Triple digit oil shackles growth: Rubin

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And that’s all from CFA Vancouver. Thanks for joining me!

1:33 pm Q. What about Japan? What are your comments?

A. When Japan had earthquake in 1995, $3 billion reconstruction. Japanese insurance companies will liquidate their positions in $US. Japan doesn’t have hydrocarbons. So the shuttering of nuclear plants have added 200,000 barrels/day to its oil intake. People burn diesel to generate electricity. That’s an expensive proposition when oil is triple digit. Disaster in Japan has meant it has become more dependent on imported hydrocarbons, so nuclear problems even more vexing. But paying out reconstruction dollars, how much will come out of US Treasury market?

1:30 pm: Q. In California, as in China, by 2020 both entities want 30% renewable energy. How does that impact oil prices?

A. China is 20% noncarbon right now. It is making biggest investment in solar and wind of any economy in world. But this pales in context of energy requirements. China burnt equiv of 3.2 billion tonnes of coal last year. 5 billion tonnes in next ten years. But that coal doesn’t exist. Coal is already $127/tonne. Coal will be $190/tonne if they burn 5 bil tonnes. Renewables have a bright future. I use the example of Copenhagen, 20% wind – 80% coal in Denmark. Yet Denmark’s reduced its carbon footprint because 30 cents/kWh in Denmark. Households consume 30% less energy than in N. America. Albertans will use less power if same thing happens. Price that comes with renewables will ration demand. The key to grow economy in triple digit oil prices is to lower energy requirements.

1:28 pm: Does 3.5% bond yield work in 5% inflation, no. You’ll find bond yields will go much higher. When people understand just as the bond market has never been so leveraged to economic growth – triple digit oil prices make that growth more problematic. 3.5% yield won’t have traction. In bond market, we’ll see a significant selloff in the bond market in next 12-15 mths regardless of what Fed does, and even more if Fed is slow in response.

1:25 pm: In a world of cheap energy it doesn’t matter how far your markets are from your manufacturing. Wages aren’t chasing inflation here. You don’t need wage inflation chasing oil and food prices, oil and food prices will push inflation 4.5, 5% in next 12-15 mths and that will make it untenable for central banks to maintain interest rates this low. You’ll see reaction in bond market, 10 yr govt bond yields will approach 5% even if central banks don’t respond.

1:23 pm: Q. When does natural gas get expensive?

A. Big difference between price of nat gas and oil. Apples and oranges comparison between oil and nat gas. Can’t really substitute more than we already have. All demand is coming from oil as a transit fuel. That’s where the linkages break down. Why don’t we use nat gas as transit fuel? Because oil = 4x the amount of energy density. Fill up 4x more frequently. Not many nat gas vehicles right now. They will remain disconnected until we can use nat gas as a transit fuel.

1:22 pm: Q. Will exchange rate policy be new monetary policy?

A: Massive devaluation of US dollar coming. It is only really been China preventing devaluation. That will stimulate some of US economy, but it will make oil even more inaccessible to US motorists. If you have a massive devaluation, the flipside is there an increase in US oil prices. Current monetary policy is US is unsustainable. Much steeper yield curve in US. China isn’t going to be exporting to US anymore.

1:20 pm: Q&A now. Q: If China can’t grow via exports, how will transition to a consumer economy? What impact will killing US economy have on Canada and our interest rates?

A: More growth will be within Asian trading markets and domestic markets. US economy screwed. When China steps away from Treasury auction, Washington will cut deficit in a hurry. But it doesn’t want to take same measures as Greece. For Canada, we will be an energy exporter. Whether that market is US or elsewhere, open for debate. In 10 years, US will not be consuming anywhere close to barrels it does today, but Canada’s dollar will rise regardless.

1:20 pm: What we face is not financial crisis, but energy crisis. The solution is very different. If you give us 2 decades of triple digit oil prices, we’ll develop a post carbon economy. But until then, when we look at these prices, we see the end of growth. Thank you.

1:17 pm: Sees 20% premium in next few years. This may bring back more NHL franchises to Canada, that’s all it’s going to bring. How long will ON be biggest vehicle producer in N. America? Will kill manufacturing. Schism won’t be east west, it’ll be energy producing and energy consuming regions. ON has become a have not. Nfld = have. Revenue distribution will dominate political agenda here.

