Every so often, the markets present us with a puzzling situation where the fundamental facts would suggest one direction, but the performance of the item in question suggests something else.  The world of the petroleum complex offers us a timely example of just such a conundrum.

For months we have been hearing about the virtual collapse of several European economies.  We have been hearing about sudden slowing of the rate of growth in China.  We have been hearing about slowing to non-existent economic growth in Canada, the USA and even Brazil.  In other words, the demand side of the economic equation for petroleum would appear to be negative and yet, one look at the price chart for Crude Oil tells us that the price has risen during the past few months from barely $75.00 per barrel to over $97 this morning.

I believe there are two factors at play to possibly explain this non-confirmation between what might have been anticipated from the fundamental economic background and what we are witnessing in the actual commodity marketplace.

First, despite short-term variations, there is an undeniable truth which we at TMR believe will become dominant over time.  At a worldwide consumption rate approximately 90 million barrels of oil per day (mbpd), the world is using up its petroleum reserves at a rate that is many multiples of the rate at which new reserves are being discovered and brought into production.  For example, a story just made today’s headlines noting that the Spanish petroleum development company Repsol has just discovered a rock-bound body of oil in the amount of 927 million barrels of oil.  The article in today’s Globe and Mail newspaper tells us this find will, “...mark a massive potential windfall for the country and the oil company.”

That may indeed be so – when the discovery turns into actual production which will likely be several years off - but it must also be noted that at today’s rate of usage, 927 million barrels of petroleum represents only 10-11 days of the world’s supply, hardly enough to be noticed.

And the situation is not improving.  According to estimates from the International Energy Agency, the long-term supply-demand imbalance trends are not improving, but gradually worsening.  The Agency now calculates that in spite of some identifiable economic slowing, the demand for crude has reached an all-time high of 89.2 mbpd in 2011 and their forecast for 2012 is an increase to 90.5 mbpd.  It is also worth noting that the continuing increases in the globe’s population – now at seven billion and counting – also augers well for increasing usage into the future. 

It appears reasonable that the petroleum industry’s most prominent analysts would be immensely concerned about this continuing and even escalating depletion of the world’s petroleum reserves and would therefore tend to bid prices higher, not lowe4r.

Second, the markets may very well be reacting to a potentially menacing situation related to the Arab-Israeli conflict in terms of Iran’s apparently relentless moves toward acquiring nuclear weapons which, judging by their past and present rhetoric, it might very well use against Israel.  The United Nations nuclear agency has just reported that Iran has developed technologies necessary to produce not fuel-grade uranium, but rather weapons-grade uranium.  They also concluded that Iran was conducting tests on a miniaturized warhead which could be delivered by middle-range missiles which Iran already has in its arsenal.

One can only imagine the consternation within Israel which such information might generate, since they would be the obvious target of such weaponry.  Fear is now growing of an Israeli pre-emptive strike against Iran, but should such action be taken, Iran could easily retaliate against Israel’s presumed friends and one of the weapons available to Iran is petroleum.

Not only does Iran produce a significant portion of the world’s petroleum supplies, but it also controls the exit from the Persian Gulf through which approximately one-quarter of the world’s supply passes.  Should they choose to do so, it is quite possible Iran could bring chaos by shutting of that exit through the Straits of Hormuz.

Few considerations rank as high in the world’s inflation calculations as the price of petroleum which has become an integral part of the price structure of many of our day-to-day expenditures.  A high price for petroleum could indeed unleash new furies of price inflation which then, by historic standards, would likely spill over into the realm of the monetary precious metals.

Italy has now taken over center stage as the European financial crisis lurches forward.  The latest drastic news is that the Italian government must pay more than seven percent interest for their short-term borrowings, a rate which will make it virtually impossible for Italy to run anything resembling balanced financial books for years into the future.  As such, they will likely be unable to meet any of the basic austerity requirements presently being set by the European Central Bank before any rescue package might be put together.

The quagmire deepens with each passing hour.

And, waiting in the wings, is the potential for trouble on an equally massive scale from Spain whose fundamental financial situation appears to be deteriorating as well.

Two items from the United States make us question whether the pampered public is at all truly ready to give up the belief that society cannot function without unending reward schemes from government. 

The people of Ohio have just handed the political forces for free enterprise and limited government a resounding defeat by rejecting the proposition that government has the right to limit collective bargaining by civil service unions.  Ohio’s ruling Republicans had attempted to limit the ability of those unions to gain unlimited benefits through the collective bargaining mechanism – but Ohio’s voters rejected any such limitations.

The state also tried to get civil service workers to actually pay a percentage of their immense benefit packages, but Ohio’s voters also seemed to think such a measure was ‘unfair’.

The net result is Ohio’s civil service personnel will continue to represent a tremendous drain on that state’s treasury, one which by standard financial analysis the people of Ohio can ill afford.

Then, the Republican Party appeared to also cave in by reversing their demand that any federal budget agreement between themselves and the President’s Administration should not include any taxation increases.  Their nominal leader, Speak John Boehner, and his party have now announced that they might be willing to accept $325 billion in new taxes in return for other bargaining considerations.  The Wall Street Journal commented the new tax stand, “...marks a potentially important shift in strategy among Republicans...”

Anyone – such as ourselves – hoping for solid movement toward diminished government spending and reduced influence by the unionized political left must be somewhat disappointed by these recent developments – and that is an understatement.

Financial markets this morning are reacting to Italy’s bond rate news by selling of quite sharply with the Dow Industrials down by about 275 points while Canada’s TSX Index is off by about 140 at 10:20 AM PST.  Precious metals have fallen on a stronger US Dollar with gold now trading near $1,785 and silver close to $34.40.  Base metals are sharply lower on the stronger Greenback with copper off by close to ten cents per pound and major mining share indexes are surprisingly trading close to unchanged. 

In other markets, as mentioned the US Dollar is sharply higher on a presumed flight to quality during crises, Crude Oil is now above $97.00 per barrel and long term interest rates have moved lower.

All quotes US$ unless otherwise noted.

We will be closed Friday in honour of Remembrance Day with the next Melman Minute now scheduled for Monday, November 15, just prior to my departure to speak at the Cambridge House Resource Conference of November 18 and 19 in Montreal.