I’d like to address the outright crash of the oil market this past week. The hope was the Saudis would cut back on production to stabilize prices somewhere in the $80+ range. This was not to be as Saudi Arabia announced no cutback whatsoever …oil then fell over 10% in one day on Friday and actually traded to a $65 handle. First and most importantly, oil is THE biggest and most widely used commodity on the planet. For a market of this importance to outright crash or rise over 10% in one day, unintended consequences not seen or anticipated can be expected at some point.
I guess the initial question that should be asked is “why has oil been so weak in the first place?” There are several answers to this but the two main drivers are “supply and demand”. Demand has definitely dropped as the global economy has slowed. There is no getting around this, less oil is being used now than say two or three years ago. On the supply side, the U.S. shale industry which has been in an outright boom has actually made the U.S. a larger producer than Saudi Arabia. I can remember two-three years back when the stories arose, “the U.S. was going to become energy independent.” What the stories forgot to include is the fact that shale production has a very high cost to breakeven. The current estimates for breakeven are $75 per barrel or higher. Just as I wrote earlier regarding gold and silver, I believe “low prices will cure low prices” for oil. I will get to this thought shortly.
When looking at the new, low oil prices, one must ask the questions “who, what and why?” Why would Saudi Arabia not want to cut back on production to stabilize the price of their product? If Saudi Arabia has budgeted a price of $95 for their own production, why would they allow the price to drop unabated (or in Friday’s case “helped”)? What’s in it for them? Before digging any deeper, I want to remind you how the U.S. broke the Soviet Union in the late 1980’s. The U.S. baited the USSR into an arms race and then with the help of the Saudis, broke the price of oil down to $10 per barrel …the rest is history as the USSR bankrupted from the starvation of oil revenues.
Fast forward to current day, are we seeing the same sort of operation? Some say that the target is Iran who is a religious enemy of Saudi Arabia and also happens to have the highest cost of production in the Middle East, I’m not buying this theory. I would rather look at Saudi Arabia’s latest business deals and go from there. They just a few months ago signed long term energy contracts with non-other than China. Taking this one step further, “who” would benefit the very most from cheap oil prices? The answer of course is China as they are THE biggest importer of oil in the world! Can you see where this exercise may be going? Most everyone in the West believes Saudi Arabia was engaged with the U.S. to hurt Russia’s energy revenues, what if this is not the case …or maybe our leaders believe this to be the case? What if Saudi Arabia, who has definitely been in serious talks with China is obliging them while wiping out one their most recent competitors?
Who is this new competitor you ask? Why the shale industry in the U.S. which was supposed to make us energy independent and a bigger producer than even Saudi Arabia? The cost of production for shale is estimated at $75 per barrel. $100’s of billions have been borrowed (and lent) in order to get this production up and running. As of this past Friday there may be a little, previously unforeseen problem. You see the debt issued is almost entirely “high yield” (understand “risky”) and makes up somewhere near 20% of this entire market. Also please understand many of these bonds are used as collateral and then re hypothecated for further borrowings. This is not yet a disaster but a “margin call” to such a leveraged industry could turn the lights out VERY QUICKLY. Of course, you can add the rest of the financial system to this as leverage has never ever been higher systemically than it is right now.
I would also like to add the comment “someone, somewhere, got hurt and hurt very badly this past Friday.” I am talking about speculators, OTC derivatives between banks and financial institutions, institutions which issue CDS, etc… We don’t know who, what, how much or even “if” this 10% drop in one day has caused a chain reaction but the odds are pretty good this will not pass without someone important being financially killed.
Before putting this all together, mention must be made of Russia. Yes, Russia is being hurt financially and economically. Their currency the ruble has been hammered as well as their sovereign bond market but …it is important to understand they only carry $200 billion worth of debt. Will these low oil prices bust Russia? No, it will however make life very hard as the economy slows and their social programs do not get fully funded. In my opinion this is a huge blow to Russia but not a fatal one.
