuel Demand to Peak Sooner ThanOil Giants Expect,” BloombergBusiness, April 1, 2015

January 25, 2015

Oil, Stocks, Bonds: An Historical Comparison

In a post a few days ago, I noted that the gold:oil ratio had reached an extremely high level of 28 to 1, such that one ounce of gold would suffice to purchase 28 barrels of oil. That has occurred three previous times over the last 25 years, in early 1994, in late 1998, and in mid-February 2009. It's of interest that all of these occurred right around the beginning of the new calendar year. In 1993-94, the high occurred on December 30, but was retested on February 15. Almost exactly the same pattern occurred in 2008-09, with a high at the end of the year and a retest in mid-February. In 1998, the high was reached on December 12; it was not retested.

I was curious what happened in the subsequent relative performance of stocks, bonds, and oil in these three previous episodes (when the gold:oil ratio touches 28). Herewith a series of charts showing the denouement.

For 1993, the chart below shows a ratio between the price of oil and the price of stocks. The second frame shows a ratio between the price of oil and the price of bonds.  As these charts show, oil outperformed bonds handily. It did so for stocks in the ensuing year, but then fell back.

Here's the same chart for the period from 1998 to early 2002.

As previously discussed, a ratio chart comparing the price of stocks with the price of oil , as these charts do, can be misleading in its practical implications. What Jeffrey Gundlach calls "investible commodities" don't correspond with a simple price chart. Still it is impressive that in both these prior instances the relative performance clearly favored oil as against both stocks and bonds over the ensuing 12-15 months. This is so even if we substitute a bond fund for the bond price, as in the following for 1993 to 1996:

For 2008 and 2009, the first chart below shows not the price index of $WTIC but the exchange traded fund USL. And I compare this to SPY (whose price reflects dividends) and AGG (a total bond  fund whose price reflects interest payments received). Just as the price charts for 1994 and 1998 don't reflect dividends and interest, the commodity prices do not reflect the transaction costs of commodity funds. That changes the implied ratio, by how much is the great question.

The above chart looks very unimpressive, especially in comparison with the price charts. The USO chart is even worse, though I forbear to show it here. The price of oil, as the chart below shows, bounced much higher than the exchange traded funds, even one, like USL, supposedly constructed for the very eventuality that transpired.  Why this happened is not clear to me; I suspect is is partly related to the incredible volatility all markets displayed during the financial crisis, greatly increasing transaction costs, not simply to the issues associated with contango and backwardization..

In conclusion: it's a mixed bag. I think oil's bottom in relation to gold is close. Once it bottoms, oil will inexorably rise relative to other financial instruments, but "investible commodities" are a pretty unsatisfactory means of expressing this, as they are handicapped by various deficiencies. Despite these deficiencies, USL looks good here relative to other financial assets; it may go down further, but over the next year I think it likely it will hold its value against other assets and will probably surpass them.

January 23, 2015

The World's Worst Investment . . . Is Looking Pretty Good Right Now

In the first decade of this century, when commodity prices were strong, there were many promoters of the idea that passive investment in commodity funds, tracking the futures prices, ought to be a key portion of any investment portfolio. Anyone who acted on that idea, however, has fared badly in the years since 2008. As far as asset classes go, funds that hold commodity futures contracts have been just about the world’s worst investment since the summer of 2008. 

There are lots of reasons why, in normal circumstances, such investments are inferior to stocks, bonds, real estate, or precious metals, but these are not normal circumstances. The precipitous collapse in the price of oil, far below the cost of production for “new oil,” makes these funds an intriguing proposition these days. To make the case for them, we shall take a look not only at the history of commodity prices as such, but also at the relationship to other asset classes as well. On the theory that what goes way, way down, must come up, we will rest our case.

First, here’s a survey of the overall carnage. The index below is the Goldman Sachs Commodity Index Fund (GSG). Because it is  heavily weighted toward energy, it has had more extreme price movements than other commodity indexes, but all the commodity indexes rose and fell along similar lines over the past two decades. 

Now let's look at a couple of ratio charts, The first chart shows the ratio between commodities and bonds, in this example the ratio between GSG and long term US Treasury bonds. 

If you started out in 1999 thinking that an investment in commodities would put the kids through college, that looked like a really good idea over the next nine years. Then it became a very bad idea and you realized you needed a second job at McDonald's to swing it. From early 1999 to mid 2008, commodities were very good and bonds were very bad. Then the relationship reversed in the years thereafter. 

The same story may be told for the ratio of stocks and commodities, though this is even more lopsided in the denouement. The following chart shows the ratio between GSG and SPY (an exchanged traded fund showing the total return, including dividends, of the S and P 500). 

Here's another that looks at the ratio between GSG and the Vanguard Total Return Bond Fund, making the picture even worse than the earlier ratio chart comparing GSG with US Treasury prices. 

