Watership up

In the 1970s British novel, Watership Down, a band of rabbits led by one Hazel escaped destruction and went on looking for a new place to live.  In the course of their odyssey, they come across a warren of well fed but depressive rabbits; these resplendent animals feed on mouth-watering lettuce planted by the local farmer, except that this farmer also sets up snare wires in his field to catch them, one by one.

Unable to resist the lettuce yet afraid of the wires, the epicurean leporids try to convince Hazel’s band to stay in order to lower their own chances of strangulation.  Showing both fortitude and wisdom, Hazel and his friends move on.

Moving on to Europe in 2016.

Last week, the human inhabitants of Britain voted to exit the European warren in search of a better life.

Unlike the rabbits, the British people don’t enjoy the support of a seer and his conviction that they will succeed.  But like the rabbits, I think that they made the right choice.  Europeans should take this opportunity to change course as well.

Originally set up as a customs union, the EEC included six founding members.  With the passing of General de Gaulle, the key opponent to federalism disappeared and the European institutions went on increasing their areas of competence.  By 1973 Denmark, Ireland and the UK had joined in. 

The 1980s set the seeds for real dissent by further enlarging membership (Greece, Spain, Portugal) and further increasing the powers of the European Parliament[1]. 

The 1990s brought the Treaty of Maastricht with expansion into foreign policy, criminal justice, the military, and of course financial matters with the creation of the euro.  The euro was a rushed job[2] and a highly political compromise: Germany was wary of the euro but eager to absorb East Germany; France was wary of German expansion but eager to adopt the euro.  And three new countries joined the European Union.  The Treaty of Amsterdam further built Brussels bureaucracy, to the point of making many of the new regulations unworkable.

The 2000s brought in twelve more members, such as the Baltics, Bulgaria, Cyprus and Malta but also created more conflicts between national and EU areas of competence.  The seemingly unchecked reach of Brussels in a 27 country union with GDP per capita ranging from $50,900 to $7,700[3] encountered growing resistance among the core countries.

In retrospect, it is amazing that such a transformative integration process as the EU was conceived and implemented with almost no popular consultation or approval.  Indeed, after the Dutch and French popular rejections of 2005, the EU Constitution was recast under the 2007 Treaty of Lisbon so as to avoid future popular referendums![4]

Suffering from a legitimacy deficit, the EU was at risk if its members faced serious difficulties, and this is what has happened with: 1) poor macro-economics in the aftermath of the 2008 global crisis, 2) recurring acts of Islamic terrorism, and 3) uncontrolled immigration from the Middle East.  Worse, being part of the Union didn’t seem to help.

I for one am fairly optimistic for the UK:

-The British Isles haven’t drifted towards the freezing Artic,

- The commercial, industrial, financial and touristic ties built with the EU countries over the last three decades are not going to disappear any time soon as they are mutually beneficial,

- The UK and London have always been open to the world; this culture, the skills and the soft infrastructure developed over the centuries will endure and should facilitate an international revival free from the cumbersome shackles of Brussels.

For the remaining 27 EU members, Breixit is also an opportunity to reform the Union.  Indeed, former President Giscard d’Estaing, of no-referendum fame, declared yesterday that the EU needed more democracy, less bureaucracy and more differentiation between big and small countries.

The EU is often made fun for silly rules such as the curvature of bananas, and why not?  But more serious rules stand in the way, such as those preventing Italy today from recapitalizing its ailing banks.

Prestige aside, the euro zone has disappointed.  Instead of bringing about stronger finances, it has incentivized its members to take advantage of lower interest rates to load up on debts.  Rich countries like Germany are now indirectly supporting the weak fiscal policies of others while the weakest ones, unable to devalue, must squeeze their workers to the point of endangering social stability.

Returning power to the states, limiting bureaucratic creep by cutting down the number of commissions and agencies, mandating sunset provisions in new regulations, tying national voting power to population and GDP size should count among the steps towards establishing a better union of so many members.

The UK has been the catalyst for change.  It is messy, jarring, worrying, yet necessary for survival.  Following in the steps of Hazel, Fiver and Bigwig, Britain is on the move again, and who knows, it may decide to join a reformed European Union?

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[1]  Starting to cause the first serious frictions with a number of member countries, Ireland having to amend its Constitution to accommodate this power increase.

[2]  Common currency without fiscal integration or even harmonization as the so-called convergence criteria were soon disregarded by the major countries.

[3]  Austria and Bulgaria.  Luxembourg is excluded.

