Trading Macro (Week 51 2020)
By: Nenko Nenov
Tags: Portfolio, Coffee, Oil, Silver, Lithium

5. Oil

Between 1997 and 2008 global oil production (excluding US and Canada) has increased by 12.7 mbd while the production in the US and Canada has for the same period has decreased by 0.7 mbd. On the contrary, from 2008 till 2019, US and Canada production increased 12.6 mbd while the global oil production (excluding US and Canada) decreased by 0.6 mbd. That was mainly due to the rise of the shale oil in the US. However, according to Art Berman, we are to see a rapid decline in the US shale production in 2021:

Conventional US production has been in decline since the 1970s

The last 20 years of US oil production

But why oil production (and consumption) are important and how they relate to the economy? There is a clear correlation between the change in oil consumption and the change in GDP per capita as seen here:

The correlation between oil consumption and economic activity should be self-explanatory. Everything we do requires energy and our main source of energy is still oil.

Information from EIA — U.S Energy Information Agency

From the above, we can see that during the roaring 20s oil production increased by 12.8% annualised. The US at the time was the biggest producer, consumer and exporter. That fuelled rapid economic expansion.

After the great depression, the annualised increase in oil production was much smaller at 3.6% for the next 10 years.

Since the 1950s, the US has started increasing its net imports until 2005.

During the 1970s the rate of increase in oil net imports has gone up dramatically as the US peaked in its oil production.

What is interesting to estimate is how much more time we have left before we run out of oil at today’s consumption rate and we can see taking into account the known oil reserves divided by our consumption:

Reserves divided by yearly consumption give the number of years left before the known reserves are depleted.

It is going to take about 50 years if we take the data from 2016 to deplete our known oil reserves. However, we have to also take into account how much we are going to discover during these 50 years:

Global conventional oil discoveries since 1947

From the above we can see that the overall trend in conventional oil discoveries is lower. It is clear that even though we have improved our technologies greatly since the 1960s, we are not discovering enough oil as the world consumption is about 36 billion barrels of oil per year. Based on the above chart we can assume that we are not going to discover more that a quarter than what we are going to use per year in the next 50 years (i.e. we are not going to discover more than 9 billion barrels per year). Therefore, this basic assumptions leads to about 65 years more before all the oil that we can get is depleted which would put it at around 2070. However, all of this is assuming that the price of oil is high enough for producers to extract oil from the ground, which might not be the case. In the next weeks, we will focus more on the energy return on investment and its implications for the price of oil and the economy.

Rapid increase in the money supply without price inflation is possible if the amount of energy produced overall is increasing matching the increase in the money supply. That is because every human activity requires energy and every product and service requires certain amount of energy. However, if energy produced is decreasing, we can get into much higher levels of inflation- a situation which Venezuela is experiencing.

Energy has to be burnt for the economy to function. Gold and silver have been store of value as they were storing that energy. Gold and silver could be seen as energy stores of value whereas stocks, bonds, fiat are energy IOUs.