The Martenson Insider - April 9, 2011

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In This Newsletter

  • In Search of a White Swan

In Search of a White Swan

Friday, April 8, 2011

The term "black swan," as coined by Nassim Taleb, refers to an unusual event that nobody was expecting because such an event had never happened before. Until a black swan has been seen, they simply don't exist; their probability is zero.

We are now in the midst of exactly what we might predict would happen when a world accustomed to sufficient net energy to drive its processes runs short of that surplus. This is our ultimate black swan.

Trained and raised in a world of ethereal numbers and ideas, today's economists simply lack the proper framework to understand that all of the 'rules' they learned about monetary theory, interest rates, debt accumulation and all the rest, were not actually rules, they were temporary conditions permitted by abundant net free energy.

Brent crude oil at $124/bbl is telling us something. While the unrest in the MENA region is certainly driving some of the price gain, it is important to note that the price of Brent crude has been climbing more or less steadily since July of 2010, when it was at ~$80/bbl.

Saudi Arabia has said many times that it has lots of spare capacity and can easily fill the gap left by Libya's temporary (or perhaps prolonged) departure. There are two problems with this view.

The first is that Libya produces a particularly desirable grade of oil, very light and sweet, whereas the spare capacity that Saudi Arabia has is very much on the heavy and sour end of things. One cannot simply ship heavy/sour to a refinery that processes light/sweet.

The second is that the data does not yet support the idea that Saudi Arabia has significant spare capacity of any sort, sour or otherwise.

At the start of the Libyan crisis, Saudi Arabia said that they had raised oil production significantly to help supply the world [note the Feb date]:

Saudi Arabia raises oil production on Libya unrest

Feb 28, 2011 12:25pm GMT

(Reuters) - Saudi Arabia has increased its oil production to more than 9 million bpd to compensate for disruption to Libyan output, an industry source familiar with the kingdom's production told Reuters on Friday.

"We have started producing over 9 million barrels per day. We have a lot of production capacity," the source said.

The only problem with this pronouncement is that it failed to align with the monthly OPEC report on production that came out in March.


(Source - OPEC Monthly Oil Report) 

Nope, there's no "9 million barrels a day" (9 mbd) to be seen in that data, and this is very concerning. The story that gets circulated in each and every article is that Saudi Arabia currently has 12.5 mbd of production capacity, or more than 3.5 mbd above what it is currently pumping.

If that's true, then where is it?  One would think that getting to, say, just 10 mbd would be a snap if 12.5 mbd was the maximum capacity.

To really add fuel to the fire, Saudi Arabia has very recently ordered up a 'surprising' number of rigs for the purpose of drilling wells:

Saudi Arabia struggles to maintain oil output

March 29, 2011

Saudi Arabia's plan to boost the number of oil rigs at its disposal by 28 percent suggest the kingdom is struggling to maintain the 12.5 million barrels a day of output capacity it has long said is in place.

Two Saudi officials told Reuters on Tuesday that the extra rig activity would maintain rather than increase the kingdom's oil capacity.

"It's not to expand capacity. It's to sustain current capacity on new fields and old fields that have been bottled up," one of the officials said.

Saudi Arabia increased its output to around 9 million bpd this month to help compensate for disruption of supply from fellow OPEC producer Libya.

In theory, that leaves a 3.5-million-bpd cushion to protect against any further supply outages on the global market. Riyadh completed expansion plans in 2009, which it said took its capacity to 12.5 million bpd.

If such as drastic expansion is required to simply maintain current production, as indicated by the above quotes, then this means that the existing fields are declining at a pretty rapid rate.  Also, pay attention to the fact that Saudi Arabia claims to have finished their expansion plans in 2009, taking their capacity to 12.5 mbd.  

There are actually a couple of ways to interpret this move by Saudi Arabia, which I thought this unnamed analyst did quite well:

A New York-based oil analyst, who tracks Saudi production and requested anonymity, said: "You could see this in one of two ways. Either they realize that 3 million barrels of spare capacity isn't enough, or they realize their capacity isn't actually that high."

Saudi Arabia hasn't publicly discussed plans to expand its overall crude capacity since completing a $100 billion project to raise it by 3 million bpd to a "sustainable" 12 million bpd last year, excluding the neutral zone, leading some analysts to conclude that the increase in rig counts responds to decline at older fields.


My vote is to follow the data.  Either Saudi Arabia has 12.5 mbd of production capacity, or they don't.

At times like these I think a picture is worth a thousand words, so let's look at the most recent Saudi oil production figures in a graphical form:


Before we get too excited by the idea that Saudi Arabia has 12.5 mbd of total capacity, perhaps we should first get excited if/when they managed to surpass their old ceiling of 9.5 mbd.

