which recovers first, crude oil or base metals?

I’m in the oil first camp.  (My private opinion is that it could take a decade or more for base metal prices to perk up.  Whether that turns out to be true or not is less important to a long-only investor like me than the idea that recovery is not soon.)

How so?


Leading with (the opposite of what you’re supposed to do) my weakest reason, look at the last cycle of gigantic investment in expanding natural resources production capacity.  Oil and metals prices both peaked in 1980-81  …and then plunged.  Oil stabilized and began to move up again in 1986; for metals recovery was over a decade later.

closing the supply/demand gap

There’s only a gap of a couple of percentage points between the amount of oil the world is demanding and the amount producers are willing to supply.  Growth in the car industry in China, the replacement of scooters and motorcycles with cars in other high-population countries like India and the strong increase in gasoline consumption in the US now that prices are lower all argue that the shortfall between demand and supply is, little by little, being erased.

On the other hand, the extent of base metals overcapacity is less easy to put your finger on, but is, nevertheless, massive.  Demand is also more cyclical–therefore less dependably growing, as well, but that’s less important than that mining capacity is added in gigantic chunks.

the nature of the enterprise

The up-front cost of a base metals mining project is very high.  There’s the mine itself, the huge machines that rip the ore out of the earth and the sometimes elaborate plants that crush or grind or otherwise separate it from the ordinary dirt.  Then there’s the transport link with the outside world.  All of this infrastructure can lie fallow for long periods without impairing the mine’s ability to be restarted–even expanded from its prior size–very quickly.

For oil, in contrast, finding new fields is a much more important issue.  Drilling new wells in an existing field is, too, in many cases.  As time has passed, the focus of the big oil majors has increasingly been on mega-projects that make them look much more like base metals miners than they did when I was covering the oil industry as a securities analyst in the late 1970s – early 1980s.

Hydraulic fracturing, however, has changed the industry for good.  This technology has made huge numbers of projects economically viable that have limited output that goes on for relatively short periods.  This converts 21st century oil exploration, in the US at least, into a sharp-pencil engineering business that even small firms can excel at.  Granted, the fact that production can turn on very rapidly when prices are high enough puts a cap on how far they can rise.  But the fact that several millions of barrels of daily output can be turned off equally quickly argues that the response time of the oil industry to a supply/demand imbalance will be much quicker than has been the case in the past.


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