[4]   Former President Giscard d’Estaing candidly confessed to that in an op-ed in Le Monde on 10/29/07.

The Prisoner of (Mar al) Zenda, an exercise in fiction

On a balmy Florida morning, the mansion staff were tidying up the veranda and cleaning after the guests had finished their breakfast.  The dinner and recital of the previous evening had gone rather well considering the palpable tension which had pervaded the relations between the host and some of his most prominent guests.

But the atmosphere had relaxed considerably come morning, and the Majority Leader, who had maintained his habitual reserve since he had arrived, was almost bubbly by the time he had finished his croissants.  The Speaker had returned from an early two hour run and was engaged in a lively discussion with a Silicon Valley investor.

As limousines started to pull up and attendants were loading the luggage, the Host was amiably chatting with departing guests before sending them on their way.  In all the buzz, one could easily be forgiven for failing to notice that the famous hair of their host had turned a shade redder, or that a small blue van was silently rolling towards the service exit.

The bombshell exploded a week later when the Host told Wolf Blitzer on CNN that he had decided to pick former General and CIA Director David Petraeus as his running mate to set up the first co-presidency in US history.

Wolf’s eyes literally bulged out of their sockets, and for a few seconds, he was at a loss for words.  The Host gently let him gather his wits and proceeded to explain why this was a win-win strategy for the country, the Republicans and him:

-“Wolf, to make America great again, we need to revitalize the economy, rebuild our military and recast our foreign policy which have been TERRIBLE in the last eight years.  I am a very successful businessman, my friend Carl Icahn will pitch me his best ideas, and I will choose a FANTASTIC Treasury Secretary!  But look, as smart as I am, I have no experience in foreign affairs or in defense, and David is the best out there, and so I am so grateful that he accepted to serve our great country as Vice President with primary authority in these two areas as well as domestic security.”

-“Donald,---woah,…ah…this is so unexpected,.euh…

-“Wolf, you are a VERY sharp journalist, one of the very best in the business, as a matter of fact I think you may be the best, and surely you can see that this ticket is bringing the temperament and competence which I promised all along and which this great country deserves.  And we will win in November!”

Within seconds, somewhere in Kentucky, the Majority Leader clasped his hands, and, in a manner reminiscent of Dinah Lord’s at the end of The Philadelphia Story, simply uttered: “I did it!”  Somewhere in Chappaqua, NY, a blond woman sunk into her sofa, sobbing: “Not again!”  Five thousand miles away, in a small Amazonian forest clearing, a thin plume of smoke was twisting in the morning mist as a few women were grilling freshly caught fish from the Apaporis river.  The rest of the small Xurungawah tribe was sitting in rapt silence as a big fair skin man with a strange yellow-white mane was haranguing them:

-“Folks, this is one incredible place and you are an amazing people!  We will build here the most amazing ecological resort in the world!  I see you don’t quite grasp what I am telling you, but we will get it done folks, and by the way,..”

Unlike in the movie, we don’t know if Donald Trump has a perfect double.  But an opinion is starting to take hold: at his age, he is unlikely to change, and for a growing number of Americans (including me) he is unelectable to the presidency.

Republican Party leaders are realizing that, but they can’t ignore the votes of millions and nominate another candidate.  They can’t go to war with him although they can’t embrace his corrosive statements.  They openly worry that he doesn’t know enough about domestic or foreign policy to govern effectively.  Yet they are unwilling to leave the White House in the Democrats' hands without a fight.

Still, they hold two aces: one is money.  Effectively, they will control the bulk of the donor contributions and therefore how the campaign will be waged.  They also know that as a man with a large ego, Donald Trump will not want to face a humiliating defeat.

They could try and convince him to resign.  But while his poll ratings have weakened, they haven’t entered panic territory.  Until then, neither he nor his supporters will let go.

Or the party leadership could convince him to share a co-presidency with a respected professional heavyweight; somebody strong enough to make that project credible.  In 1976, Gerald Ford briefly offered a similar deal to Ronald Reagan.  It didn’t work because the two men were not complementary and believed that they could win on their own[1].

This is not 1976.  A co-presidency of the kind suggested above would have several key benefits for the Republicans: 1) it would wrong-foot a Democratic strategy focused so far on discrediting a personality, Trump, 2) it would prevent many Trump voters from bolting or abstaining, 3) it would force the Democrats to come up with a government program agreeable to both Clinton and Sanders factions, and 4) it would also force them  to do the same, giving them credibility.  Win or lose, the benefits for the country are obvious.

