Oil and Debt and Never the Twain Shall Meet
- The smartest guys in energy
- And bonds
- And they’re not telling the whole story
In the investing world, specialization is the rule. You don’t see too many people who take a worldwide or multi-disciplinary approach.
Nowhere is this point more clear than when you listen to an energy analyst back to back with a bond analyst.
Energy analysts like the well-respected Charles T. Maxwell of Weeden & Co. rightly issue dour warnings about our inability to maintain and/or increase oil production:
“Currently, we are utilizing about 98% of our world crude oil-producing capacity. The system should be considered stressed at a 95% utilization rate. We are no longer investing enough to lift capacity additions above the level of future demand growth on a consistent basis.”
That’s a big problem, because as he says, the demand for oil doesn’t stay still. Each year, oil demand from the developing world increases total demand by 2%. We don’t have very many months left of that kind of oil demand growth.
So, that’s bad.
But then you hear from a bond analyst like Pimco’s Bill Gross, the bond king.
He says that the US Treasury bond market is headed towards a D-day. He asks the question, “Who will buy Treasuries when the Fed doesn’t?”
Here’s a visualization of this question from Pimco’s website:
Without the Federal Reserve lending its prodigious printing press to the effort, Treasury yields will necessarily rise. And that’s a terrible situation for our Federal Government and its debt.
And while both of these analysts are experts in their field, at the tops of their respective games, neither one has discussed the ramifications of the combination of Peak Oil along with massive deficits.
Here’s what we know, right now: the United States produces far less oil than it consumes. So every drop of oil we have to purchase outside of our own production goes somewhere else – outside of our economy. The New York Times recently published a storyabout the disruption in Libya’s oil production that sheds some light on how much GDP we lose to oil price increases:
“As a general rule of thumb, every $10 increase in the price of a barrel of oil reduces the growth of the gross domestic product by half a percentage point within two years.”
At the same time, our official deficit is on track to equal 100% of our $14 trillion GDP any minute now. So every increase in the yields on US Treasuries is a commensurate dip into the GDP.
In 2010, oil averaged about $80 a barrel, and 30-year Treasuries averaged about 4%.
As a thought experiment, let’s assume that oil averages $100 over the next year, and that bond yields spike 1% after the QE2 expires in June.
In this scenario, GDP will effectively shrink 2%. For every $20 increase in the price of oil and every 1% 30 year Treasury increase, we lose 2% of GDP. The United States economy is shrinking at the same time that the Federal Reserve is increasing money supply. More dollars are chasing fewer resources.
Oil prices and loan servicing will hollow out the United States economy like a bloated corpse in a tank full of piranhas, and there is no one in a significant position of power who has the temperament or ability to fix either problem.
Here’s to knowing the inevitable,
Kevin McElroy
Editor
Resource Prospector
