CNBC reports Greece Austerity Strike Will Hurt GDP Further even as Cyprus Expects Bailout as S&P Cuts Ratings to Junk:

Cyprus said on Wednesday it expected talks to start with lenders on badly needed aid next week, as ratings agency Standard & Poor's pushed it deeper into junk territory, implying domestic political expediency lay behind a delay in clinching a deal. One of the smallest nations in the euro zone, Cyprus sought European Union (EU) and International Monetary Fund (IMF) aid in June after its two largest banks suffered huge losses due to a write-down of Greek debt.

Well, our Contagion Model showed clear paths of the knock on effects of Greek infection, and we haven't even gotten started with the economic pathogen party yet!

Of course, where there is a loser, there's always a winner as well - sometimes hidden beneath all of their spoils... On Friday, 04 May 2012 I penned The BoomBustBlog Pan-European Distressed Asset Acquisition Initiative, which clearly outlined the investment opportunities forthcoming in the tiny nation state known as Cyprus, as excerpted:

Asset sale by sovereigns is can be seen in the sale of stakes in government owned infrastructure assets and corporations. However, the approach adopted to dispose of these assets is to make partial sales in tranches in order to participate in any benefits of valuation recovery.

Professional and institutional subscribers should download the full version of this document ( The BoomBustBlog Pan-European Distressed Asset Acquisition Initiative) which outlines investment opportunities in the following nation/banks: UK, Portugal, Italy, Cyprus, Greece, Ireland and Spain.  Our initiative runs the gamut from whole companies and equities, to real estate, infrastructure assets, rare earth and hard tangible assets to IP.

Dispositions by Europeans banks have consisted mostly of foreign assets outside of Europe. Most of these assets had the potential for high returns but are being offered at prices reflecting the perception that future investment performance would be robust. This is why there is so much interest in the private equity and asset management space in scanning for strong deals among those assets. However, the competition among these entities to buy quality assets at reasonable valuations has created a micro bubble of sorts, the type that make profitable vulture investing a very difficult proposition.

Over the next week I will lead readers and paid subscribers through a journey of distressed assets being disgorged by banks and sovereigns that are poised to give those who are perceptive enough out-sized returns. I find this research and foresight to be invaluable, and I believe many institutions, asset managers and UHNWers will as well. Of course, the potential winners may be those who aren't among the usual suspects, and I feel TPTB amongst the EU clan may feel downright intimidated.

Yes, Spain will contribute to this vulture-fest, as will those still hooked into Greece, et. al.

• The Embarrassingly Ugly Truth About Spain: The IMF, EC and ALL Major Rating Agencies Are LYING!!!
• European Bank Run Watch: Spaniard Edition
• And confirming opinion from ZeroHedge: Chart Of The Day: Spanish Bad Loans Hit New Parabolic Record
  • Last month we reported that Spanish bad loans jumped by the most ever, rising by over 1%
    to just under 10%. Today, last month's number was revised even higher to 10.1%.
    But the worst news is that the August bad loan total just hit a fresh
    record of €178.6 billion, or 10.5% of the total €1,698.7 billion in bank
    loans. Making things worse is that the primary bank funding lifeline -
    deposits - continues to flow out. That both Spain, and its banking sector are
    utterly insolvent, is clear to anyone but Oliver Wyman and those who have bought
    SPGBs (although granted the latter are merely hoping for a quick flip). And the
    ECB of course. Indicatively, as a % of GDP, this would be equivalent to roughly
    $2.7 trillion in US bank loans going sour (for more on the collapse of Spanish
    banking, and the laughable stress test whose worst case has already become the
    baseline, read
    here). The chart summarizing this staggering statistic is below.
  • 
• This Time Is Different As Icarus Blows Up & Burns The Birds Along The Way - Greece Is About To Default AGAIN!

Stay tuned, and follow me!

First, a quick historical synopsis of where I'm coming from. If you have followed me regularly, then feel free to jump down to the next bold heading to get started - all others please read on...

I have been warning of the collapse of the European banking system, the Euro as we know it, and periphery states of the EU for going on three years now. What many thought was tomfoolery back then, is thought of as prescient now - reference the Pan-European Sovereign Debt Crisis series which started in late 2009. I then went on to explicitly query Is Another Banking Crisis Inevitable?, of which I believe most of the realistic among us already know the answer.

