On fools and memory loss

I had a bit of an epiphany the other night. Few would deny (aside from the ignorant themselves) that deep ignorance is taking hold in this country at a truly frightening rate. This ignorance covers a vast swath of issues and it’s getting more difficult by the day to find subject areas that are unaffected by it. As I was reading some laughably foolish anti-vaccer rant, it occurred to me that all forms of this ignorance stem from the same problem: utter lack of historical perspective. Given the American public’s fifteen minute memory, this should come as no surprise. Remember when Ebola was going to kill us all – people were ranting all over social media about the impending apocalypse, need for immediate border closings, and Faux News was calling for the impeachment of the president over it? Me neither. Oh wait, was that just last summer? I got it confused with this time in 1995, never mind, I mean 1990... no wait, make that 1976. Every time as if it’s the first time ever. Why? Because when you have no memory, all events are unprecedented.

After thinking about this phenomenon for some time, there wasn’t a single ignorance movement in the US that I couldn’t relate back to a lack of knowledge of history. The anti-vaccers seem to have no knowledge of the 350+ million people killed by smallpox or the fact that polio used to affect 350,000 people annually and now affects less than 1,000. It’s easy to be anti-vaccines when, in your fantastical world, those diseases never did any harm and maybe never even existed. People constantly parroting the “terrorists hate us for our freedoms” and “Muslims are violent, evil people” lines are oblivious to over a century of Western imperialism and the West’s own terrorism. They seem to have totally forgotten about the Crusades and the Inquisition, and all manner of other Christian lead terrorist actions. While decrying ISIS beheadings they ignore US torture than happened just a few short years ago. They bemoan troops killed by the Taliban, not even realizing they were killed by weapons we supplied the Taliban with. It’s easy to see third-world peasants and Muslims as the aggressors when you’ve forgotten about everything that lead up to the conflicts we’re in today. Then of course there’s some of my favorite ignorant people: the champions of deregulation. They’re demanding the gutting of Dodd-Frank because their memories have failed them on the 2009 financial crisis and its lead up that was caused by the destruction of Glass-Steagall. Hell, most of them probably don’t even remember Glass-Steagall existing. They want the EPA closed down and the FDA shuttered. Why? Because they have no idea what life was like when people were choking on black clouds of pollution in cities, waterways were brown with sewage, food poisoning was a routine occurrence, cholera was the cool thing to have, and people had no information on the content of their food or drugs. In their small minds with memories that only extend as far back as today’s breakfast, none of this ever occurred. If you can’t even remember why regulation was put in place to begin with, of course you’re going to see it as superfluous and want it removed. We also can’t forget the close cousin of the deregulation fool: the “free market” fool. These are the people beating the drums for the removal of all workers’ protections and a return to feudal times. These people have no idea that this country’s organized labor movement (not the benevolence of corporations) is what gave us things like overtime pay, paid vacation, paid sick leave, maternity leave, equal hiring, child labor laws, minimum wage, healthcare benefits, unemployment insurance, social security, and pretty much anything else benefiting workers. We would have none of the labor laws we take for granted today if it were not for strong unions and the workers’ right movement petitioning the government for change. Yet these anti-labor people want the government out of business. They want to break “evil” unions. They want to undo everything the American worker fought hard for. Why? Because they don’t have even the slightest clue that the American worker fought for it. They have no concept of history. They have no idea what working in a 1920s factory or mill was like. They forget that huge, government stimulus packages are why we have an interstate highway system and hydroelectric dams. They think because things are this way today, surely they were this way always. Trickle down economics was tried and failed – but they don’t know this because they don’t know or understand anything that happened prior to fifteen minutes ago. When so many people’s minds are blank slates like this, the ground is ripe for the seeds of rewritten history to be sown – which is exactly what we see happening today, championed by the leaders of the ignorance movement.

This all left me with the conclusion that the best way to reverse this country’s rapidly growing ignorance problem is not to educate people on current events (as I had previously believed), but to educate them on history. Current events are meaningless if they are not put in historical context. People must understand how we arrived at where we are. They need to understand why things are the way they are today and what life was like in years past (in some cases even reminders of forgotten events that occurred in their own lifetimes). Only then will the spread of ignorance slow and, hopefully, reverse.

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Oil meltdown: day number… what day is it?

I had no intention of this oil discussion turning into a running series, but it has because the oil price plunge has been a fascinating chess game to watch unfold. Previous posts on oil can be found (in order) here, here, here, and here. Today, there are two points I’d like to talk on. Now, to the Batmobile!

I recently came across an interview with the Saudi oil minister Ali Naimi that took place in mid-December. The interview (not to be confused with the terrible movie of the same name) is confirmation of exactly the strategy I proposed in my original oil post, this time coming straight from the Saudi’s mouths. The full interview is a good read, but I want to pull a few key quotes from it. In my original post on oil, I proposed that OPEC wouldn’t cut production purely because that was the most logical business decision for them; then normal market forces would take the reins from there. Since then, and now with everyone and their mother on the oil talk bandwagon, there’s endless conspiracy theories being thrown around about the US trying to hurt Russia, ISIS flooding the oil market to hurt the US economy, etc. Reality is much simple than that.