The general collapse in commodity prices is especially striking in light of expectations prevailing only a short while ago. In 2011, the investment guru Jeremy Grantham produced a chart showing the movement of commodity prices over 110 years, beginning in 1900. Grantham titled the essay in which the chart appeared "The Great Paradigm Shift." Its argument was that "this time is different"--that is, that the general movement downward in commodity prices that had occurred over the preceding century had been reversed by a series of shortages so severe that the trajectory of prices was almost certainly upwards. 

As Grantham explained, the GMO Commodity Index equally weights 33 different commodities, so it is measuring different things from the GSG index. Summarizing its significance, he argued: "The prices of all important commodities except oil declined for 100 years until 2002, by an average of 70%. From 2002 until now, this entire decline was erased by a bigger price surge than occurred during World War II. Statistically, most commodities are now so far away from their former downward trend that it makes it very probable that the old trend has changed – that there is in fact a Paradigm Shift – perhaps the most important economic event since the Industrial Revolution." 

This chart was produced shortly before the huge break in the commodities market in the summer of 2011. Grantham emphasized that his argument was about the medium to long term. In the short term, he acknowledged, a bust was possible, after which would come the mother of all buying opportunities. Grantham's is a proprietary index and I have not seen an updated version, but the following chart of the Greenhaven commodity index (GCC) is probably a reasonable proxy for the GMO Index. It gives a much heavier weighting to agricultural commodities as compared with the GSG, which helps explain the big rise from late 2008 to 2011. Given its relative under-weighting of energy, it hasn't fallen as far as the GSG, but it's still packing a lot of hurt in the last few years. 

The conclusion I draw from these various charts is that investing in commodity funds has indeed been an extremely bad idea since the great blowoff of 2008. Since mid-2011, everything has gone down, with oil leading the pack of late. Investment firms have pronounced the end of "The Great Commodity Supercycle." Huge investments were made in oil, cooper, iron ore, gold, silver, corn, and soybeans. And they have just about all come a-cropper. 

As we said at the outset, however, what goes way, way down must come up at some point. The firms which made these investments may have lagging share prices for some years; by the same token, however, the prices of the underlying commodities are likely to recover before the share prices do, and with greater relative vigor. (It was observed recently by an oil expert that the share prices of the major oil companies reflect a long term oil price of $75-85. The price at this writing is $46). Another objection is that the funds tracking energy commodities will probably lag a simple price index, because the futures markets are in contango. True enough, but these deficiencies of commodity funds did not prevent the out-performance that occurred between 2000 and 2008. Whereas there are reasonable arguments that both stocks and bonds are in a bubble, the same cannot be said about commodities. They are definitely in bust mode, oil most of all. (James Paulsen has a recent piece in Barron's summarizing the data on the pricey character of US stocks. 10 year US treasury bonds, by the same token, have a yield of 1.90%.). Most convincing of all is that the marginal cost of "new oil" is within shouting distance of $100 a barrel. Unless the world faces another Great Depression or, better yet, The Apocalypse, the price has got to recover. 

One more point. One of the things that the promoters of investment in commodity funds always emphasized was that commodities have not been especially correlated with stocks and bonds. They therefore help balance out a portfolio and make it less susceptible to wild swings. As the following chart shows, however, that is not always true. Stocks continued to go up during the commodity bust of 1998, but beginning in 2001 there was a fairly tight correlation for the next ten years. That has now broken apart. While the 1998-99 precedent does command some respect (and while stock prices rose after the oil price collapse in the mid-1980s), the chart also suggests the existence of a Great Divergence. Both commodities and bonds are forecasting a recession, whereas the stock market sees only sunny vistas ahead. Something has got to give.  

All in all, I think it a decent bet that our miserable companion in this journey through commodity history, the GSG, will outperform either stocks or bonds over the next three years. It might outperform both. The former possibility (outperforming one or the other) is of a sufficiently high order of probability as to justify some inclusion in an investment portfolio (anywhere, say, from 5 to 10%). If economic activity is as poor as the markets in both bonds and commodities are saying, stocks would have great difficulty maintaining their current valuation. Since oil has borne the brunt of the recent decline, the oil fund USL(holding futures contracts over 12 months)  looks like a more eligible instrument than GSG for playing a rebound in commodity prices. [I am much more confident about USL than GSG, as explained below, but its trading history only goes back to late 2007 and thus can't be shown on the long term charts used above.]

There are certain perils in this strategy. You would be trying to catch a falling knife; there's an old saying (especially among momentum investors as opposed to the value mavens) that you shouldn't try to do that. Secondly, the process may take several quarters to play out, so cost averaging into the position would definitely be the prudent course even for impulsive types. Third, as a general rule, most commodity mutual funds have high expenses, front end loads, and returns that fall well short of a pure price index; they are, as a rule, poor instruments that are more valuable to their administrators than their clientele. I guess that leaves us all dressed up and nowhere to go--that is, convinced of the overall merit of the analysis favoring commodities, especially oil, but rather perplexed over how to implement it.

* * *

Update 1/25/15: By way of further caution, here's a chart provided by Jeffrey Gundlach in his recent investor presentation, notes of which are available at Business Insider. "The white line is the commodity index, the yellow line is the commodity index you can actually invest in. Investable commodities have been losers for years. Gundlach says you lost 800 basis points per annum over the last 10 years investing in commodities."