Walking through European bank collapse is not enough, even through we did it in detail through BoomBustBlog, reference The Anatomy of a Serial European Banking Collapse, a nearly guaranteed scenario. If one were to even come close to marking the EU banks' books to reality, market prices, or anything in between, the Lehman situation would look tame in comparison!

As excerpted from the subscriber document (click here to subscribe): The Inevitability of Another Bank Crisis

You see, you can avoid reality for but so long, primarily because reality is... well, reality! What happens when reality hits bank asset prices and liability values... 

Now, since we have finished that quick traipse through recent history as a summary of events and opinion, let's move on to the topic at hand. Last week, ZeroHedge posted a scathing article on the IMF's "Global Financial Stability Report", as excerpted:

...especially as pertains to Europe's insolvent banking system. The most notable finding of said report is the admission that the IMF was only kidding when it said six months ago, in April of this year, that the worst case outlook now has European banks deleveraging to the tune of $3.8 trillion through the end of 2013, or over the next 14 months: now this number is 18% higher, or a gargantuan $4.5 trillion (12% of bank assets). This is how much debt Eurobanks will need to shed in a "weak policies" case in which Europe continues to delay implementing fiscal reform, aka austerity, as per Figure 2.14. Even the baseline (and this being the IMF it means it has zero chance of happening) scenario is not much better, at a revised $2.8 (7.3%) trillion in deleveraging.

Although it seems as if Tyler is being a smart ass, he couldn't be farther from the truth. Reference my piece Lies, Damn Lies, and Sovereign Truths: Why the Euro is Destined to Collapse! concerning the accuracy of the IMF's baseline scenarios...

image005.png

And back to the ZH post:

....Breakdown of IMF deleveraging forecasts for the three scenarios, of which the realistic one is highlighted:

• • Under weak policies, the withdrawal of foreign investors accelerates to twice the pace seen since 2009. Periphery spreads widen by about one standard deviation above the baseline.

The biggest loser here, as in every other category: Germany, which will end up seeing €2 trillion in TARGET2 claims which in turn will never be satisfied as the system merely accelerates its collapse into a debt supernova.

 EXACTLY!!! BINGO!!! Now, we are all starting to come to the BoomBustBlog way of thinking, aka, REALITY! In the beginning of this year, I penned The Biggest Threat To The 2012 Economy Is??? Not What Wall Street Is Telling You... In short, this piece made clear that Germany poses the biggest threat to global harmony for 2012. The widely accepted belief that Germany is economically bullet-proof and somehow immune to malaise effecting the periphery as long as it does not attend the bailout party is fallacious, indeed. Please click the afore-referenced link for the full story on Germany and why some should consider the "Bund short play". Back to Tyler...

The big picture, of course, is that even the IMF now concedes Europe is in a closed loop Catch 22: unless European countries manage to restore "foreign" confidence which in turn would mean putting their fiscal houses in order, something which has proven absolutely impossible in Europe absent such one-time gimmicks as LTROs and otherwise hollow confidence boosters as ECB warnings to not fight the ECB (which work until they are tested, but first need to be activated, ahem Mariano Rajoy), the banks will be forced to delever even more, which would mean the ECB would have to "onboard" even more of their debt as nobody else will, which means even more foreign creditor flight, which means greater deposit outflows, which means more ECB intervention, until finally, the ECB is the only player in town...

Ah, yes! The Truth gets outed... I went through this in EXPLICT detail throughout 2011-12. Reference the following:

1. On Your Mark, Get Set, (Bank) Run!
2. ECB As European Lender Of Last Resort = Institutional Purveryor Of A Pan-European Ponzi Scheme
3. The Anatomy Of A European Bank Run: Look At The Banking Situation BEFORE The Run Occurs!
4. The Fuel Behind Institutional “Runs on the Bank" Burns Through Europe, Lehman-Style
5. European Bank Run Watch: Swiss Edition - BoomBustBlog
6. European Bank Run Watch: Spaniard Edition - BoomBustBlog
7. Bank Run! Italiano Style? - BoomBustBlog
8. French Bank Run - BoomBustBlog

Back to that Tyler piece:

...a process which can be visualized (in progress) in the following capital flow image, especially Figure 1.7:

Reggie on USA Watchdog

Dr. Benjamin Shalom Bernanke, AKA Dr. FrankenFinance, Has ...