In truth, the options for the Republicans are very limited and risky, and they only have themselves to blame.  Our “Prisoner of Zenda option” is a long shot.  But hoping that Hillary Clinton is forced to retire would only bring in Joe Biden, and he would trounce Donald Trump (my opinion).  Allocating most of the money and efforts to the Congressional races at the cost of the presidential one is risky: it could divide the Party further and encourage Republican voters to stay home.

If only Ruritania were real!

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[1]  Ronald Reagan believed he could win in 1980.

On the head of a pin

The Republican primaries are effectively over.  Donald Trump has won.  The Democratic ones continue, with Bernie Sanders hammering at the only Establishment figure left, Hillary Clinton.

2008 was the year Americans felt they had come together behind an historic candidate, Barak Obama.  Eight years later, they are angry, frustrated and more divided than ever since the Vietnam War.  So much so that they are betting on two outsiders who promise to bring the “corrupt” system down. 

Now what?  Reality is starting to dawn on Republican Party grandees that Donald Trump is not their candidate, rather that they are his supporting cast.  Who is the boss?  The question is being asked now and will be answered soon.

Republican mediators hope that Donald Trump will change his tone to unite the Party.  This is unlikely for several reasons.  Dumping a winning strategy has risks for Trump.  Besides, one of the most surprising sights of the primaries was to see prominent politicians taking little offense at being called corrupt, liars, weaklings or told to shut up on live tv.   

My view is that Donald Trump calculates that the Republican Party leaders lack courage and vision and that they will ultimately back him up in order to save their sinecures: better being tame courtiers than proud exiles.

A Trump president would likely go over the heads of Congress and the Senate to appeal directly to voters, make extensive use of executive decrees, and go for big targets: big infrastructure programs, NATO shake-up, big budget and spending battles.  He obviously believes that he would win most of these; he would enjoy the negotiating game;  but the US is not the NY real estate market, or even France, Germany or Russia:  Gamesmanship at the US level has far greater potential destabilizing effects.  Unpredictability may be a good negotiating tactic but it is not a strategy for the world leader[1].  Likewise, loading the US with debt – because if the economy rebounds it is easy to pay it off, and if it fails you just restructure – can’t be the best way to sell  hundreds of billions of US treasuries every year.

The Trump candidacy will have had some positive effects, such as exposing the dysfunctionality of the Republican Party, imbalances within NATO contributions and the not so hard nose negotiating abilities of the Obama administration.  But the negatives of a Trump presidency are difficult to fathom and potentially huge.

What about the Democrats?

Hillary Clinton is unloved and polarizing, but is the safe pair of hands among the last three remaining candidates.  Yet she has been pulled further to the left by Bernie Sanders than she wanted or expected (and her miseries are not over yet).  That Senator Elizabeth Warren is talked as a possible running mate makes that very clear.

She also has hanging over her head, as the Sword of Damocles, the inquiry into her use of a private server and the sharing of “classified” emails.  It is possible but unlikely that the Department of Justice pursue a criminal indictment against her; but if this decision were a close call, some disgruntled FBI or DOJ staff could leak embarrassing related documents; then, we would have a new ball game.

To succeed in the general elections, she would need to retain the support of Sanders’ voters while attracting independents and non-Trump Republicans: no small task.   

If she succeeds, and unlike the other two candidates, she is more likely to seek consensus because she won’t have a solid base of believers.  She would need a good communicator to help get her message through that, as Talleyrand once said, governing is the art of the possible. Would this be her Vice President, her Secretary of the Treasury or her Secretary of Labor?  I don’t know.  Would she succeed?  Way too soon to tell.  Besides, if she didn’t heed Sanders’ entreaties, over time his supporters could set up the Democratic equivalent of the Tea Party.

In summary, and as of today, this presidential election looks like the most frustrating in years.  The two most likely candidates are viewed more negatively than positively.  The two with the greatest fan bases are party outsiders who promise the moon and howl that the political parties whose banner their carry are rigging the primaries against them and their voters.  The cooler headed one enjoys stronger support from party officials than from party members.

Fasten your seat belt but don’t get off the plane!  

Because if you think this political season can't hold any more surprises, THINK AGAIN.

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[1]   But it has been for North Korea.

A flash in the sky

65 million years ago, the dinosaurs ruled the earth. No other specie could compete in diversity, dominance nor offer surer prospects for more of the same for eons to come. And then, suddenly, they were gone. A catastrophic event, perhaps a large asteroid crashing into the sea off the coast of Yucatan. The world would never be the same after that.