1:15 pm: Let’s talk about Canada. Everything I’ve said is true for Canada, but we’re also a producer of oil. We were tier 2 for conventional oil, but now we’re tier 1 on bitumen. We’re going to be an energy superpower. We’ll have a super exchange rate. $Cdn trading at 2-3% premium with $100/barrel oil. And it will become more of a petrocurrency.

1:13 pm: US is likely candidate for that. China and US will trade places in less than 20 years. What does that imply about economic growth? Our calibration of growth has to be readjusted. Traditional fiscal and monetary remedies are not a solution to this dilemma. Might in fact speed up triple digit oil price arrival.

1:12 pm: People complain about price subsidies in China, Russia – all of a sudden this is the biggest subsidy China can have. Price of oil in yuan will fall 30-40%. China doesn’t have to build a deep bluewater navy, it just has to not show up at the US Treasury auction. US dollar will fall, oil will be less accessible to N. America. We’re increasingly facing a zero-sum world. When oil supply is no longer growing globally, China cannot increase its consumption 1 mil barrels/year without someone else reducing their consumption.

1:10 pm: US can print more money, but if growth needs oil, lowering US dollar will not allow Fed to get more oil. Because oil is in $US! There is no commodity price more directly related to $US than price of oil.

1:08 pm: Does it make sense for China to ship steel to US? Only takes 1.5 h to make a ton of steel. Wage advantage gone. Need to import iron ore from Australia, make it, and then ship to US. With expensive oil, doesn’t make sense. Trade will become local and regional. No more exporting to US. Then yuan can go up. When China’s bank doesn’t go to US Treasury auction, every borrower in US will recognize that.

1:06 pm: Is US biggest PIG of all? How will US finance itself? Courtesy of People’s Bank of China. In past, China’s rapid economic growth was driven by export growth to US, and it was important to hold down value of yuan. I would argue that world is a past world. That is a world of cheap oil, because with triple digit prices, China will not supply Walmarts. Wage advantages don’t make sense anymore because transport cost is going to outweigh that advantage.

1:05 pm: Greece can’t comply with EU obligations. In past, Greece would devalue drachma. But can’t do that now, because it surrendered its monetary authority. Greece will leave euro in next year and bring back drachma. But that will create domino effect because tourism is its biggest part of economy. Portugal will get rid of euro too – maybe Ireland, Spain, Italy too?

1:04 pm: Silver bullet is economic growth. But economic growth requires oil, because you can’t grow without burning oil. Demand is 88 million barrels/day right now. So how much more do we have to burn to service debt? 32 billion barrels/year being burnt now. Not like it couldn’t find 60 billion to burn, but can it afford to pay for them? Without economic growth, debt is unserviceable. While debt is denominated in euros, yen, dollars – it might as well be denominated in barrels of oil.

1:02 pm: Triple digit oil is not a fluke. Today’s challenges are different than last time though. We’re going to be left with record defaults. Look at Athens, Washington – every country you can think of is mired in red ink. Governments have borrowed a lot. Given these deficits in Ireland, Greece, USA, we see the solution is not about fiscal action. You have to cut bone, not fat here.

1:oo pm: While we in the West support democracy in the Middle East, let’s not confuse that with oil exports. Because people on the street have never been consulted about what to do with their oil. If they are, they may not want to export the oil to you.

12:58 pm: Regime change is never bullish for production, and it’s even less bullish for exports. We all miss the 6 mil barrels/day that Iran was producing before the revolution, and the 5 mil they exported. After Saddam’s overthrow, production plummeted. Libya isn’t producing anything now.

12:57 pm: The same place where oil demand is growing faster than China is the place you’ve been told is going to supply your oil. OPEC countries – Saudi Arabia consuming over 3 mil barrels/day. Gasoline cheaper than water – that’s why. They’re burning oil and nat gas for power at 7 cents/gallon. They’ll consume 8 mil barrels/day in 20 years.

12:55 pm: World has never been more thirsty for oil. What we confuse is oil consumption in N. America with that of the world. Oil consumption has peaked here on this continent. Yet today, barely half of oil is burnt here. In 5 years – developing world will be burning a lot more than developed. Income growth is driving oil consumption in emerging markets. People going from bicycles to Tatas. Demand is not calibrated to prices like in developed world.