Feb 8, 2011 – Dr. Benjamin Shalom Bernanke, AKA Dr. FrankenFinance, Has ... Well my dear BoomBustBlogger, its one part regulatory capture (More on ...

Welcome to the World of Dr. FrankenFinance!

Nov 29, 2007 – Well, The Doctors' FrankenFinance have enabled corporate America (and corporate Europe and Asia as well, I just don't have the time to cover ...

I Go To The NY Fed To Illustrate The Lies Perpetrated By The Fed Chairman Himself

Here's proof, pulled off of the St. Loius Fed's site, and espoused in front of the actual entrance to the NY Fed.

Bernanke's Lying Through His Teeth and Not A Single Pundit/Analyst/Banker Has Called Him On It!!!

Much Of The Developed World Prints Today, But Where's The Wealth? Real Value Of Risk Assets Continue To Plunge!

Yesterday, I posted The Difference Between Money and Wealth and Why You Can Easily Print One But Must Actually Create The Other, and as if on cue, global inkjet nozzles 'round the world started whizzing - to wit:

• ECB Cuts Rate to Record Low of 0.75%, Deposit to Zero and Bank of England Prints Money Again to Boost Economy
• China Cuts Rates for Second Time in Month and China Set to Post Worst Growth Since 2008 Crisis
• BOE Restarts QE Amid Euro Crisis

 

Gold Is Money Interview

Reggie Middleton on banking problemsReggie Middleton on banking problems

Those damn rating agencies...

Of course, we all know how reliable and timely the rating agencies are, right? See Rating Agencies vs Reggie Middleton, Part 3 and the Interesting Documentary on the Power of Rating Agencies, with Reggie Middleton Excerpts

Reggie_VPRO_Ratings_agenciesReggie_VPRO_Ratings_agencies

Bloomberg reports - Greek Strike Marks First Test for Samaras’s Coalition:

Police fired tear gas near the Greek Parliament after protesters threw fire-bombs as thousands of people joined a strike opposing wage cuts and austerity that Prime Minister Antonis Samaras said are vital to keep the euro.

Demonstrators streamed into the central Syntagma Square in Athens, opposite the Parliament House, shouting slogans such as “struggle, clash, overturn: history gets written by those who disobey.” Police spokesman Takis Papapetropoulos estimated the crowd at 35,000 people.

... “The strike marks the beginning of what is likely to be a tough time for Samaras as demonstrations and industrial action heighten in the weeks ahead,” said Wolfango Piccoli, an economist at Eurasia Group in London. “Samaras should be mainly concerned about how much time he has left to tackle all these interrelated challenges.”

The shutdowns, called to protest the cuts to benefits, wages and pensions that will form the bulk of an 11.5 billion- euro ($14.8 billion) austerity package, comes as speculation swirls anew about Greece’s finances. International Monetary FundManaging Director Christine Lagarde said on Sept. 24 that the financing gap won’t be solved by the savings because a weak economy and delayed asset-sales worsened Greece’s finances.

Then there's Bloomberg reporting that the ECB will not fill Greece's budget gaps: Weidmann (Reuters) - The European Central Bank will not fill potential financing gaps in Greece'sbudget, Governing Council member Jens ..

This is a budget gap that's not only a foregone conclusion but one that will gap signficantly!!! As clearly demonstrated in my past writings...

I believe I was one of the very few to declare Greece a foregone default in February 2010 (I Think It’s Confirmed, Greece Will Be the First Domino to Fall and then with with more specificity a month later As I Explicitly Forewarned, Greece Is Well On Its Way To Default, and Previously Published Numbers Were Waaaayyy Too Optimistic!). By the 2nd quarter of 2010 I was one of the very few to clearly and articulately detail exactly how Greece would default with specific structures in play- What is the Most Likely Scenario in the Greek Debt Fiasco? Restructuring Via Extension of Maturity Dates. Due to a few institutions who were skeptical, I attempted to make it a bit more real - A Comparison of Our Greek Bond Restructuring Analysis to that of Argentina.ThThis is basically inevitable. Several months ago I penned the piece Greece Fulfills Its BoomBustBlog Derived Destiny - Shows This Time Really Isn't All That Different After All!!!, and in it I claimed - among other things, that not only would Greece default, but they will defualt again relatively shortly thereafter....

