By John Richardson
JUST four months after the blog first moved to Asia, we got the shock of our lives: The Asian Financial Crisis.
We were bewildered and didn’t know what to think, but fortunately, perhaps, there wasn’t much of an Internet in those days. So we had smaller mountains of news and analysis to distract us.
So instead we picked up the phone and talked to people. Yes, this is still quite useful.
And one of the people we talked to said with great authority, when the crisis spread to South Korea: “Three of the country’s crackers will definitely have to shut down because they simply cannot carry on losing money like this.”
We believed him and published the story. But the crackers kept running as they carried on bleeding money for another 12-18 months. The markets then turned for the better. All three crackers are still on-line today, and two have undergone major expansions.
This taught us two things, which were:
1.) We were idiots to publish the story before talking to people in South Korea. We never made that same mistake again.
2.) Not everything in the world can be understood from cost-per-tonne analysis. Human nature, politics, different business cultures, different cultures and societies in general – they all also matter hugely. This became clear when we talked to people in South Korea, including lots of visits to this great country. Good cost-per-tonne analysis is vital work, but other things count as well.
Wind forward to today. A lot of the talk in oil markets at the moment centres on at what point the higher cost US shale capacity will shut down. It is assumed that once this capacity shuts down, the world will return to the old normal of stable prices in the region of $100 a barrel.
But here are some thoughts on this, based on, again, talking to people and wandering up and down our local beach:
- It depends on what return on investment you think that producers in the US will be satisfied with.
- What if they end up being happy with much lower rates of return than most people have forecast?
- What happens if they keep on producing, as oil prices continue to tumble, in order to protect their market shares?
- And why shut down when you are still earning some money, even if it isn’t much? You will still have to pay your debt back if you are not running, and, of course, if you are not running, you will have NO revenue.
- Isn’t it therefore much better to “tough it out” and to wait for a recovery in oil prices?
- And what if some shale oil producers go bust? Might their debt be written off and might they then be taken over by private equity players? These new owners would then only have to cover variable costs.
This might end up being very wrong and, as, a good friend of the blog, Shivprasad Naik, Senior Vice President for polyvinyl chloride with India’s Reliance Industries, warned us yesterday: “Only two people can forecast oil prices. Either one has to be a fool or a god. Since none of us are gods, we don’t want to prove to the contrary.”
But our point is that human nature, although it is often devilishly hard to predict, has to always be taken into account.
And so the above scenario, where US shale oil production carries on running harder than some people predict, should be built into your business planning.
Very recent history has taught us that do this kind of thinking. How many of us, just a few weeks ago, predicted that for geopolitical reasons, Saudi Arabia would chase market share rather than try to prop up prices by cutting back on its production?
The great news in all of this, for people who have to tell their bosses to go left or right, and not hang around in the useless middle, is this: When it comes to the demand for oil, we think that human beings are telling us something that is clear as the difference between night and day.
Human nature, which helped us interpret the data, has led us to these conclusions:
- The ability to gamble either in oil, other commodities, equities and high-end Chinese properties used to be huge, thanks to central bank stimulus.
- This meant that real supply and demand for crude didn’t matter much at all. Markets lost their role of price discovery.
- Now that central bank stimulus is being withdrawn, real price discovery has returned to oil markets.
- Crude had never really been affordable at $100 a barrel, but financial markets didn’t care about the damage they were causing to real demand during the era of “false calm” created by all that easy central bank money.
As we said the other day, ‘be careful what your wish for”. The world simply cannot afford $100 a barrel crude and so if prices recovered to this level, they would soon retreat again.
What the world instead needs is stable, lower oil prices. This would be great news for major oil importing countries, such as India and China. And it would help the world economy in general to adjust to the New Normal.
Here’s a final thought: If production cutbacks fail to keep prices anywhere near $100 a barrel on a long-term basis, chasing market share might end up being the priority of most producers, not just the lowest cost producers in the world – the Saudis.