What goes up must come down (please, please, please)

by Michael Arbow, MBA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

Over the centuries, our world has experienced many financial bubbles, most recently from real estate.  Most of these bubbles have been burst in large part by some increase in supply, either through improved crop yields or just building more homes or silicon chip factories.  However, as the emerging economies become wealthier, their populations healthier, the ability to continue to limit price increases by upping supply has diminished.  This is particularly so in the world of finite commodities and even more so in oil.  Recently, the International Energy Agency stated that even with soft global economic growth, the oil producing nations will find it difficult to meet the world’s demand requirements of 89 million barrels a day in the second half of 2011.

 

The result of this supply constraint – which cannot be remedied in weeks will be the pushing up of oil prices (Brent crude has been trading at triple digits for almost the entire year).  Motorist will feel the pinch immediately and the rest of society will feel it in the following months as wheat prices (50% of which is derived from the price of oil), transportation etc. move up or possibly down in the case of houses in the exurbs.  For those living in the risk world the demands for hedging will possibly move from idea to necessity as business’s struggle to lessen the pace and impact of another wave of commodity price increases.  I believe that it will be the pro-active risk managers that are acting now that will survive and possibly thrive in this new environment.  Hopefully you will be one of them.

 

For more Jeff Rubin’s thoughts on oil prices, click on the link:

http://tinyurl.com/5wnlwdb

“I cann’t do it Captain (of industry). We got no power."

by Michael Arbow, MBA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

With these words Chief Engineer Montgomery Scott (Scotty) of television’s starship Enterprise would warn Captain Kirk of the ship’s limits and capabilities.  These very same words are being said again but this time in China where the providers of electric power are warning China’s industries to expect massive rolling black outs and power restrictions this summer.  With subsidies in coal (where industrial users pay 1/10^th the price of oil) and oil, Chinese industry burns through the stuff with near hopeless abandon.  The subsidies may end, eventually, but in the interim expect the demands for energy making stuff – like coal, oil, uranium and equipment like windmills, solar cells, generators to increase.  Assuming you don’t work in the oil industry or at General Electric; sadly what is China’s problem is our problem.  Commodities will continue to rise as will the currencies of those who produce the goods and this will be over a number of years.  In the short term look for another spike in energy prices this summer.

 

While this may sound like a broken record, I fear and sense that many industries and governments are not fully preparing for the shocks and have not put in place risk reduction measures.  Some of these will be long term (energy efficient buildings and infrastructure like public transit) and some will be short term (hedging strategies).  The past is past and we are entering a new dynamic environment – has your risk perspectives and handling changed to better suit this new world?

 

For Jeff Rubin’s thoughts on this subject, click on the link:

 

http://tinyurl.com/4348gtm

 

China’s energy needs = America’s sacrifice

by Michael Arbow, MBA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

Over the past two months the markets have witnessed rising oil prices and a quick snap correction.  The culprit cited for the rise is unrest in the Middle East (still unresolved) and for the fall a slowing of the US economy.  These are immediate term issues which will eventually fade in the wash of time and are only masking the continued upward movement of oil due to a world which if not at peak oil then is at least increasing reserves at a rate less than usage increases.  Surrounding this news is China, a growing economy that requires only a 1% increase in oil demand to wipe-out a 10% decrease in US use.  So how will China get the oil it needs to continue growing? 

 

The idea sported by Jeff Rubin (see link) suggest that the Chinese slow down on their uptake of US government debt.  By doing this the US government has two options either a) print money and thus debase the dollar and therefore raise the US dollar price for oil/gasoline or b) reduce the government debt which in itself will either cause the economy to slow and/or US consumers to be taxed more and thus less able to afford gasoline (already on average 9% of US disposable income up from 5% two years ago).

 

Either solution will result in a weaker US dollar relative to most currencies and an economy that can no longer afford some of imported luxuries.  The risk questions that arise from this scenario are numerous and can only be reduced by some positive US Black Swan event (?).  I believe the path has been decided it is only the knowledge of the timing that remains elusive.  In this volatile global village even smaller local firms can be take a “hit”.  How is your risk team looking at this eventuality?  Or is it still too far out there to consider? 