For decades, macroeconomic management in western economies was carried out through the competing and complementary efforts of business practitioners (mostly ex-bankers) and economists. The final arbitrages were made by elected politicians.

This balance of influences served us well. “New” ideas were thoroughly debated between theoreticians and practitioners, with the most toxic ones being filtered out. This didn’t prevent preeminent economists like Paul Volcker or bankers like Robert Rubin from making key positive contributions to the economy.

But then came the financial crisis of 2008 and the ensuing Great Recession, and the banker specie became extinct, figuratively speaking.  (Investment) bankers[1] had been playing with fire, resorting to dizzying debt leverage, funding huge quantities of dodgy mortgage loans with overnight funding, betting on derivatives without properly hedging themselves, and the list goes on.

In truth, bankers were not the only ones responsible for the crisis, but they were the richest, they were politically tone deaf and they were the ones standing among the ruins. Politicians were equally despised, but since they couldn't be fired, knew how to quickly blame somebody else, and fake compassion by writing new regulations and imposing huge fines on bank shareholders to atone for the sins of bank executives, they survived.

The economists were neither rich nor elected, and they had two hands (“on the one hand…on the other hand..”). And so the new era of the homo economicus began.

Unchecked, unchallenged, economists rose to the status of doers, saviors, and seers. They were empowered to carry out real life experiments on a massive scale and test their theories in the real world.

The last act of the banker/economist tandem (Paulson/Bernanke) of opening the liquidity spigot and forcing a massive recapitalization of the banking sector was appropriate at the time.

But subsequent and continuing experiments in printing huge amounts of money, forcing interest rates down to zero and even below, and in having central banks buy hundreds of billions of shaky sovereign and corporate bonds have hardly been conducive to inspiring confidence.

Under such altered financial states, home owners may see their equity go up (because of rock bottom capitalization rates), but they also see their investment income collapse to a trickle.  Not likely to encourage splurging.

Working people, if they pay attention, worry that their pension plans are way behind in building up the kind of retirement assets they will need later in life.  In all, some five trillion dollars in public and private US pension plans are affected.  It is even worse in Europe.

While governments have taken tens of trillions in new debt, they expect their national currencies to weaken just enough to facilitate exports but not enough to trigger capital flight.  Good luck with that.  And whose currency is appreciating to soak all these exports?

The current economists’ bold plans remind me of the Collor Plan in Brazil, back in the early 1990s.  One of its key measures to crush inflation was to drastically reduce demand by freezing financial assets.  All of a sudden, households couldn’t touch their investment accounts, could only withdraw US$600 from their savings accounts and up to 20% of their interest-bearing checking accounts!  That monetary freeze was to last six months!  And ultimately the frozen money would only have limited use.

Debasing the currency, targeting private savings, encouraging excessive risk taking may help balancing some equations on paper, but they destroy confidence, and without confidence there is no economic growth.

In fairness to economists, bickering politicians had left monetary policy as the avenue of last resort. But the adepts of the Dismal Science didn’t need much encouragement.

And now these sorcerer’s apprentices must undo their clever constructs, like Disney eponymous character.  I may be wrong, but the reign of the economists is unlikely to challenge that of the dinosaurs.

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[1]  By and large, the most egregious excesses were committed b investment bankers, but some commercial bankers joined the fray.

Sister Souljah moments

It seems that all major political campaigns have their Sister Souljah moment, when the candidate(s) face a high risk question or situation which opens or closes their path to success.

The original one of course was when candidate Bill Clinton, speaking to Jesse Jackson’s Rainbow Coalition, chose to publicly rebuke a well known black activist’s justification of black on white violence.  Clinton did endure harsh criticism from some quarters, but he gained the broader support of moderate Democrats who had had their doubts about him.

In 2012, Mitt Romney and the rest of the Republican presidential candidates had their own Sister Souljah moment, and they blew it.  When a debate moderator asked them if they would accept a hypothetical deal to increase taxes by $1 for every $9 in spending cuts offered by the Democrats, they hesitated, looked at each other, and demured.  How could getting 90% of what you want be unacceptable to those “conservatives” when their idol, Ronald Reagan, famously said he would settle for 80% and fight for the rest another day?  They were so afraid of losing fringe support that they ended losing the support of the majority.

