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Have Oil Prices Bottomed?

Have oil prices bottomed?  Was the high profile merger between two industry behemoths an indicator of prices bottoming and the harbinger of mergers to occur?  Wire services report in order for the merger to be economically feasible, oil is expected to average $67 barrel in 2015, $75 in 2016 and 2017 then $90 barrel through 2020.

These forecasts are consistent with Wall Street consensus with the 2016 median at $70 and $75 in 2017 which incidentally closely mirrors OPEC’s outlook.

Speaking of OPEC, Saudi Arabia announced its intention to borrow monies from international creditors for the first time in more than a decade.  The oil rich kingdom stated it will post a 2015 deficit of $106 billion compared to a December 2014 projection of a $39 billion deficit because of plunging crude prices.   This is the first deficit since 1998.  Saudi Arabia is now forecasting 2015 oil revenues to fall by 35%.

As noted/inferred above, Saudi Arabia is expecting oil to rebound to $60 by the third quarter and $70 by the fourth quarter.

According to Saudi Arabia, total 2015 state revenues are expected to decline 33.7% to $186 billion while public spending, spending required to placate its largely unemployed youth, is expected to remain unchanged at $290.9 billion.

At the end of February, Saudi Arabia has massive foreign currency reserves of $714 billion.

It must be noted Saudi Arabia’s budget does not take into account the widening war in Yemen or its publically announced intention that it may seek to build or acquire a nuclear weapon if the Iranian nuclear proposal is adopted.

What is the point of the above diatribe?

I have argued oil prices are unsustainably low, the inverse of the current market narrative.   There is no interest like self-interest and I will again argue the true intent of Saudi Arabia’s oil policy is to bankrupt Iran and Russia before Iran obtain a nuclear weapon, which incidentally is only 2 or 3 months away according to President Obama.

Economic warfare did not bring about its desired effect.

If prices rebound as projected, consolidation should continue in the energy sector as values have been decimated during the last nine months, a decimation I will argue is partially the result of ETF and institutional monies that have greatly influenced share prices.

Wishful thinking of someone who is long energy?  Perhaps but I will again write whoever thought the dollar would rally 25% and crude would fall 50% in nine months?

Commenting about the Minutes from the March FOMC meeting, the Committee was split over whether economic data is strong to raise interest rates as soon as June.  The interpretation is changing by the minute, perhaps the result of the jobs data.

In my view, I think monetary policy will be dependent upon inflation.  I rhetorically ask what will happen to inflationary expectations if oil rebounds as some outside the media expect and if home prices continually to rise as Owners’ Equivalent Rent (OER) or what someone thinks one can rent their house increases consistently?

All must remember the US is an asset based economy where the basic economic system is predicated upon borrowing money in today’s dollar and paying it back with tomorrow’s dollar, secured by an asset that should increase in value over the term of the loan.

If the value of the collateral/asset declines as was the case with residential real estate, the threat of deflation which is far more devastating and more difficult to combat rises.

What will happen today?  It may depend upon the infinite number of interpretations of Alcoa’s first quarter profit report.  The aluminum giant beat on EPS but reduced global aluminum demand from up 7.0% to up 6.5%.

Last night the foreign markets were up. London was up 0.86%, Paris up 1.12% and Frankfurt up 0.62%.  Japan was up 0.75%and Hang Sang up 2.70%.

The Dow should open little change.  Perhaps the emerging narrative will be the effects of the dollar on revenues and profits.  The 10-year is up 7/32 to yield 1.88%.  Oil is up about $1 barrell.

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Ken Engelke

Chief Economic Strategist Managing Director

The views expressed herein are those of Kent Engelke and do not necessarily reflect those of Capitol Securities Management. Any opinions expressed are statements of judgment on this date and are subject to certain risks and uncertainties which could cause actual results to differ materially from those currently anticipated or projected. Any future dividends, interest, yields and event dates listed may be subject to change. An investor cannot invest in an index, and its returns are not indicative of the performance of any specific investment. Past performance is not indicative of future results. This material is being provided for informational purposes only. Any information should not be deemed a recommendation to buy, hold or sell any security. Certain information has been obtained from third-party sources we consider reliable, but we do not guarantee that such information is accurate or complete. This report is not a complete description of the securities, markets, or developments referred to in this material and does not include all available data necessary for making an investment decision. Prior to making an investment decision, please consult with your financial advisor about your individual situation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. If you would like to unsubscribe from this e-mail distribution, please reply to this e-mail and indicate that you wish to unsubscribe in your response.