Putting this all together I will ask some questions, however, there are no firm answers yet. Who is really behind this? Would the U.S. cut the legs out from under their own shale industry or is it more likely the Chinese wooed Saudi Arabia into aiding them in filling their reserves? If it is China rather than the U.S., what does this say about Saudi Arabia? Are they in the process of switching allegiances? Is this a case where they are abandoning the petrodollar? I obviously do not have the answer but I will ask another question or two. Is it possible China has swayed Saudi Arabia by promising to pay them with something real? Like gold? Could this even be possible? It is already rumored that Russia is trading oil for gold, maybe the Saudis have seen this and a light bulb went on for them?
Financially, yes I believe it is possible but not probable. Much more likely would be payment in yuan. Would Saudi Arabia accept the paper of another sovereign in the place of dollars? In my opinion they would …if they are able to see the writing on the wall. Has China let the Saudis in on their future plans for their currency? Maybe a gold backed yuan? A gold backed yuan which is backed by or one that is ratio pegged to gold? Does China have enough gold to do this? Let me say this, China very probably has as much gold (or much more) as the U.S. “claims to have.” Would this be enough gold? The answer of course depends entirely on what “price” they value or peg gold at. At “some price”, China can go to a 100% gold backed yuan, any country can …if they have gold and the international price is high enough.
This is much speculation on my part but it does make common sense. The U.S. may believe we can bankrupt Russia with low oil prices …and this is “our” plan, I don’t believe it is “the” plan. In fact, the argument can be made that not only does this hurt (destroy) our shale industry, crashing oil prices actually endangers our financial system. After six years of trying to reflate the system via outright monetization, would we really risk a wildfire of deflation? I don’t think so. I believe it is much more likely this is a Chinese/Saudi partnership play where they both “win” and the U.S. is left out in the cold. This would also be a terminal event for the U.S. petrodollar and a “polite” way for the Chinese to move center stage. If this is so, we will be watching the formation of a “new world order,” just not the one the Rockefellers had in mind!
The oil crash is an interesting topic since no one really knows who is behind it, except those responsible, but everyone’s trying to make sense of it. The issue I take with the idea that it is China and Saudi doing this is that we don’t really know for sure how the oil price is set. Since the Fed has basically stated that they manipulate all markets, it only makes sense that they set the price of oil using the ESF and derivatives. This would make the East unable to make such drastic price swings. Since most producers can’t really slow down production since they need the revenue, this price plunge shouldn’t affect immediate production rates, but it will affect future production as new development slows. It should increase demand, or at least help offset the recent decline in demand, and I bet the Saudi’s are kicking it up to fill the gap.
One other theory could be that the elites in the West see that the gold is almost out and they are taking pre-emptive action to position themselves. This could be the grenade that destroys the system, first by triggering a deflationary crash in certain sectors, after which they will swoop in and “buy when blood is on the streets”, buying up the stronger oil companies and assets (oil sands, legacy long term US producers, some offshore) while letting he weaker ones fail (“shale” oil). Then when the currency crisis starts and we emerge on the other side, they will be left holding all the cards, at least in the West, as oil gets drastically repriced higher.
If the Saudi’s were making alliances with the East I think we’d see a lot more noise from Washington over this, especially considering all the US stations there. But who knows, at this point anyone’s guess is speculation. I have a feeling we’ll find out soon enough.
which is why I wrote “this may be ‘our’ plan but not ‘THE’ plan”.
China has overtaken the United States as the world’s largest consumer of crude oil and accounts for 22 per cent of global energy usage.
The IEA estimates Chinese crude oil imports alone will rise to 11 million barrels a day in the next three years.
China knows where its bread is buttered. Bottom line. The US doesnt produce anything any longer. We are rapidly, as proven by the weekends purchasing dive by 11% from last year becoming non consumers.
No manufacturing means a drop in energy use, no jobs and even more energy drop since no one is driving to work any longer and the protestors call for a walk out of the people who do have jobs. “Yea, dont worry Barry will take care of you”
What happens when JP Morgans SNAP card wont buy them a bag of rice?
… or when the SNAP cards don’t work or are simply shut off?
Great piece Bill..