Well, Greece defaulted according to plan, despite all of the "people in the know" saying otherwise -Greek Crisis Is Over, Region Safe”, Prodi Says – I say Liar, Liar, Pants on Fire! - from government officials tothe EC and IMF - Lies, Damn Lies, and Sovereign Truths: Why the Euro is Destined to Collapse! Even after the default, I made clear that this wasn't over for Greece, for the default actually left Greece worse off fundamentally, not better. Go wonder... I know I did, reference the warning from 5 months ago:

This will be exacerbated by a re-default of the Greek debt that was designed to bail out the defaulted Greek debt. Why will this happen? Greece has severe, rigid structural problems that simply cannot (and will not) be solved by throwing indebted liquidity at it. As a matter of fact, the additional debt simply exacerbates the problem - significantly! This was detailed in the post Beware The Overly Optimistic Greek Speculators As Icarus Comes Crashing Down To Earth!

This situation will simply get worse, considerably worse. I demonstrated in the post The Ugly Truth About The Greek Situation That'sToo Difficult Broadcast Through Mainstream Media that anyone who purchased the last set of bailout bonds from Greece will simply lose their money as well (that's right, just like those who purchased the previous set) since Greece is still running deep in structural problems and can't afford the interest nor the principal on its borrowing. It's really that simple. 

This is a tragic Greek comedy. Professional/institutional subscribers should reference the Greece Public Finances Projections 2010-03-15 11:33:27 694.35 Kb in its entirety. For those who chose not to subscribe, I am posting excerpts from pages 5 and 6 from said document, don't read this while eating or drinking for fear of spitting up your lunch!

Any subscribers who would have went heavily bearish into these banks when I first commented on the would have done quite well:

•  Banks exposed to Central and Eastern Europe
•  Greek Banking Fundamental Tear Sheet

As excerpted from Greece Sneezes, The Euro Dies of Pneumonia! Yeah, Sounds Bombastic, Yet True!

Wait until a 2nd Greek default (virtually guaranteed as we supplied user downloadable models to see for yourself, the same model used to forecast the 1st default) mirrors history. Of the 181 yrs as a sovereign nation after gaining independence, Greece been in default 58 of them. Don't believe me! Check your history, or just read more BoomBustBlog - Sophisticated Ignorance Or Just A Very, Very Short Term Memory? Foolish Talk of German Bailouts Once Again...

image022image022image022

Greece's default will hit an already bank NPA laden Spain quite hard: The Spain Pain Will Not Wane: Continuing the Contagion Saga and ditto with Italy "As We Assured Clients Two Years Ago, Italy's Riding The Broken Promise Express To Restructuring". Once Italy gets hit, the true bank runs will start as socialist France (the so-called half of the EU anchor) loses control of its bankinsg system. Reference "As The French Bank Runs....": 

Saturday, 23 July 2011 The Anatomy Of A European Bank Run: Look At The Banking Situation BEFORE The Run Occurs!: I detail how I see modern bank runs unfolding

image012

Related reading of import...

European Bank Run Watch: Spaniard Edition

European Bank Run Watch: Swiss Edition

Germany's Sophisticated Ignorance Doesn't Even Look Sophisticated Anymore

 Moody's Actions Add Pressure To The Inevitable In France?

Beware The Day When The Bulging Bunds Go Bust From The Bullshit - Or Doesn't Anyone Use Math Anymore???

Now Is The Time To Prepare For The (Next) French Bailout Of Their Banking System & Potential Bailout Of France

 

Thumbnail  Greece Contagion Hits Belize

Thumbnail6:06

The Little Known, Yet Significant "Domino Effect" Powers Of Small EU Nations: Enter Greece

Reggie Middleton Ruminations on how small countries such as Greece and Iceland yield influence in the EU through the threat of the bank failure ...

1. Thumbnail

   Reggie Middleton Ruminations on Greece's Sovereign Debt Crisis

   Thumbnail28:07

1. Kung-Fu Analyst Reggie Middleton Karate Chops the Troika's Numerical Farce in the Face!

   
   Thumbnail6:56

2. Reggie Middleton Speaks on Greece, China, and US

   
   Thumbnail10:41

1. Reggie Middleton Delves Deeper Into Wall Street Brokerage & Investment Banking Business Model

   Reggie Middleton answers the question: "Why hasn't anyone became wealthy trading Wall Street investment advice?" We believe Reggie Middleton and ...

