A really good market commentary by Goldman Sachs on the state of the oil markets points out that capital has become the marginal adjustment in the oil markets. Prior to the shale revolution, the price tended to be balanced around the marginal barrel of production, which in turn was micro-managed by the major producers (OPEC in particular). In this environment, barrels would be removed or added based on the target price for the major producers given their associated quotas (albeit with some cheating among the minor players). The key was that external barrels outside of OPEC never really altered the price picture significantly. Fast forward to today, and we could not be in a more different world. The shale boom in the U.S. has minimized the influence of the major producers (Saudis) as swing producers thus leaving the oil markets susceptible to the total global barrels produced. Goldman astutely points out that the barrels coming from shale production are driven by the capital employed in these very fast producing, short-lived reserves. Unlike deep, long-lived traditional oil reserves, the economics of shale plays can  thus shift much more rapidly. If you think about it, the shale boom is reminiscent of the fibre optic cable buildout during the late 90’s in that they were both liquidity fueled production booms built solely on the access to capital rather than the necessity of  immediate demand.  The above got us thinking on several fronts about what larger takeaways we can draw from the sharp decline in oil prices. 1) The decline in oil cannot be extrapolated to other non-related parts of the commodity complex 2) The decline in the price of energy will not sustain non-economic production across the commodity complex-this is driven by the spot and forward price curve of the individual commodities 3) As we pointed out in an earlier post, the falling price of oil is not indicative of rapid deflation but rather is an outgrowth of the massive liquidity injections by the Fed and other Central Banks 4).The dislocation in the price of oil has vast implications for global geopolitics, the immediate impact of which we probably will not be able to foresee.

We all were enthralled with the new Fed Chairwomen Yellens’ speech in New York regarding the future path of Fed policy. She stuck to the script as all Fed Chairs are wont to do, but in response to a question about inflation she remarked that the “odds of deflation are much greater than the odds of inflation”. In response to a question about the potential for said inflation, she remarked that the Fed would be way out in front of a potentially damaging rise in inflation. The Fed’s inklings of this dangerous brand of inflation would be drawn from a variety of indicators, not necessarily  only a tightening of labor slack. The re-emergence of this Fed “dashboard” gave much comfort to those that were concerned that the Fed would do something reckless like normalize interest rates.These comments dovetail with Minneapolis Fed Governor Kocherlakotas’ recent talk where he stated that he is not worried about what to do in the event of escalating inflation because they already know exactly what to do “that’s Central Banking 101”. I’m not sure where they teach this class, but it would appear that they should throw out the old textbook, as the low to negative real rates of interest imposed by the Fed over the past 5 years have done almost nothing to aid real economic activity.This experiment in Central Planning is still just that, regardless of how Central Bankers may spin it.Drop your Central Banking 101 class and take something more practical like behavioral psychology( you will need it). Buy Stuff Sell Paper

The unfortunate  political and human tragedy in the Ukraine has the potential to cause significant shifts across a number of commodity markets, regardless of whether sanctions are imposed or not. We already know the obvious markets involved: Natural Gas, Nickel, Palladium and titanium but there are a number of ancillary markets and outcomes that could be affected by Mr. Putin’s aggressive actions in the FSU. Russia accounts for roughly 30% of Europes Nat Gas needs so it is clear why the Europeans are treading lightly when it comes to heavy- duty sanctions. We wonder however whether Germany and others are speaking frankly with the U.S. and others about the potential for  a step up in LNG and CNG imports. Such a shift would mark an important dynamic in world Nat Gas pricing and one only assumes that the beneficiary of such a trade shift would be China.It is not hard to envision Mr. Putin extending this policy towards other commodities as well, preferring to strengthen his alliance both politically and economically with China. While Russia has been more than happy to use its petrodollars as a diplomatic weapon, the ability to extend this reach across a wide variety of commodities might seem attractive, particularly if it is with a partner that is highly agnostic as to its politics. While the chances of such an escalation are probably not great, Norilsk  recently was in negotiations to sign a long term supply deal with a Chinese buyer for both platinum and palladium (payable in renminbi). The ramifications of such long term deals are that significant supply is taken off the market permanently, which could cause some sleepless nights among non-asian purchasing managers. Putin sees the intrinsic value of Russia’s stuff, take the advice of Obama’s spokesman who recently suggested that investors not buy Russian Stocks, we concur and instead suggest that investors should be looking to buy what Russia has stockpiled.