Macro Commentary
Are rules meant to be broken? Australian mining company BHP Billiton is certainly doing what it can to skirt by the US’s ban on exporting crude oil that dates back to the embargo days of the 1970s. Interestingly, BHP Billiton decided to seize upon a recent ruling to allow certain forms of condensates to take a go at the exportation of Texas oil to the global market. The key to their decision is that the light sweet production is being very lightly refined and thus, in their opinion, does not fall under the categorization of “crude.” What is unique here is that they are self-classifying. They have not received a sign-off or approval from the US government before contracting to sell the approximately 650,000 barrels. We shall see what blowback comes from this unintended consequence of the Commerce Department’s earlier approval of a similar situation earlier this year. Is this what Saudi Arabia is thinking when they are taking action to defend market share? They dropped the price premium on their light sweet product to the US market to around $0.45 per barrel over the US gulf coast benchmarks. It will take more than that to stop production growth in the US. We continue to read research on the current drilling economics in the oil patch. As discussed in our quarterly outlook, different basins are economic at different prices. However, those economic prices continue to drop for another reason. Initial Production (or IP in energy lingo) is very high with a quicker decline rate in the horizontal drill and frac process. That means that producers are mobile to move towards economic projects and that, as they gain continue to improve cost efficiency per well, the cost per unit of production drops (i.e. lower total cost divided by higher initial production). From what we see, US volume growth of energy seems to maintain steam.
Meanwhile, investors continue their wait for European Central Bank (ECB) President Mario Draghi to break their rules. In the meeting and press conference this week, the ECB took no action and announced no new programs. That said, there was again specific reference to moving the balance sheet back towards 2012 levels implying significant follow through. With now two weeks of purchases past us, there has been around $6bln in purchases – still slower than what is needed. We have seen research from a major wire house that estimates the current programs will expand the balance sheet at around $400bln per year – again too slow as it would take three years to get to 2012 levels. We continue to believe that the ECB is working on the next program. The currency believes it (EUR/USD fell to around $1.24) but action needs to be soon.
Finally, the US rules-making body (Congress) is under consolidated management. The results of the mid-term election led the Republicans to take control of the Senate in addition to maintaining the House. Having met with a political strategist this week to parse the results, there was a few interesting take aways. First, this election became a referendum on President Obama’s policies – by his own doing. Several weeks ago, President Obama commented that he was not on the ballot but his policies were. After that, all Republican candidates linked their Democratic adversaries with Obama and we saw the results. Second, the younger generation (Millenials) did not turn up despite the significant voter participation. In addition, those that did vote did not necessarily vote Democratic as they did in the presidential election. Finally, he commented that the mid-term election is not necessarily a good indicator for the presidential race to come. In this environment, he said that Republican success in 2016 will hinge on their actions in the next 6-12 months. They must be neither too weak nor too strong in their dealings with the White House. Too weak goes against prevailing popular opinion (given the recent results) and too strong appears stubborn and impractical which US voters have also tired.