   Thumbnail9:27

1. Why Didn't Wall Street Foresee the Sovereign Debt Crisis? Reggie Middleton Speaks

   Reggie Middleton, in a conversation style discussion, explains how Greece became over indebted through banks making bad loans, and more ...

   Thumbnail7:24

1. Are we headed for another Lehman moment in Europe?

The 2nd demo of my new Financial REALity TV show is available. The variable audio is due to the total lack of cooperation from the subject company's employees, as you could probably assume. After all, there are a few things not to be too proud of...

 steinway earnings

Subscribers, please download the full report here:  Steinway Musical Instruments Note. Valuation and further analysis available by the weekend. Click here to subscribe. Non-subscribers can peruse page one below:

Steinway Musical Instruments Note - blog Page 1

This REALity TV thing has actually been very, very well recieved. More so than I thought. Here are previous episodes and related research...

1. Reggie Middleton's Documentary-style Reality TV Show, ep. 0 - Sizzle Reel
2. Reggie Middleton REALity TV #1: Benjamin Bernanke LIED To The World About QE3/Unemployment
3. Reggie Middleton's REALity TV #2 - Bernanke's Bank Bailouts Blow Up Consumer Discretionary 

Related research...

Retailer Preliminary Analysis 08/03/2012

Consumer Discretionary Company Bear Note 09/13/2012

Consumer Discretionary Bear Note 2 _Aug 22_Final new!09/11/2012

Here's proof, pulled off of the St. Loius Fed's site, and espoused in front of the actual entrance to the NY Fed.

More on the matter...

Bernanke's Lying Through His Teeth and Not A Single Pundit/Analyst/Banker Has Called Him On It!!!

Is The New US Consumer Consumption Bubble Primed To Pop? Yes, There's A Bubble!!!

Recent and related research

Below are three companies that probably will not do well even with Bernanke's machinations. When and if Bernanke fails, look out below.... Click here to subscriber!

Retailer Preliminary Analysis 08/03/2012

Consumer Discretionary Company Bear Note 09/13/2012

Consumer Discretionary Bear Note 2 _Aug 22_Final new!09/11/2012

No, I didn't even bother to listen to the Bernanke speech! It was a waste of perfectly good hot air. The MSM is all abuzz with the bullshit. A quick Google search for Fed QE3 reveals the cackle...

• Fed to launch QE3 by buying mortgage securities MarketWatch‎ - WASHINGTON (MarketWatch) — The Federal Reserve, worried that improvement in the unemployment rate has stalled, announced a third ...
• Fed Undertakes QE3 With $40 Billion Monthly MBS Purchases www.bloomberg.com/ – The Federal Reserve said it will expand its holdings of long-term securities with open-ended purchases of $40 billion of mortgage debt a month ...
• Federal Reserve launches QE3 - (CNNMoney) -- The Federal Reserve announced plans to unleash more stimulus Thursday, in its third attempt at a controversial ...

• QE3 Decision: Fed Vows To Buy Bonds Until Economy Recovers ... www.forbes.com/.../feds-monetary-policy-decision-bernanke-...

• Fed To Markets: Take Some QE3, There's A Lot More Where That ... www.forbes.com – The Federal Reserve finally did what everyone was expecting: it unleashed a third round of quantitative easing (QE3), extended the Twist and ...
• Federal Reserve announces QE3 — RT  – The Federal Reserve announced Thursday that they will spent $40 billion a month on bond purchases in an effort to kick-start the US economy...

So, this is the scam story, in a nutshell - Bernanke says he will target the mortgage market to reduce unemployment by pledging to buy $40 billion USD of mortgage securities per month until a demonstrable improvement in the labor force materializes. What the F^ck!!!! So, is it just me or does everyone assume that the most common job in the US is MBS trader? Exactly how direct is the mechanism between MBS purchases and employment? Does anyone truly believe (obviously, from the links above, many actually do) that Bernanke can lift employment by buying mortgage securities? 

