US shale oil hitting the skids, page-79

Don't worry I'm listening BW. They'll all turn around in a few years and wonder what happened to all the new investment. Oil isn't iron ore or copper, the scrap overhang doesn't enter the oil picture. Oil is burnt never to be seen again. In developed economies like the US about 80-90% of steel is recycled and countries like the US, EU28, Japan and Russia are net exporters of scarp steel. China's scarp steel overhang is huge and its scarp usage ratio is extremely low at about 15% whereas from memory the US ratio is more like 60-70%. As China matures it usage of scrap will increase. BHP estimates that the steel scrap usage ratio in China will grow to about 35-40 per cent by 2030.

The over investment in iron ore mines and steel making capacity and the large overhang in Chinese scrap are good reasons not to touch iron investments with a ten foot pole. The reaction to falling prices in the iron ore industry is to produce more. With oil the reaction has been the same but the underlying dynamics aren't the same. Cut backs now on the large oil projects will end up biting in the long run as there is no such thing as a scrap oil reservoir, only national strategic reservoirs. In China they plan to build this reservoir to a level equal to 90 days of imports. In November 2014 the reservoir stood at 91 million barrels equal only to 9 days of oil usage. The plan is to build the strategic reservoir it in three phases, with phase 2 to hold 170 million barrels. I can't find information on phase 3 but they plan to complete it by 2020. Well even if phase 3 is as large as phase 2 the total reservoir (if ever achieved) will probably be no bigger than 500 million barrels which by 2014 consumption rates is only about 50 days of consumption.

In a world war situation you can see how vulnerable China remains to seaborne imports of oils and iron and with not a very big navy they have resorted to building a land based missile defence system with over the horizon capacity. They can launch attacks out to 2,000km with conventional anti-ship ballistic missiles (ASBMs) and out to 6,000km over land or sea from within their territory with land attack cruise missiles (LACMs) and manned FB-7 and B-6 aircraft. Never underestimate the military strategic importance of commodities when trying to predict commodity prices. That's the mistake we made in Australia. We assumed that when the iron ore price fell to the marginal cost of iron ore production in China those marginal producers would just down according to conventional economics101 wisdom. Originally that marginal cost was thought to be about $110/tonne but when that broke the experts revised it down to $90/tonne. When $90 broke the experts, including treasury experts here in WA and nationally threw their hands up in the air. Many of those experts were affectively sacked at a national level by the closure the advisory body. What they all missed was the socio-military strategic importance of the domestic iron ore production to China. Not only are China vulnerable to having seaborne supply cut off in a war situation but a lot of their steel plants are vertically integrated with the low grade iron ore mines which supply them. These vertically integrated state owned steel enterprises in China also represent many many jobs which the central government would not put at jeopardy by closing mines for fear of political and social unrest.

The long term future of the oil price is good in my opinion. It is only the threat (as I've mentioned in previous posts) that comes from localised pollution in China and the need to move to electric cars that will challenge the oil industry. This threat goes hand in hand with advancements in battery technology. The promise of graphene that was discovered over a decade ago is to be able to create batteries that charge in an instant but still store energy just like or better than conventional lithium batteries. If the world can invent a battery for are car like this that can be charged instantly and provides enough battery life and power to satisfy our driving needs, oil will be dead.

Eshmun