Oil's unlikely alliances likely unnecessary

ERIC REGULY
From Monday's Globe and Mail
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December 1, 2008

ROME — When the Russians are ready to hop into bed with OPEC, you know the world's oil exporters are in a panic about prices.

Russian President Dmitry Medvedev last week said his country is ready to "co-ordinate" but not "collude" with OPEC as the cartel considers more production cuts to end the price slide.

At a weekend OPEC meeting in Cairo, Saudi Arabia said $75 (U.S.) a barrel represented a "fair price" for oil. A decision on new OPEC production levels is to be made in two weeks.

Since July, oil has gone from a record $147 a barrel to the low $50s. Unless the price reverses direction, the Russian economy, and the ruble, are in trouble. Like Canada, Russia fancies itself a diversified economy; in reality, the C-buck and the ruble trade as petrocurrencies.

While the difference between "co-ordinate" and "collude" is one for linguists with international law degrees to figure out, the point is clear: Russia will do whatever it takes to get oil prices back up to repair its battered economy, even if it means joining forces with its main energy rival.

But you have to wonder why the Russians (and OPEC and the non-OPEC exporters, like Norway) are getting their oily shorts in a knot. Prices overshot on the way up. In the spring, they were tacking on about $10 a month. Now it looks like they're overshooting on the way down. The case for sustained $50 oil is just as hard to make as the case for sustained $150 oil.

Oil prices could keep sliding. Institutional investors obviously helped to propel the price of oil and virtually every other commodity, from copper to wheat, on the way up.

Now the institutions are getting out and they haven't finished unloading their positions. In jittery markets, even relatively small sales can knock prices down hard. The institutional purge could easily push oil down to $40, perhaps lower (just before the Thanksgiving holiday in the United States, January crude futures were trading at just under $54).

In market selloffs, the bearish news can easily overwhelm the bullish news. For example, in September, year-on-year U.S. oil demand was down by 2.6 million barrels a day, or 13 per cent. It was a big number and the market apparently took this as a sign that the Americans' love affair with petroleum was over and that minor amounts of whale oil could meet their energy needs.

Largely ignored was the offsetting dose of bullish news. OPEC, which is responsible for some 40 per cent of global oil production, has reduced output by about two million barrels a day in recent months, and is almost certain to cut again in December.

Here's another data tidbit: In October, China's year-on-year oil imports were up 28 per cent. It was ignored because the world is fixated on China's expected 2009 GDP growth rate of about 8.5 per cent, down from double-digit growth rates as long as anyone can remember.

With China still expanding at a speed Western economies can only dream about, you can bet it will keep sucking up every drop of available oil. But never mind; the market apparently considers China's downgrade from a white-hot, to a hot, economy means it, like the U.S., no longer considers oil essential.

The market is shrugging off even more compelling data that $50 oil is unrealistically low.
At the current price, oil developments everywhere are being curtailed or shut down. Royal Dutch Shell last week announced it's yanking its application to build the 100,000-barrel-a-day Carmon Creek oil sands project in northwestern Alberta. At the same time, Irving Oil said it is in no hurry to build the $8-billion (Canadian) Eider Rock oil refinery in Saint John. Construction will be stretched out over eight years instead of four.

And so on, around the planet.
As new developments are being sent to the morgue, old developments are entering retirement homes. The International Energy Agency produced this sobering fact a couple of weeks ago: Production at 800 of the world's biggest oil fields is declining by 6.7 per cent a year, a rate that is accelerating.

The falloff means that about 45 million barrels a day of new production in the next 22 years would be needed just to meet current world demand of about 87 million barrels a day. Filling the gap would get harder every year because the IEA expects demand to rise to 106 million barrels a day by 2030.

If these findings alone were not enough to get you excited about oil again, nothing will. Bearish sentiment still rules, as Russia's unlikely alliance with OPEC shows.

But a few bullish souls are starting to break from the pack. Barclays Capital has expanded its commodities team this year by almost 50 per cent, taking it to 300 employees, even as prices plunge. It considers the downturn a blip in a long-term commodities upswing. In a year or so, Barclays' move might look inspired.

TLM and QEC Houses

Investors look down

RTGAM






If the stock market roared back to life last week on relatively little good news, it may seem fitting to some investors that the market fell back into the sick ward on Monday on relatively little bad news.


But what a fall it was: Canada's S&P/TSX composite index closed at 8406.09, down 864.41, points or 9.3 per cent - the most severe one-day downturn this year in percentage terms, and the worst since the crash of 1987. In the United States, the Dow Jones industrial average closed at 8149.09, down 679.95 points, or 7.7 per cent. The broader S&P 500 closed at 816.21, down 80.03 points, or 8.9 per cent.


The U.S. indexes had been down throughout the day, but were able to contain their losses at relatively modest levels (emphasis on "relatively") soon after the National Bureau of Economic Research declared that the U.S. economy had fallen into a recession in December, 2007.


Investors were also treated to another bad reading on manufacturing activity from the Institute for Supply Management, but one that was not widely out of whack with economists' expectations or with the previous month.


Meanwhile, the far harsher Canadian selloff occurred even after Statistics Canada reported that the economy expanded at an annualized rate of 1.3 per cent in the third quarter - a better clip than economists had expected.


In all probability, the reports probably had little bearing on investors, since they all look backward. If investors were going to do any backward gazing, it was to look at the heady gains of the previous week, when markets enjoyed their best rallies since the 1930s.


Now, Monday's losses have erased all of the Dow's gains over the previous four trading days. In a single day, Citigroup Inc. fell 22.2 per cent, Bank of America Corp. fell 20.9 per cent, General Electric Co. fell 9.7 per cent and Microsoft Corp. fell 8 per cent. All 30 stocks in the Dow fell. At the S&P 500, an amazing 498 stocks fell. (The two winners: Rohm and Haas Co. rose 3.5 per cent and Autonation Inc. rose 0.1 per cent.)


Monday also erased all of last week's gains for the S&P/TSX composite index, which was hit particularly hard by declining commodity prices. Among financials, Royal Bank of Canada fell 8.7 per cent and Manulife Financial Corp. fell 14.8 per cent. Among energy stocks, Suncor Energy Inc. fell 16.4 per cent and EnCana Corp. fell 12.8 per cent after crude oil tumbled to $49.28 (U.S.) a barrel, down $5.15.


Gold stocks were no help, after the price of gold fell to $776.80 an ounce, down $42.20. Goldcorp Inc. fell 16.7 per cent and Barrick Gold Corp. fell 13.4 per cent.

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