Interviewer: 

Will Saudi Arabia not cut production if the Russians do not cut?

Ali Naimi:

First of all, why did we decide not to reduce production? I will tell you why. Is it reasonable for a highly efficient producer to reduce output, while the producer of poor efficiency continues to produce? That is crooked logic. If I reduce, what happens to my market share? The price will go up and the Russians, the Brazilians, US shale oil producers will take my share.

…..

It is also a defense of high-efficiency producing countries, not only of market share. We want to tell the world that high-efficiency producing countries are the ones that deserve market share. That is the operative principle in all capitalist countries.

This was exactly my point from day one. There is no grand conspiracy. Why would OPEC cut production to bolster prices when higher prices will favor the marginal fracking operations in the US and Russia?

Interviewer:

If the price remains at roughly $60/B the call OPEC crude will be 2mn B/D less than current output. If OPEC production does not fall by 2mn B/D, is there some point within the coming year at which OPEC would have to take the decision to cut?

Ali Naimi:

I want to make one thing clear. It is unfair of you to ask OPEC to cut. We are the smallest producer. We produce less than 40% of global output. We are the most efficient producer. It is unbelievable after the analysis we carried out for us to cut.

If the price falls, it falls, you cannot do anything about it. But if it goes down, others will be harmed greatly before we feel any pain.

Interviewer:

Venezuela needs a higher price than you

Ali Naimi:

That is true, but that is not of any use. But all we will do if we allow prices rise as we did in 2008 in Oran [is to raise] the production of marginal barrels. This was less than 1mn b/d [in 2008], today it is around 4mn b/d.

Has that point been sufficient reinforced? No conspiracy. No Russian punishment. Turn off the idiots on CNBC. OPEC is on the same page that I was on when I presented what I believed would be their strategy in my original post. It’s simply wise business people looking out for their own interests by making good business decisions.

With that clear, we come to my second talking point. Anyone that’s watched CNBC or read any so-called “expert” analysis has surely heard about this oil glut we have. Supplies are just through the roof and demand is nearly at zero. That’s why we have such low oil prices… except it’s not. In fact, I find this hilarious. As recently as six months ago, we were talking about surging demand in developing markets driving world demand skyward.

Change-in-Oil-Consumption-MMBPD

The conclusion, as recently as last July?

The story of oil in 2013 was one of surging US production and increasing demand in developing countries. The US continues to lead the world in increasing oil production, while developing countries — in particular the Asia-Pacific region — have added the vast majority of oil demand in recent years. Arguably the only thing preventing the world from experiencing oil prices in the $150-$200/bbl range is the continuing shale oil boom in the US.

Yes, that’s right, $100+/barrel was not only reasonable given the supply/demand outlook, but we were barely holding off $150-200/barrel prices. That was in July. Last July. So what’s changed since July? Nothing.

Untitled

Worldwide crude production increased 1.5% from Q2 to Q3 in 2014. A whopping 1.5%. Demand only increased 0.005% during that period, so let’s just say it didn’t increase at all. In Q4 of 2014, demand actually up ticked almost enough to meet production, while production only increased 0.00011% between Q3 and Q4 2014 (per above chart)… yet this is the period of the most drastic plunge in oil prices. There was virtually no change in the oil market between the time people were justifying $100+/barrel oil and the time people were calling for $20/barrel oil. So what gives? Oil is now worth less than half of what it was six months ago. Where are the fundamentals to support this drastic price swing? They don’t exist. Everyone is talking like they exist and “oil glut” is the new buzzword, but where’s the evidence?

It must be the rapidly growing oil stocks... oh wait it's not. We're in the same channel we've been in since 2009 and before.

It must be the rapidly growing oil stocks… oh wait it’s not. We’re in the same channel we’ve been in since 2009 and before.

Yes, there is a relatively small production surplus and it is predicted to grow into the first half of 2015, but we’re talking about a 55% drop in oil prices NOW. The current surplus does not account for a 55% price swing, especially when considering the impending drop in marginal well production at the new, lower oil prices. The facts just don’t agree with the narrative. That leaves us with two possible conclusions: oil was grossly overvalued in the summer of 2014 or oil is grossly undervalued today. If you believe $108/barrel was a reasonable oil price, then the only conclusion you can come to is that oil is currently grossly undervalued. If you believe oil’s current price is reasonable, then you can only conclude that it was grossly overpriced in July 2014. At the time, oil prices of $100+/barrel last summer were justified on the speculation of future shortages (that never panned out). Today we have the opposite. We have a massive plunge in oil prices based on the speculation of future surplus (but will it pan out?). What do those two explanations have in common? Speculation and no basis in our current situation. Lay people often joke about how fickle oil prices are and how they drastically increase seemingly with as little prompting as a change in the wind direction. There’s actually truth to this. I know it’s cliché to blame traders for commodity price swings, but unfortunately it’s also completely accurate. Fundamentals are an afterthought when it comes to prices of equities and commodities traded on the open market these days. Big money plays with the market to create profitable trades and then the “analysts” at CNBC and elsewhere swoop in long after the move to cherry pick fundamentals to mold into a false back story they can sell us on why the price change happened. Any event can be used as an excuse to drive prices up or down by completely unrealistic amounts (relative to fundamentals) in an attempt to make money. This is a fact that’s lost on the average American (like so many facts), but, funny enough, is not at all lost on the Saudi oil minister.

