Oil is spitting on the parade

Sorry to be a party pooper. On a day when iron ore, copper and gold plus the Australian dollar are driving the share market higher there is a warning sign – the price of oil.

The current fall in oil price (A crude awakening for energy stocks, October 23) is an ominous sign for the prices of our LNG and ultimately our thermal coal exports.

With the US debt crisis having extended the life of quantitative easing, money is flowing into commodities while China is taking all the iron ore it can load into ships. The US dollar is falling.

That should have seen oil joining in the fun and rising. Instead the black gold is falling to around the $US98 or $US99 dollar a barrel mark and the futures have it falling below $US98. That’s just over 10 per cent below levels of a couple of months ago but above July.

The reason for the fall is simple – the US supply is rising rapidly as a result of escalating production from its shale oil. Looking further down the track, Iraq is set to lift production while Iran is doing all it can to have the bans on its oil lifted.

Demand is strong but it is being swamped by supply.

And further down the track the fracking techniques that the US has pioneered are going to lift oil production in other countries, including China. Australia’s LNG producers have contracts that are a combination of factors but a large component is the price of oil. The Japanese are crying that LNG from Australia and around the world does not enable them to compete with the cheap gas coming from the US. They want LNG prices dropped even further.

Because of the massive investments required to build the plants so that the energy can be transported, LNG is always going to be an expensive fuel but, like any other commodity, it is vulnerable to the market.

Here in Australia, on the east coast, we have exported our gas and desperately need new supplies, which are being blocked by a New South Wales government that looks like it may have been captured by the greens. There is a real chance we will pay very large prices for gas at a time when the rest of the world is seeing lower energy prices.

Meanwhile our new LNG plants have all cost more than expected – especially Gorgon in Western Australia. They will manage with the current price of oil but it must not fall too far or they will be in trouble. In other words what we are seeing is an LNG alert, not a disaster.

What makes it potentially serious for the LNG producers is that much of their costs are in Australian dollars. They hoped that if the oil price fell, so would the Australian dollar. The combination of a rising Australian dollar driven by iron ore prices and QE3 and lower oil prices is a clear threat. Again, we have not yet reached crisis point but there are danger signals. By contrast countries like Saudi Arabia need a $US100 a barrel to maintain the current spending which is what delivers stability in the kingdom. Maybe we will get some Middle East instability to help the oil price.