As Gundlach's chart suggests, the really big hit that occurred in this regard was from the summer of 2008 to the summer of 2011. Since that time the two indexes have tracked pretty closely. This is shown in a ratio chart of USO with WTIC (that is, the etf holding near month futures contracts) and the price of oil. Interestingly, both USO and USL have outperformed $WTIC since the summer of 2013. As the ratio chart of USO:USL shows in the bottom frame, USO has been the consistent underperformer of USL (holding 12 month contracts), especially of late. Weirdly, USO is traded far more frequently than USL (a recent figure shows 40 million contracts for USO, only about 100,000 for USL), and this despite USL's clear superiority based on the historical record and the fact that, logically, USL is the far better instrument when the oil market is in contango, as now. (See this very useful primer at Seeking Alpha)

Another note of caution comes from Steve Briese, a commodity market specialist who has been bearish on oil prices the last year and has been cited in several pieces in Barron's. In a January 10, 2015 followup at Barron's, Briese argues that oil could fall as low as $20 a barrel. He puts emphasis on the very large long positions that commodity funds still hold in oil futures, and draws an analogy with the crash of oil prices that occurred in 2008-09. "From the peak in July of last year, the funds have liquidated about 25% of their long positions. But their positions are so large that, even if they liquidate another 25%, they would hold a significantly greater number of contracts than they did in the bear market of ’08."

Briese's thesis raises an important question about the impact of "financialization" on the commodity markets, a subject I delved into a few years back. Briese's forecast of $20 a barrel oil seems absurdly low to me, but the general argument that these commodity funds matter for the movement of prices is undoubtedly sound. (If it were to fall to that level in a general liquidation, it would indubitably constitute the mother of all buying opportunities. Given the danger of a further fall in prices, I guess right now we're at the stepmother of all buying opportunities.)

One final series of charts suggests that, if you were to play this dangerous game, USL looks to be the most eligible instrument. It is a series of ratio charts comparing the price of USL with other commodity indexes. USL is much less exposed to the contango issue than USO or GSG, and these ratio charts suggest support levels right about here relative to just about every other commodity index.

January 21, 2015

Gold-Oil Ratio at Extreme Level

One of the most reliable of financial indicators has just reached a crucial level, indicating a likely turn in the markets. I speak of the gold/oil ratio, an idea first introduced to me back in the 1980s in a book by John Dessauer (the title of which escapes me). The long term gold-oil ratio is something like fifteen. As the following chart indicates, it has reached a level just shy of 28. Over the last twenty years, it reached this level three separate times, and on each occasion fell promptly back to earth.

Those inclined to immediately rush out and buy oil and sell gold may duly be warned that the gold-oil ratio did reach nearly 33 on two occasions in the 1980s (though in neither case was it there for very long). However, it is rather impressive that in late 1993, in early 1999, and in early 2009, it reached the precise level at which it now sits, and that in each case the 28 level constituted the turning point  in the price action. This must surely count as an extremely strong line of resistance.

But there is another anomaly that makes the picture even more interesting from a financial standpoint. Though gold is extremely expensive in relation to oil, gold stocks are still very cheap in relation to oil stocks. Consider the following chart looking at the ratio of the $HUI, a gold stock index, with the $XOI, an oil stock index. The data here go back to 1996:

Given what has happened to the gold-oil ratio, one would think that the gold stock-oil stock ratio should be closer to the top of the chart than to the bottom. For gold miners, oil is a very considerable cost of doing business, so a decrease in oil prices increases their profit margins (at least, what there is of them). As the chart shows, there has been a very considerable rally in the gold stock-oil stock ratio, from .10 to .16 over the last six months, but these were from very depressed levels. Given the gold-oil ratio in the first chart above, this suggests that the gold stock-oil stock ratio has much further to run, that is, that gold stocks will do much better than oil stocks over the next year or so.

The conclusion suggested by these two charts is that one should go long oil and short gold, and long the gold stocks and short the oil stocks.

Just to round out our look at these various ratios, here's two other charts that reinforce the conclusion that oil is a lot cheaper than the oil stocks, and that gold stocks are a lot cheaper than gold.


One note of caution. Going long oil is tricky because the oil market is in contango. That is, the contracts further away from the immediate month are more expensive. The most widely traded oil fund (USO), an etf that tracks the daily movement of the oil price, will not keep pace with the futures contract when the futures curve is in contango. A way around this is another etf, USL, that buys contracts in equal amounts over the next twelve months, but the gold-oil ratio is not as extreme in the outer months, so it is not clear whether that is the better strategy.

One final chart that puts together these various relationships. Let's call it The Grand Anomaly, a testament to the inefficiency of markets.

I cannot depart the subject without recalling Adam Smith's observation in The Money Game, a popular market book from many years ago. Anyone who has a desire to speculate in the commodities markets should take a nap until the feeling goes away.