Okay, all bullshit aside, this is the skinny. The banks are in trouble again. Actually, they've been in trouble since 2007, but the stress seems to be approaching the acute phase again. The housing scam is once again catching up to this nation's lenders and credit gamblers. The pending downturn in the CS index will prove my point, as will the stress emanating from the inevitable break in Europe. Bernanke has come to save this market and its participants by a) buying the stuff that there is still really no market for, and b) announcing that he will do so indefinitely.

Do I sound conspiratorial? Well, mortgage rates are already at record lows, so what the hell is the purpose of trying to push them even lower, and by force at that? Oh yeah, I forgot... To increase employment. Let's not leave all of those MBS traders to fend for themselves in the unemployment line.

This is what I would do if I was Fed Chairman and I was serious about lowering unemployment - Which Bernanke is not!

 I would take the Fed's resources and purchase SBA bonds aimed at pumping cash into the small business sector, not the housing sector  which is still trying overcome the ramifications of the last bubble popping.  You see, the SBA guarantees loans to small businesses, a group which represents the single largest contributor to employment this nation has. $40 billion per month in SBA bond purchases which would be used to guarantee loans to business creating a significant multiplier effect of no less than 5x - 7x ~ around a quarter trillion US dollars per MONTH in direct small business and direct employment stimulus is like sparking a live wire in a vat of gasoline with a semtex lid - at least in terms of the potential explosiveness this would have in terms of invigorating the small business sector, hiring and within a very short order, the spiking of employment. Now, I admite that this would be blowing a new bubble, but Bernanke is trying to do this now with housing finance, no? Now I admit, the process would not be that simple, but its a whole of a lot simpler than what Bernanke is trying now - that is unless he's really not trying to boost employment... Hmmmm!!!!

The argument can't be made that the SBA loans are not that liquid either. I query, how liquid is the MBS market now?

Of course, the old Bernanke put - which has morphed and metastasized, and is now the Bernanke CDO cubed with inverse kickers - has lit a fire under the ass of stocks. As usual, fundamentals and common sense take second seat to momentum gambling and non-sense. When does the math return? When things get real ugly. This is why my team and I have been focusing on the sector that has mistakenly been seen as much stronger than it actually is - the retailers and vendors of consumer discretionary products and services!

Is The New US Consumer Consumption Bubble Primed To Pop? Yes, There's A Bubble!!!

Recent and related research

Below are three companies that probably will not do well even with Bernanke's machinations. When and if Bernanke fails, look out below.... Click here to subscriber!

Consumer Discretionary Company Bear Note 09/13/2012

Consumer Discretionary Bear Note 2 _Aug 22_Final new!09/11/2012

Reggie Middleton on banking problems 

Investor Reggie Middleton — author of the BoomBustBlog.com — discusses the problems in our banking system with GoldMoney’s Alasdair Macleod. Reggie states that the current zero-interest rate policy being pursued by the Federal Reserve (often referred to as “ZIRP”) is masking problems with banks, but not solving them. He points out the basic truth that money-lending institutions make money off of interest, and that as long as rates remain artificially suppressed, this will constrain lenders’ profits. This is an issue all over the world — something that makes investing in this sector tricky. Middleton argues that the European situation is particularly fraught, on account of their being “too many chiefs and not enough Indians...

See the original interview posting on Gold is Money.

 image007 copy

Below is the Oilprice.com interview of Professor James Hamilton. James is a professor in the Economics Department at the University of California, San Diego. He has been a visiting scholar at the Federal Reserve Board in Washington, DC as well as many of the Federal Reserve Banks; and has also been a consultant for the National Academy of Sciences, Commodity Futures Trading Commission and the European Central Bank and has testified before the United States Congress. You can find more of his work on his website Econbrowser.
Topics include:
•    Why we shouldn’t get too excited with the shale revolution
•    The “Real” cause of high oil prices
•    The incredible opportunity presented by natural gas
•    Why long term oil prices will creep upwards
•    The geopolitical hotspots that could cause an oil price spike
•    Why sanctions could cause Iran to lash out
•    Why speculators and oil companies are not to blame for high oil prices.
•    Changes we can expect to see under a Romney Administration
•    Why Short term oil price forecasts are worthless
•    Peak oil & Daniel Yergin

Direct link can be found here.

James Stafford: Oil prices have shot up in the last month. What range do you see oil prices trading in over the next 12 months?