 

For more on Jeff Rubin’s views on this click on the Globe and Mail link:

http://tinyurl.com/3l9fkg6

Help – this roller coaster goes up and down!

by Stephen McPhie, CA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com 

 

Saudi Arabia’s oil minister recently commented that he thinks the world crude oil market is oversupplied.  His Kuwaiti counterpart agrees.  They believe that prices are driven by speculation.  This is not much comfort to you and me when we fill our cars up at the petrol (gas) pump.  (Actually I personally can barely afford to fill my tank any more but that is more to do with the tax regime in Britain than world oil prices.) 

One thing that appears apparent is that when prices of anything go up or down very fast, especially if it appears that speculation is a major factor, rather than demand and supply fundamentals, they tend to overshoot and come back off their peak or low point. 

The last time oil prices peaked at a higher level than where they are now and they come off quite quickly and quite a long way.  A client who came to us after this and who suffered major losses would have been all right if their derivatives intended as hedges had matured a couple of months later.  After all, as they said, nobody would have expected prices to do what they did!  However, their “hedges” actually increased their risk.  They were unsuitable and the company did not understand them properly. 

The client would also have been better off had they done nothing.  But they would have been best off with a properly conceived hedging approach.  They should have avoided expecting or not expecting anything out of the ordinary.  The only thing that will inevitably happen is “unknown unknowns” and a risk management system should be designed with this in mind.

 

A Drive to the beach or take in a movie? Not both. Demand destruction has begun.

By Michael Arbow, MBA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

Last week the IMF raised its expected average price of oil for 2011 from $89 to $107 (20%); about where it is as this blog is written. Note: that is the yearly average so you can expect spikes above that during the year. IMF expectations for 2012 are $108: so the IMF is advising us to say goodbye to double digit oil prices and hello to Jeff Rubin’s world of triple digit oil. What the IMF’s guesstimate is also saying is that even the surplus supply of oil is tight and that even after geopolitical tensions ease don’t expect prices to drift far below $100.  

This view of a tight global supply for crude is being confirmed by the International Energy Agency.  From a risk perspective what is coming into play now is demand destruction – the high price of a commodity that decreases the demand for the high priced good but which can also decrease the demand for other goods. This will likely be the case for oil as it is broadly considered a necessity for Western economies to operate. Thus expect reduced demands for air travel, weekend jaunts to the country and restaurant meals. This oil lead demand destruction will then translate into changes of behavior and possibly price increases for energy or activity substitutes. The question is, will this positively or negatively affect your business and how is your risk team advising you to live in this triple digit oil environment. 

 

For more on the International Energy Agency’s view of oil, click on the link to BBC news:

http://www.bbc.co.uk/news/business-13047854

 

In the tank or on the plate? Bioenergy vs. Food. It's game on.

by Michael Arbow, MBA

Partner, RSD Solutions Inc

www.RSDsolutions.com

info@RSDsolutions.com

 

 

Jeffery Rubin in his book “Why your world is about to get a whole lot smaller” talks about triple digit oil prices and the effects this will have on our economies one being the push to bio-energy; energy derived from plants such as corn, sugar cane, palm oil.  Interestingly as the price of these commodities has risen the Chinese have sought out other plants capable of producing an oil substitute.  They have recently moved to and focused on cassava, a tropical plant whose root we use for animal feed, tapioca pudding and ice cream.  While the ingenuity is admirable the effects of this and new government regulations forcing the consumption of bio-energy is having distributing ramifications namely a growing trade-off between crops for fuel or crops for food.  The upshot of this is an unstable equilibrium in food commodity prices which looks set to continue for the foreseeable future.

 

What all this means to the food processors and bio-fuel makers is that price volatility may become the new normal and having a better economic understanding of price movement causality may be beyond the skill sets of the accounting department and conceivably the more traditional risk management team.

 

 

For more on the food/energy trade-off click on the link to a New York Times article:

http://tinyurl.com/3b6tfgz

 

For more on Mr. Rubin’s thoughts on energy prices, click on the link:

http://www.jeffrubinssmallerworld.com/blog/