Oil prices have been rocked over the past few weeks, dropping by more than 30% from their summer peak.  This is great news for holiday travelers as gas prices are now under $3 a gallon.  However, we are most interested in why oil prices are falling in order to determine if it is truly a positive event and the impact of the drop on our clients’ portfolios.  Some of the questions we are asking ourselves include the following:

1)   Are oil prices falling because of lack of demand?  In the 2008-2009 Great Recession, oil prices dropped 70% as demand fell off a cliff.  Is demand dropping because business activity is slowing in Europe and China?  Are we headed for another economic slowdown?

2)   Are prices falling because of an increase in supply?  Due to fracking, the US has gone from producing 5.0 million barrels of oil per day in 2008 to 8.5 million this year.  It is expected to be 9.3 million in 2015.

3)   Is Saudi Arabia trying to punish Russia and Iran for their stance against the Assad regime in Syria?  Estimates we have seen indicate that both Iran and Russia need oil over $100 a barrel to keep their governments in the black.

4)   Are oil producing countries trying to keep prices low to hurt US fracking efforts?  With fracking, the US is now a serious competitor in the world oil markets, with many of the current projects profitable when oil is over $70 a barrel.      With the drop in oil prices, this will cause pressure on these projects and may reduce US output if prices remain low for an extended period.

5)   Is this an effort to reduce the valuation of US oil assets so they can be purchased at a lower price?  One way to beat a competitor is to buy them out.  By bringing down oil prices temporarily, this will cause financial pain for US energy companies (especially those that have borrowed for their expansion) and in turn make the companies cheaper to buy.

These are just a few of the questions we are trying to answer at THOR.  The biggest question of all is:  What will Russia do in the months ahead (the book we recommend this month explains why we think Putin is the “chess master” who needs to be watched at this time)?  

What does this mean for investors?

During turbulent times like this in commodities (oil, natural gas, etc.) it is good to have a position in managed futures that can short these commodities.  The funds we use can, in fact, short these commodities and are currently short at this time.  We would not be surprised to see oil prices fall further over the next few weeks or months.  When prices fall this sharply, it actually has the perverse initial affect of causing a jump in supply.  Why?  To oil producing countries like Iran and Venezuela, it is all about how much cash flow they generate everyday.  When prices fall, they actually produce more and sell more volume in order to try and receive the same cash flow they are use to receiving.  We have mentioned that we believe volatility will rise because of the end of QE3.  That is certainly happening with commodities right now.  If the drop in oil prices ends up being a “real” drop because of continued excess supply, this will be good not only for the US economy, but for Europe and emerging markets that are not commodity-based.  If the drop is because of an economic slowdown, this is not good for any economy.  Either way, disruptions like this create opportunities.  We are actively searching for investments that will benefit from this disruption.

Book of the Month –  “The Colder War: How the Global Energy Trade Slipped from America’s Grasp” – Marin Katusa

This is a new book by an energy hedge fund manager from Canada.  The book discusses the rise of Putin and talks about his desire to use energy to remake Russia as a global power.   According to the author, many in America have discounted Putin at their own risk.  Putin is a leader who was initially groomed by his grandfather until he passed away when Putin was 13.  His grandfather wasn’t an ordinary Russian – he was the chef for both Lenin and Stalin.  Being savvy enough to stay on after Lenin passed is one thing, to learn directly from these leaders takes it to another level.  The book gives a great history of Putin and his rise to power.  More importantly, it discusses the steps Putin is taking in Russia and around the world to build his energy empire.  In the US, we tend to look at things on a short-term basis.  Putin is willing to sacrifice his pawns and other important pieces to win the long-term chess game.   A must read for anyone interested in geo-political matters and the energy markets.

Sincerely,

Your THOR Team

THOR Investment Management, Inc. is a registered Investment Adviser with its principal place of business in the State of Ohio.  The commentary contained in this market update is limited to the dissemination of general information pertaining to THOR’s wealth management services.