James Hamilton: Oil prices have always been very volatile.  If you look at 12-month logarithmic changes in WTI going back to 1947, you come up with a standard deviation of 0.27.  In other words, 25% moves up or down within a year are fairly common, and 50% moves or greater have also been seen on a number of occasions.

If you look at options prices at the moment, they imply the same level of uncertainty looking forward.  For example, somebody today is willing to pay $2.90/barrel for a NYMEX option to buy oil in September 2013 at $120/barrel, consistent with a standard deviation of annual log changes of 0.26.  The market is saying that prices that high or higher are not that remote a possibility.

And if you look at current fundamentals, it’s not hard to imagine big moves in either direction coming fairly quickly.  The price of oil would surely collapse if we saw a significant economic downturn in China (something nobody can rule out) or if Iraq succeeds in producing even half of its ambitious production targets (though I personally consider the latter unlikely). On the other hand, a military confrontation with Iran could produce a pretty spectacular price spike.  If the Strait of Hormuz were to close, for example, it would represent a shock to world production that in percentage terms would be 3 times as big as the 1973-74 OPEC embargo.

Because the demand for oil is so insensitive to the price over the short run, and because there is little excess capacity in the world at the moment, even small disruptions or additions could produce big price changes.  For this reason, I do not have a lot of confidence in anybody’s near-term oil-price forecasts.

On the other hand, I think we understand pretty clearly the main factors behind the overall increase in oil prices since 2005.  Demand for oil, particularly from the emerging economies, has grown significantly, and we have had a hard time increasing global production.  The single most likely outcome is that both conditions will continue to be with us.  The most likely scenario is that the next decade will look something like the last, with oil prices volatile but exhibiting an upward trend.  
 
James Stafford: For the past century or so, economies have generally been built upon energy. The economies with access to plentiful, cheap energy have developed the most. With the stagnation of oil production growth, how do you suggest economies could continue to grow from here? Should we stop expecting to see constant economic growth as the norm?

James Hamilton: I think this has put a significant burden on the oil-consuming countries.  These economic problems have been compounded by the fact that some of the key manufacturing that once came out of countries like the United States and Japan has now been taken over by the emerging Asian economies.

But there is still a strategy for trying to take advantage of the resources we do have.  The United States has had astonishing success in producing natural gas.  This could be the basis for a renewed manufacturing advantage, a new source of U.S. exports, or an alternative transportation fuel.  We should be looking for regulatory reform and infrastructure investment to encourage consumers and entrepreneurs to adopt alternatives to conventional gasoline-powered vehicles.

James Stafford: Apart from the Iran and Syria situations – are there any other geopolitical risks that could lead to increased volatility in the energy markets?

James Hamilton: The list of oil-producing countries is almost a Who’s Who of world trouble spots.  There is ongoing unrest in Sudan and Nigeria, and it wouldn’t take much to see a major turn of events in Venezuela and Kazakhstan.  Iraq, a key hope for future increases in production, has been a place of conflict for most of the last three decades.  The same forces that disrupted production in Egypt and Libya last year could easily return.  And the key worry about Syria and Iran is the possibility that instability there could spill over into other nations of the region.   
 
James Stafford: Even though many Asian nations have found a way to continue trading with Iran, its economy is still suffering from high inflation and high unemployment. Do you believe that the US Sanctions are having enough of an impact on the Gulf state’s economy to force them into a deal over their nuclear program?

James Hamilton: I was surprised that the sanctions were as effective as they were in preventing Iran from selling all the oil it wanted.  But the other key element of that diplomatic strategy is the assumption that Iran will respond to economic pressure by acceding to U.S. demands.  The other possibility is that, if significantly wounded, the regime would lash out more desperately.  This looks to me like a scary situation.
 
James Stafford: Whenever oil prices spike politicians are quick to blame speculators and oil companies for manipulating the markets. Are you in agreement with this – are speculators and oil companies to blame? Or are there other factors that are overlooked deliberately or otherwise by the mainstream media?

James Hamilton: The story is pretty simple, and even though politicians may try to distort it, you’d hope that the media would do a better job of reporting the truth than they have.  World oil production was basically stagnant between 2005 and 2008, even though world GDP was up 17%.  With economic growth like that you’d normally expect increased demand, particularly from the rapidly growing emerging economies, and in fact China did increase its consumption by a million barrels a day over these 3 years.  But with no more oil being produced, that meant that the rest of us-- the U.S., Europe, Japan-- had to reduce our consumption.  It took a pretty big price run-up before that happened.  To those claiming the price is too high, I would ask, how high do you think the price had to go to persuade Americans to reduce oil consumption by a million barrels a day?
 
