Gyroscopic Investing

  It is one of the
ironies of this complex oil system that despite this unexpected gush of U.S. oil and the ensuing impressive
current drop in oil prices, nothing that really matters in the long term is changed by U.S. fracking. Yes, it
has produced most of the short-term kick to the U.S. economy that makes the U.S. look superior to others
(although despite this help the U.S. economy, too, has been persistently below earlier estimates, including this
year). It has also created a temporary oil glut and pushed down world oil prices. Yet what it has not done is
more important, and that is what makes it a red herring. It has not prevented the underlying costs of traditional
oil from continuing to rise rapidly or the cash flow available to oil-producing countries like Saudi Arabia, Iran,
and especially Venezuela from getting squeezed from both ends (rising costs and falling prices) with potential
political consequences that I will leave to others to speculate about. The same pressures will of course also
expose those oil operators that have been borrowing amounts close to the total of their cash flows for, strangely
indeed, the fracking sub industry in total does not clearly show much positive cash flow despite considerably
higher prices over the last two years than exist today. Yes, they have been drilling more wells that chew up
money, but not that many more, and good operations have lowered the costs per well by over a third. On the
other hand, they have drilled, as always the best parts of the best fields first, and because the first two years
of flow are basically all we get in fracking, we should have expected considerably better financial results by
now. The aggregate financial results allow for the possibility that fracking costs have been underestimated by
corporations and understated in the press.
Because fracking reserves basically run off in two years and can be exploited very quickly indeed by the
enterprising U.S. industry, such reserves could be viewed as much closer to oil storage reserves than a good,
traditional field that flows for 30 to 60 years. Fracking oil reserves could consequently be treated as our
emergency reserve. In real life we are using it up as fast as we can. Let us hope that there will not come a time
in 10 to 20 years when we will regret the absence of reserves that could be developed in a hurry. Meanwhile,
cheap traditional oil, in contrast, becomes increasingly difficult to find both in the U.S. and globally. Last year
for example, despite spending nearly $700 billion globally – up from $250 billion in 2005 – the oil industry
found just 4½ months’ worth of current oil production levels, a 50-year low! Despite currently falling prices
from a temporary glut that has exceeded storage capabilities, rising costs of finding and pumping traditional
oil continues to put pressure longer term on resource prices. Because of this the global growth trend will be
lucky to be over 3.5% with the developed world closer to 1.5% and both may well be less. The continued run
of disappointing economic growth seems likely therefore to continue. Indeed, it is quite likely, although hard to
prove, that any oil price over $40 or so has been putting sustained underlying pressure on global growth and that
it did not take the spikes to $150 in 2008 and $115 recently to throw some sand in the works: the sand has been
there since 2006 and is likely to stay there indefinitely or at least until alternatives provide very cheap energy
under a $50 per barrel or so equivalent.