12:54 pm: 2007 was peak of conventional oil, says IEA. 3/4 of all wells producing today will not be in operation in 20 years. 80% of the oil the world will be consuming in 2025 hasn’t been discovered yet!

12:52 pm: We need to find more oil each year, because we lose 4 million barrels/day due to depletion. We’re losing light sweet or West Texas, not the stuff that’s hard to get. In the next 5 years we need to find 20 mil barrels/day so in 2016 so the world can consume the same as it does today. But what if world demand increases?!

12:51 pm: Depletion is not just a geological concept – it’s economic, too. We’re never going to run out of oil in a physical sense. But what we are running out of is the oil we can afford to burn.

12:50 pm: There are no more North Seas. There is deepwater, there are tar sands. You saw these marginal resources that were inconsequential become the focus of the global industry. Problem is, the prices needed to get that oil out of the ground. Take tar sands: it’s the world second largest oil reserve in the world at 170 million barrels. At $20/barrel, costs of extraction greater than price of oil, can’t give it away. Fort McMurray in last recession, $50 million of cap spending was cancelled. In $150/barrel oil world, then it makes sense.

12:48 pm: How come oil prices are at these levels? Economists told us it could never happen. Triple digit would never happen because of theory of the upward sloping supply curve and downward sloping demand curve.

12:47 pm: In January, short-dated Brent futures contract was $125/barrel. Only $20 away from peak of last cycle. Yet in second year of economic growth. It took 8 years to get it there last time. Food prices already higher than 2008. As of March, UN food index already surpassed 2008 rate. Seeing return of inflation in India – over 8%, +5% in China. You’ll see BRIC inflation rates in N. America, Europe in a year.

12:45 pm: Subprime mortgage crisis happened because money used to be free. It was free because US inflation was 1%. Then all of a sudden 2 years later, it’s 5.5%, highest since 1991 when Saddam lit Kuwait’s oil fields on fire. From 2004 to 2006, when US CPI rose to 5.5%, the rate of energy inflation went from 1% to 35% as the price of oil over doubled.

12:43 pm: Most significant impact of oil shocks on economy, where it has unleashed a mortal blow, is the inflationary fallout. Oil shocks without exception have led to growth-ending increases in interest rates as central banks are compelled to respond.

12:42 pm: Transfer of $ from OECD to OPEC countries due to oil price spikes. Saving rates 10x as high in OPEC companies so transfer not neutral. Oil price rises also squeeze out other expenditures.

12:41 pm $30/barrel early 2004 up to $150/barrel right before recession. That was over twice the price shocks of either previous OPEC spikes. Why wouldn’t a spike larger than that be an explanation for this deep global recession?

12:40 pm Feed the economy cheap oil, and it runs like a charm. Shock it with expensive fuel, and it seizes up overnight. Every major global recession in last 40 years has had oil’s fingerprints all over it.

12:37 pm Rating agencies get paid by issuers. In economics, we call that a moral hazard problem. In i-banking, it’s called “shit happens.”

12:35 pm Rubin: Knowing the nature of a disease is essential first step in finding a cure. So is it with the economy – knowing true cause of recession helps us to avoid falling into another.

12:32 pm Jeff Rubin now being introduced. Author of Why Your World Is About To Get A Whole Lot Smaller. Known for calls on oil prices, and one of first economists in world to predict rise of oil prices to crippling levels.

12:30 pm This team advised by two CFAs and did research on Vancouver-based Westport Innovations, which specializes in natural gas engine technology.

12:27 pm BC winners of the Global Investment Research Challenge speaking now, from Simon Fraser University. Picture of Marg Franklin, Chair of CFA and Warren Buffett on screen. One of BC winning team took one of Buffett’s Coca-Cola cans home with her.

12:10 pm Lunch is served and the room is buzzing. Jeff Rubin coming up in about 15 min.

11:47 am CFA Vancouver members are a youthful bunch. 47% are between the ages of 31 and 40. 76% are between 26 and 45.

11:20 am PT It’s a cool, overcast day in Vancouver but the mountains are still peeking through. Cup fever is alive and well, though I think everyone’s a bit sore after yesterday’s shutout. But tomorrow is Game 5 on home ice – so here’s hoping. CFAs are slowly trickling into the Regency ballroom here at the Hyatt downtown.