The world is in crisis, but things are looking up.
In America, recovery is slow and painful, but housing data and unemployment levels are creeping their way back toward pre-crisis equilibrium. And just as politics tends to calm down following an election, indications are that Congress will find a solution to the impending fiscal cliff, regardless of who is elected president.
In Europe, messier policymaking and deeper interregional distrust have prevented an adequate monetary, fiscal and banking rescue, but even there the latest statistics are surprising on the upside and the fear of a Euro Grexit (or Spanxit, or Itxit) look as foolish as the idea of a Grentry in the first place. Sure, it’s not a happy situation, and Europe has a long, winding road ahead of it, but it is – for the moment – a relatively stable situation.
Over in China, meanwhile, the economic data are getting worse and no signs of rebalancing are yet to be seen. Moreover, while the process of democracy in America and Europe looks positively anarchic in comparison with the sober efficiency of Beijing’s grey-suited apparatchiks, beneath the surface byzantine machinations have already deposed one populist leader – provoking internet rumours at one stage of a palace counter-coup – and amid widespread dissatisfaction over environmental damage, labour and internal migration restrictions and blatant inequality, the Chinese Communist Party looks more vulnerable than at any time since 1989.
Yet still, Beijing has plenty of policy tools left at its disposal to artificially stimulate growth, raise living standards, create jobs and, of course, control discontent. Indeed, as long as deleveraging and disinflation continues in the West, Beijing can pump-prime the economy without fear of the inflation– coinciding as it did with rising world food and energy prices – that previous stimulus engendered.
Needless to say, pump-priming the economy through credit and investment is far less optimal or sustainable than growth through exports or internal consumer demand, but it will at least allow China to muddle-through until Europe and America return to a more even keel. This in turn should allow Australian asset prices to muddle through as well, though their own internal drivers – especially property – remain uncertain.
But there is one thing that could derail all that. It’s not credit; as sick as the global banking system and as discredited as its key metric – Libor – now stands. It’s not food prices; as high as they are today, there is still little sign of a confluence of factors emerging, as they did when La Nina struck, to push prices higher for long. It’s not even sentiment; while we’re very much in a secular bear market, PEs are still low and technological development is still driving margin growth in spite of a much more consolidated debt and workforce position – Tyler Cowen’s low-hanging fruit.
The risk is energy, particularly oil. And although pipelines have now opened to bypass the Strait of Hormuz, the risk of destabilisation in Iran, Iraq or indeed Saudi Arabia – where popular Shia cleric Nimr al-Nimr was recently shot and arrested (Saudi’s minority Shia population are concentrated in its main oil- producing province) – loom large; not to mention continuing uncertainty of supply in Sudan, Nigeria and recently-democratic Libya.
The risk of supply-side meddling also looks large. Venezuela, whose government’s legitimacy rests on pricey oil, is heading to the polls and Russia – which needs crude at $US110/bbl to balance the budget – is not unknown to prop up a rogue Middle Eastern regime or two if this helps its domestic objectives.
Finally, nobody besides Saudi Aramco really knows just how much oil is actually left in major fields like Ghawar. And with deep-sea discoveries in the Atlantic and Arctic still years away to coming online – not to mention reduced estimates for American shale oil reserves – there’s still not much to plug the cheap energy gap.
Yet for all that, the risks to the upside (or oil price downside) are significant as well. If Iran did find itself in a Persian Spring, who is to say it couldn’t peacefully return to the world crude market, with all the benefits of investment and increased production capacity that would bring. If Venezuela, similarly, found itself ruled by better leaders, who is to say its inefficient state producer couldn’t be overhauled to better exploit its wasted resources?
And then there’s natural gas, the global reserves of which (if properly developed) could swamp the world with cheap energy for years to come. As much as there is massive potential for Australia’s burgeoning LNG export industry to deliver the country a second commodity boom, there is potential that the huge projects underway in WA, NT and Queensland could end up being giant white elephants; reminders to the world that committed and contracted projects don’t mean much when the commercial reality changes.
With the supply-side dynamics of energy so uncertain at this point in time it is difficult to say whether prices will deliver black swans or black gold to the global recovery in the next twelve months. One thing’s for sure however, energy use, policy, strategy and discovery will be one of the big issues this year and every investor will need to take notice.
Michael Feller is an Investment Strategist at Macro Investor. A full essay on the future of energy (including specific stock and trade recommendations) will be published in next week’s edition of Macro Investor.