This year, we have seen Republican presidential candidates being called liars and other names in front of millions of TV viewers and hundreds of spectators by Donald Trump, and not responding.  Is their sense of value so distorted that they didn’t think such attack on their honor deserved the most vigorous response?  Or were they afraid of Donald Trump?  Either way, they let their Sister Souljah moment pass and will live to regret it.  So will we.

Yet another such moment came in yesterday's debate: after arguing, sometimes literally, that Donald Trump was unfit to be president, his three opponents pledged to support him if he was nominated.  I am glad they do not work as check captains at my favorite airline.

Oil economics: a peak under the hood

In our previous post, we looked at the current imbalance between supply and demand.  We concluded that this imbalance was clearly due to an excess supply.  We concluded that, barring (likely) geopolitical turmoil, it would take two to three years for crude oil markets to stabilize.

But how will this take place? Which oil sources will be affected the most and see their production curtailed first?  How will producers decide to cut or not to cut output?  Many of the answers can be found in basic oil economics, accounting and finance; in particular, in the difference between profits and cash flows.

Shale oil is the sector which has grown the most, and the one which has been the first to retreat.  There are three reasons for that:

1.     Its upfront (capex[1]) costs are relatively low; as a result the lead time to production is short which represents low entry barriers for small, entrepreneurial and innovative companies.  The result has been a boom in production; it has also made it easier for producers to step back;

2.     Second, as shale well production typically falls 50% to 70% within the first  12 months, shale producers must continually invest in new drilling to at least maintain  production levels, the result being chronic free cash flow deficit;

3.     Thanks to rock bottom interest rates and the popularity of shale, producers had no problem avoiding equity dilution by financing these deficits with ever mounting debt.

But when credit markets tighten and oil prices plunge, shale producers face both deeper cash flow deficits and scarce credit.  They have no choice but to pare down capex and current operations. This retrenchment, combined with the naturally steeply falling production curves, explains why shale oil has been the sector most affected.

At the other extreme, Canadian oil sands producers have very different economics:  their business calls for very high upfront investments and very long lead times to production.  Afterwards, their operating costs are average but they do not need to invest much besides maintenance.  In the current environment, their cash operating costs are close to breakeven while the depreciation of their investments will push them into accounting losses.  Oil sands operators are like copper miners: once they have completed at least 70% of the investment for a new project, and unless long term oil/metal prices are expected to stay very low, they are committed to completing the project, and taking their losses for a while.  Of all the oil producers, they have the least flexibility to cut back on current production.

All other oil sectors fall somewhere between these two extremes.  Most of the non-OPEC and non-shale new production has come from sources which call for high levels of upfront investment.  As producers in these areas are strapped for cash and pull back on new investments, future production will suffer as there will be no quick fix for expensive, long lead time projects.

Accounting will also impact future production in another way.  Most oil producers must adjust the value of their oil reserves to the economic reality.  Typically, they are obliged to verify that the book value of their proven reserves doesn’t exceed the present value of their future cash flows[2].  This test is carried out quarterly, based on the monthly average market oil prices for the previous 12 months[3].  The steep drop in prices since last summer - and the likelihood that they will continue for at least two years - will force massive asset and equity write-downs and inhibit producers from raising additional capital financing.

Finally it is often forgotten that industry costs are just as dynamic as their prices, making it difficult to rebalance supply and demand.

When a cycle of rising oil prices gets under way, it attracts more money to the industry and encourages companies to boost their production.  This reverberates through the supply chain of goods and services: demand for new crews, drilling services and equipment boosts their costs and raises the producers’ breakeven points. 

Conversely, when oil prices fall, the relationship works in reverse: headcounts are reduced, third party contracts are renegotiated and weaker demand for inputs lowers their costs; the breakeven of oil producers goes down and production cuts are delayed as cash margins remain in positive territory.

Again, in a such a scenario producers may show accounting losses, but if they lower their costs to a level that lets them eke out positive cash flows, they will maintain their output as the cash is needed to service debt and stay above water.

This phenomenon was clearly illustrated by the ability of shale producers to defy predictions and survive oil prices well below what was thought to be their breakeven points. 

The result is that the adjustment to falling oil prices is not linear but more akin to a series of waterfalls, where not much happens until a sudden drop follows a shallow decline, followed by another gentle decline and another sharp fall.

When this dynamic plays through the whole industry, and when geopolitical risks are layered on top, one better understands why oil is such a volatile commodity.

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[1]  Capital expenditures.

[2]  Usually, net future cash flows are discounted back to the present at a rate of 10%.