Interviewer:

Were you taken by surprise by how much [the price of oil] fell?

Ali Naimi:

No, we knew the price would go down because there are investors and speculators whose job it is to push it up or down to make money.

Something about learning nothing from history

It’s incredibly cliché, but the truth of it can’t be argued: what we learn from history is that we don’t learn from history… or something to that effect. In yet another follow-up to what has unintentionally turned into an ongoing series (here, here, and here) about the decline in oil prices, I’ve started to notice that things are feeling very reminiscent of the lead up to the mortgage crisis.

Prior to the mortgage crisis, we had a real estate industry high on years of asset appreciation and believing that nearly any investment in real estate, no matter how crass, would automatically be a winner because real estate prices could do nothing but rise for the foreseeable future. This widespread mentality lead to banks giving mortgages to people who had no business borrowing the amounts of money they were receiving. The banks didn’t care, because real estate prices could only go up, so their risk exposure was zero – or so went the belief. Then one day, as everyone and their mother was flooding the market with flipped houses they were sure to make a fortune on, the unthinkable happened: real estate prices began to decline. One would think that the impending meltdown of the industry would only affect the industry itself – not so in the Wall Street Casino States of America. Greedy Wall St. folks behind the scenes wanted to cash in on this “can’t lose” real estate boom too. So they made these extremely marginal mortgages into complex financial instruments and they sold insurance against defaults on these mortgages, with all these decisions being made under the assumption that real estate prices would continue rising for near eternity so no holder of these investments would ever take loses even if people did default on their mortgages. So when that fantasy scenario didn’t play out, it didn’t only crush the physical owners of real estate, but the entire first-world’s financial system.

The current situation with oil is looking frighteningly similar (albeit on a smaller scale). Once again we have a market that people almost unanimously believed to be headed skyward for eternity. Much in the same way people jumped into houses they couldn’t actually afford assuming rapid value appreciation of the house, drilling companies have spent the last 2-3 years diving head-first into extremely marginal projects involving very low oil reserves and exceedingly high drilling costs – all under the assumption that high-priced oil was here to stay and would only continue higher. Then it didn’t.

No worries though. There’s no systemic risk this time. The oil price crash will clean up the market, the poorly planned projects will take their drills and go home, prices will stabilize somewhere higher again, and we’ll be back to business as usual. Wrong. Just as with the mortgage crisis, this would be a terribly naive assumption. Whenever there is easy money to be had and a bubble is inflating, count on Wall St. to be there making reckless investments.

Rice Energy Inc. (RICE), a natural gas producer with risky credit, raised $900 million in three days this month, $150 million more than it originally sought.

Not bad for the Canonsburg, Pennsylvania-based company’s first bond issue after going public in January. Especially since it has lost money three years in a row, has drilled fewer than 50 wells — most named after superheroes and monster trucks — and said it will spend $4.09 for every $1 it earns in 2014.

That’s right, almost a billion dollars invested into a company that has a proven track record of hemorraging money for the past three years. What kind of insanity is that? The same type we saw pre-2007 collapse. There are very large amounts of money in the bond market backing these extremely marginal drill projects. Just as in real estate, these poor investments looked tolerable when oil prices were sky-high and on the rise. Now, with a >50% decline in WIT crude per barrel price, suddenly we’re on the verge of a meltdown. Energy companies make up over 15% of the entire US junk bond market:

cotd-high-yield-energy

Just like the mortgage derivatives and credit swaps, these bonds are spread throughout the financial system as assets of bond funds, retirement accounts, and the like. They’re owned by people who don’t even know they own them. So what’s the risk? How many of the main US drill areas remain profitable at the current (as of this writing) $55/barrel WIT price? Turns out… almost none of them.

cotd-shale-breakevens

So let’s recap what we have here: A market in which wild and reckless investments were made under the assumption that the underlying commodity price would always rise, massive outstanding liabilities to bond holders, and a plunge in the underlying commodity price that just put the bond default risk on these already flighty investments through the roof.

Yup, things are looking just like they did minutes before the mortgage meltdown. Who will be on the hook for all the Wall St. trading losses this time? You will – thanks to that nice Cromnibus bill that passed with the Citigroup written Dodd-Frank repeal.