When we put all of this together, the anemic production increase, surging Brent crude prices, and a sudden rush to expand the Saudi rig count, we might conclude that Saudi Arabia is already at something of a production limit, give or take a few percent, and that world oil markets are actually tight.

When, not if but when, the world wakes up to the reality of Peak Oil, things will change very, very rapidly. Oil will go from $100 to $200, and then onto $300 and 400, and it will keep going.

Against this backdrop, it is entirely obvious what will happen if more money is dumped into the world economies, even as the fuel for economic expansion is dwindling: massive inflation. More money and fewer things is simply the recipe for more inflation.

Unfortunately, our current economic maestros are thoroughly unversed in the Three E framework and will continue to be baffled and clueless as to why the old incantations and monetary efforts seem to be losing traction with every passing round.

The most important advice I can give you is to become prepared for energy to consume more and more of your disposable income and/or savings. The actions you take today to reduce your exposure to oil prices (and its first derivates such as food and other things made out of oil) will pay off handsomely in the future. They will be among the very best investments you have ever made.

Even as other events unfold across the world, diverting our attention, the possibility that Saudi Arabia will have to sooner than later admit they are having production difficulties will be one of the biggest and meanest black swans to ever grace the world economic and financial landscape.  

Market News

I must comment here as well on today's market action. I am tracking very, very closely the decline of the dollar and Treasury bonds, because this is the 'dual signal' that I think will presage the next big financial jolt.

The USD index is putting in new lows for the year, and if it closes below 76 today, it will be a new closing low for the past 2.5 years.

Key resistance/support for the dollar is at the ~72-73 level. If it breaks below that, then look out below. Who knows where it might go next, because there's nothing but air underneath that level on the charts.

At the same time that the dollar is weak, so, too, are Treasury notes, although these are just rummaging around at recent lows:

Bonds are not yet flashing 'danger,' but we're keeping a close eye on them, because if they start selling off at the same time that the dollar is breaking to new lows, that means it is 'game on' for the next leg of the developing financial crisis.

Helping to drive the dollar lower was the ECB decision to raise rates, which they did even though they are facing a resurgent sovereign debt crisis:

ECB Raises Interest Rates

FRANKFURT—The European Central Bank on Thursday raised its benchmark interest rate to 1.25% from a historic low of 1%, making it the first central bank among the world's large, developed economies to raise interest rates since the world fell into deep recession in 2008.

The ECB's first rate rise since July 2008 comes despite the deepening debt crisis in the euro zone's periphery, after Portugal became the third nation in the 17-country bloc to ask for an international bailout.

The widely anticipated rate increase means the U.S. Federal Reserve, the Bank of Japan and the Bank of England now lag the ECB in reversing low-interest policies.

The pressure will stay on the dollar until the US raises rates, and it will only grow larger if the ECB follows its usual pattern of steadily raising rates during a rate hiking cycle.

The longer the US waits to raise rates, the more the dollar will fall.

Of course, this is exactly what Bernanke wants, but I wonder if he is prepared for a sudden rout in the dollar, which is the chief risk from a DC fiscal situation that seems more broken than not and an overly lenient monetary policy.

The possible outcomes are certainly not lost on gold and silver, which are putting in new highs, which, in the case of silver, are almost alarming. I cannot recall seeing any chart that looks as ruler-straight as this one:

And gold has now safely broken through resistance and is therefore set to run.


With everything happening in the world today, I am desperately seeking a white swan, some sign that something normal is happening somewhere.

The current volatility and the sense that everything is speeding up, however, is exactly what the exponential framework would predict would happen. Yes, things actually are speeding up. That's what happens when you are in the last five minutes and the water is rushing up the stairs.

Instead of being paralyzed by all this, I hope you find yourself energized to take actions that will minimize your future risks.

Finally, I am still trying to parse through the Fed's words to determine if they are serious about hard-stopping QE2 at the end of June. If they do, I think that the current inflationary forces will get whacked, at least temporarily, but new doubts are beginning to arise for me.

The concern that is growing in my minds centers on the idea that the inflationary forces may already be too far gone for a simple cessation in the flow of new liquidity to be sufficient to reign them in. It's entirely possible that the Fed, should it be serious about halting commodity inflation, will need to 'pull a Volker' and raise interest rates by obscene levels.

There is an inflationary level beyond which simple words and small gestures are powerless. In The Coming Dollar Crisis, Richard Duncan argues persuasively that an inflationary rate of 8% per annum is the level at which inflation becomes a self-sustaining process, immune to all but the most drastic of monetary withdrawals.

Maybe it's a little higher, maybe lower, but such a level certainly exists. By first ignoring inflation ("We're worried about deflation") and then minimizing it ("eat iPads….it's transitory…"), the Fed risks being dangerously behind the inflation curve.

If gold and silver are right, it has already lost the battle.

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