[3]   Should the oil be committed to be sold under multi year contracts, the price imbedded in these contracts would be used.

Crude oil blues

While hard commodities are going through very tough times, crude oil has grabbed most of the headlines, and no wonder: its derivative, gasoline, is an essential product that billions of human beings consume every day.  Oil is also associated with the most volatile areas of the world which are making the headlines of newspapers and TV evening news.

Crude prices have fallen from over $100 per barrel in the summer of 2014 to under $30 today.  Some experts foresee $20 and even $10 before any rebound takes place.  Are they right?  A better question is whether such collapse is cyclical or secular.  Crude oil is a global commodity, largely driven by supply and demand.

Two charts are most instructive in this regard.  The first one shows the quarterly global demand for oil from 1Q 1996 to 3Q 2015:

Source: Bloomberg.

What is striking is how linear and steady the rise in global demand has been over the last 20 years.  Yes, the Great Recession of 2008-2009 cut demand by some 3 million bpd, but that drop was erased in less than 2 years.

Despite a short but a massive global recession, global demand for oil has grown fairly consistently at a rate of 1.5% p.a.  The supposed crumbling of the Chinese economy is not apparent over the 2010-2015 period; indeed, Chinese demand for gasoline grew by 12% in 2015 over 2014[1].  It is also interesting to note that the demand for oil kept rising steadily from 2002 to 2007 and from 2009 to 3Q 2014 despite prices soaring from $19 to $91 and from $36 to $94 respectively.

Put it another way, global demand for oil is fairly price inelastic over the medium and long-term; despite claims that fossil fuels are on their way out, there is little evidence that demand is falling, and I doubt that this will happen for the next few decades.

The second chart shows US oil production over the 1983-2015 period.  It does much to explain why prices have suddenly dropped.   Or why OPEC, and Saudi Arabia in particular, have decided to no longer play the role of market moderator. 

Source: Bloomberg.

After peaking at 9 million bpd in 1986, US production steadily decreased to 5 million bpd in 2008.  However, thanks to the development of shale extraction, it skyrocketed to 9.6 mm bpd in June 2015 before falling to 9.2 mm bpd by year end.  From the end of 2011 to the middle of 2015, shale oil production grew at an astounding annual rate of about 1 million bpd!

With oil at $100 shale was a terrific business.  At $40, it is a losing proposition for most.  Already, US shale production has dropped by 400,000 bpd since June of 2015.  Estimates of another 600,000 bpd cut this year are reasonable, for a cumulative 1 million bpd.

When might global oil markets get back into balance and prices rise to a range of $50-$70 which would permit the commercial exploitation of most sources of crude except for the more expensive shale and oil sands?

If we assume that the sudden oversupply of shale oil caused the current imbalance, then the secular annual increase in global demand of 1.5% (or about 1.4 mm bpd today) should take 3 years to close the gap, everything else being equal[2].  This would get us to the end of 2018.

But it is unreasonable to assume no extraneous factors, especially in today’s world.

First, as we indicated earlier, US shale production is likely to fall further, probably by another 600,000 bpd this year.  This decrease will probably be compensated in large part by increased Iranian exports of 300,000 to 500,000 bpd.

Towards the end of projection period, drastic cuts of close to 40% in investments made so far by the oil industry are bound to result in flat, not rising, production.  Among the world leaders, Petrobras for one has already massively scaled back its growth and may be forced to do more.

Geopolitical factors may cause more significant swings in global supply: Venezuela is teetering on the edge of economic chaos; Libya is in even worse shape. The second largest OPEC producer with 4.4 mm bpd, Iraq is in a state of war with IS.  And then there is the rising tension between Iran and Saudi Arabia where the principal actors don’t want a war but do want to test each other.  Russia is strapped financially and barred from access to the best of western petroleum technology.

Between cuts in US shale, increases in Iranian exports and difficulties faced by OPEC and non-OPEC producers, it is not unreasonable to envisage a net reduction in global supply of 800,000 bpd to 1 mm bpd over the next three years.

Finally, there is the reality that at least 5 mm bpd of new production must be ramped up every year to make up for natural field depletion.  That costs money.  A lot of money.

I don’t know what the oil prices will be this year or the next.  However, I think that, barring major geopolitical accidents or a recession,  the global oil market should get back close to equilibrium by early 2018 through a combination of lower production and higher demand.  Financial markets should anticipate that by six months or so.

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[1]  RBC Capital Markets.

[2]  At present, the US shale production is about 4.2 million bpd.  4.2/1.4=3 years.