James Stafford: Could you let us know your thoughts on the shale revolution. How do you see it playing out and do you think we have been oversold on shale’s potential?

James Hamilton: This is a real success story, and a primary reason that U.S. production is now rising rather than falling.  But there are several key points to keep in mind.  First, it is not cheap to produce oil with these methods-- tight oil is never going to be the reason we get back to $50/barrel.  Second, we’re likely to face much steeper production decline rates from individual wells than was the case for conventional oil production.  The same also applies to deepwater production.  So those who think these new technologies will put us back in the world we once knew are in my opinion missing the big picture.
 
James Stafford: Drilling technology advances, new oil finds and now all the hoopla over shale oil – one would assume we are swimming in the black stuff, yet we have seen no material increase in global annual crude oil production for six straight years. Have we reached a period of peak oil? Or is Daniel Yergin correct in saying that we have decades of further growth in production before flattening out into a plateau?

James Hamilton: I do not think the expression “peak oil” is the most helpful way to frame the question.  Too many people have a knee-jerk reaction as soon as they hear the phrase.  I can’t tell you how many times I’ve seen people assume that it means that we’re “running out of oil”, which straw man they then try to debunk.  I would instead call attention to the basic fact that the annual production flow from any given field shows an initial period of increase followed by subsequent decline.  Anyone who tries to deny that has a serious lack of grip on reality.  Production from the original Oil Creek District in Pennsylvania peaked in 1873, and from the state of Pennsylvania as a whole in 1891.  There’s a long, long list of areas that have exhibited declining production rates for a long, long time.   Global production nonetheless continued to increase for a century and a half, not so much because we got more out of the old fields, old states, old countries, but because we turned to new ones.  But that game is obviously not one we can continue to play forever.

Yes, Yergin today is optimistic about the future.  But I remember that Yergin was also very optimistic in 2005, and the last 7 years have not looked at all like he was predicting they would.  We’ve increased production only a little bit since 2005, despite tremendous incentives to do more.  I think many people are making a mistake if they assume that world oil production is always going to increase, year after year.
 
James Stafford: What are your thoughts on the Keystone XL Pipeline – is it something that needs to be pushed through after the presidential elections? Or something the country can live without?

James Hamilton: It is ridiculous to see oil selling in Cushing at a $20 discount to the world price and oil in North Dakota selling at a $20 discount to WTI.  Since the 1860s we understood that pipelines were the logical way to transport oil.  Somehow the Keystone pipeline became a symbol of some bigger controversies that in my opinion should be completely separate from the question of the most economically efficient (and for that matter, the most environmentally friendly) way to transport oil.

There are several work-arounds in progress, such as reversal of the Seaway Pipeline and plans to build just the Gulf Coast portion of Keystone.  But I think that given the magnitude of the drop in U.S. demand and success of North American production, we’ll need additional measures.
 
James Stafford: How would you see energy production changing in the U.S. under a Romney Administration?

James Hamilton: Romney wants to be more aggressive in approving oil exploration and development, and that should make a difference.  But it’s easy for the politicians to overstate how much they can change.  The U.S. is moving ahead with tight oil production, and is going to do so no matter who is the president, because the economic incentives are just too powerful for anybody to stop it.  On the other hand, it’s a big world out there, and anyone who thinks that U.S. production alone is going to make up for declines from mature fields and burgeoning consumption of emerging economies is in my opinion way too optimistic.  The world faces a huge challenge, and I think we need to take that challenge very seriously.

James Stafford: James, thank you for taking the time to speak with us. For those of you who haven’t seen Professor Hamilton's site please take a moment to visit Econbrowser

Related BoomBustBlog research: 

Frontline investment highlights - Pro Page 1

Frontline investment highlights - Pro Page 2

Frontline investment highlights - Pro Page 3

FRO Oil Price Arbitrage Addendumhot! 01/07/2009

Potential Spillover Effects from the Middle East to the EU 02/02/2011

Frontline Investment Highlights - Pro 12/18/2008 

Frontline Investment Summary - Retailhot! 12/18/2008