You are correct to say that at this point we can only speculate who is responsible for what..
But in all of this there is a deeper message in my view.
The world powers are in a struggle not for supremacy alone but also for economic survival.
Every player is ALL IN.
Yes, we are likely going to witness a major upset event but what has yet to be determined is who will control what and what will be the cost…..once the dust settles.
Society should be terrified.. because it is likely to get ugly.
thanks Mike. …yet they sleep on unworried about anything other than who will win this week on the voice or who gets thrown off of survivor!
Wow, makes great sense, Bill, a behind-the-scenes Saudi/Chinese alliance on this oil action. That would tie with the continuing drip of news on closer military ties between the two:
Change is in the air!
we’ll see soon enough.
Russia seems to be sitting at the table facing the EU with a mirror behind them.
How stupid can the EU be? Wasnt Nuland clear enough about washingtons perceptions of them during her leaked phone call?
Thank you Poland and the Baltic states for offering to be the front lines for this mess when it blows up. Im sure wahington appreciates…… Oh wait. Never mind.
it’s getting cold over there.
I love being involved in these kinds of discussions with people who truthfully think things through. We are participants in a battle of EPIC proportions- a war without guns. I like to remind the kids( and home team sports nut adults) that in all contests, the other guy get’s to “play” too!
hopefully it doesn’t get to a war with guns.
Me too. Thanks Bill. Great insightful articles and no flags flying everywhere for telling the truth.
I little history of the extremes people went to find gold.
enjoy a glimpse into the past.
Odd how the Asian Pivot timing seems to coincide with the China / Saudi Nuclear Cooperation Pact in 2012. For “peaceful purposes” of course. (eye roll)
there are no coincidences.
Bill, great piece as always.
Chances are that the bulk of the Saudi Gold held in Western vaults has shipped to the East and China in particular, so a deal where China pays for Saudi Oil with Gold makes a lot of sense to me.
has Arab gold been leased out by Western custodians? We may find out.
Jim Willie seems to think so. He could well be right.
Bill your articles are always thought provoking. Excellent stuff!
For every 400 oz gold bar that China has purchased from LBMA, I am sure the serial numbers and the bar’s history have been recorded and stored before any remelts take place.
Visualizing a Chinese- Saudi Arabia get-together!!!
Chinese Interpreter to Saudi Arabia Interpreter —- give us a serial number of one of your stored bars in London and we can tell you within 5 seconds whether we bought it or not. And we will tell you the name of the refiner, exact fineness level, exact ounces, exact length, width and height and year it was produced.
Ok, I am just speculating here!!!!!
“If Saudi Arabia has budgeted a price of $95 for their own production, why would they allow the price to drop unabated (or in Friday’s case “helped”)? What’s in it for them?”
It was not SA alone. It was OPEC. So what’s in it for all of them? Maybe we have to suppose that it’s an OPEC/Brics alliance in work?
OK, ;et me refine what I wrote, “maybe it is not “our” deal, maybe it is “THE(ir)” deal? Future business with China AND putting our shale business on the shelf “is what’s in it for SA”!
And there is more to it, as you so smartly wrote:
Big volatility is crushing shale oil firms once and for all and America’s dream of energy independance and hegemonism with it. An “energy independent bully” cannot be allowed by the rest of the world hence everybody is working together to create a solution for this challenge:
a slow and stable transition to the next monetary system.
He who has the oil makes the rules. That’s the reason why the CIA+Mossad-led ISIS is destabilising the whole ME. USrael’s goal is to let them fight against eachother and then overthrow and control all oil-exporting nations in this region one after the other to finally become the new US-led OPEC.
Too far-fetched? I don’t think so!
And I, like you Bill, think that SA and Iran are aware of their situation and aligning with the Brics.
Good work Bill. Right on!
thanks nity, the transition will not be “slow” in the end.
Bill I thought I would post this link because to my knowledge it was not highly promoted within the USA.
Great story with awesome amount of historical and modern history.
sorry, only have two hands, sometimes things slip by. Thanks Mike.
Something that wasn’t mentioned in your article….
IF (because not one of us knows what is really going on behind the scenes), China has struck a deal for lower oil prices with Arabia, why would China cut the economic throat of Russia, with whom they just recently signed a second blockbuster energy deal?
Now, one possible scenario could be that China is backstopping Russia’s loss of oil and natural gas revenue with either gold or U.S. Treasuries that Russia is using to purchase gold on the open market.
yes, exactly, China is the money.
Shale oil production break even is now $57
In the current cycle, though, prices will have to decline much further from current levels to curb new investment and discourage US production of shale oil. Most of the growth in shale is in lower-cost plays (Eagle Ford, Permian and the Bakken) and the breakeven point has been falling as productivity per well is improving and companies have refined their fracking techniques. The median North American shale development needs an oil price of $57 to breakeven today, compared to $70 last year according to research firm IHS
Source: WoodMackenzie, Barclays Research
I believe you are on the right path and ISIS will be attacking SA oil fields soon.
yes, this could be.
Society is doomed unless it can take back control of the monetary system and start over without repeating the mistakes of the past.
Without the return of honesty we are doomed.
I honestly do not believe we can fix what is wrong without Major pain.
The lies have simply gone on way too long.
and compounded themselves.
Bill, Well the short covering rally was nice (for gold) but it does not look like it was anything else. Gold stocks really did not do that good yesterday and today puke. The dollar rally continues, and that says it all. That story of gold being bought for 50% over spot Sun night looks highly suspect to me.
Rob did not give me what I consider to be real evidence. I personally do not believe the story.
Volume was heavier in GDX/GDXJ yesterday when they were up than it was today while they were down – that is a good sign.
certainly, this is also true of the two other outside reversal days.
Hi Bill, did Rob Kirby get back to you at all? Far from cooling down from his interview with Greg Hunter, he is doubling down on it. According to him, for practical purposes the paper market is already irrelevant. These are quite incredible claims.
If they were true, how come nobody from Hong Kong, Singapore, Shanghai, Dubai reported on them?
I know, I’m not sure what to make of it. Murphy’s “Stalker” source has informed him of the same but as we discussed last night, where is the arbitrage? Why aren’t the streets being swept of every last morsel of “50% giving” Western gold and sent East? I will remain skeptical until further information of the vacuum cleaners arrive to suck up the gold!
I would suggest that the most widely used commodity on the planet is WATER
That said,I believe you are right on target with the conclusions drawn here Bill old boy !
Since September 19, 2014, the Peoples Bank of China (PBC) had inaugurated the Shanghai International Gold Exchange (SGEI) that is selling gold internationally, denominated with the Yuan, on a “cash and carry” basis. This means that China’s Yuan has been and is now a de facto 100% gold-backed.
The main trigger for the Yuan is when China’s PBC attaches and freezes the price of Yuans to a gram of gold, which would make the purchasing power of the Yuan remain constant for the next 100 years. This consistency of the Yuan is a basic requirement for these long-term 30 year contracts between Russia and China.
if so, this is the point where the dollar devalues greatly from the yuan.
Bill, Really enjoy your posts. I’m also a subscriber to the Hat Trick Letter (Dr. Jim Willie), who’s ‘insider intel’ has confirmed all the suggestions you’ve posed in this article. Further, it’s important to note that Russia & China’s debts are primarily INTERNAL, whereas the US debt is primarily EXTERNAL. (Big difference!). I laugh when I hear MSM talk about Russia & China’s economies failing. Further, shale (fracking) oil is not only not profitable, but wells are only good for about 2 years, while worse, global sentiment on fracking is mostly rejection due to poisoning of ground water supplies and earthquakes resulting. Shale oil extraction is doomed in the very near future in my opinion for all of the above reasons. So, a little more digging, and I’m sure you could confirm the answers to your questions in this article, which would no longer be posed in the form of questions.
thanks Paula, I write in the form of questions because I am not an authority on anything …I just question everything while trying to connect dots along the way. Finding topics to write about has become easier and easier as all I need is something that doesn’t make sense …and then call bullshit on it!