“The zero-interest policy of the Federal Reserve should lend support to oil and gold”

Related to his new oil report for Erste Group Bank, Vienna based commodity analyst Ronald Stoeferle answered in this exclusive interview some questions with regards to supply and demand; the demise of the petrodollar; the repercussions of Quantative Easing for the oil price; and the so called “skyscraper index.”

By Lars Schall

Ronald Stoeferle, who is a Chartered Market Technician (CMT) and a Certified Financial Technician (CFTe), was born October 27, 1980 in Vienna. During his studies in business administration and finance at the Vienna University of Economics and the University of Illinois at Urbana-Champaign in the USA, he worked for Raiffeisen Zentralbank (RZB) in the field of Fixed Income / Credit Investments. After graduating, Stoeferle joined Vienna based Erste Group Bank (http://www.erstegroup.com), covering International Equities, especially Asia. In 2006 he began writing reports on gold. His five benchmark reports on gold such as “A Shiny Outlook” and “In Gold We Trust” drew international coverage on CNBC, Bloomberg, the Wall Street Journal and the Financial Times. Since 2009 he also writes reports on crude oil. The latest oil report by Stoeferle, titled „Nothing to Spare?“, was published today.


The study is covering the following highlights:

*       High liquidity, low interest rates, and QE should create a positive environment for oil
*       Does the skyscraper index signal a weaker oil price?
*       Excursus: Oil price development from the perspective of the Austrian School of Economics
*       Petrodollar exiting through the back door?
*       Break-even oil price (BEOP) suggests rising „floor“
*       Sharply rising oil consumption in the exporting countries could trigger shortages in the long run
*       US natural gas has a attractive risk/reward profile
*       „Clean fracking“ will make shale gas production more efficient, cleaner and cheaper
*       Neo-Malthusians vs. Cornucopians
*       Economic consequences of the high oil price
*       The aorta of the oil business – How likely is a blockade of the Strait of Hormuz?
*       Technical analysis: Sentiment does not (yet) signal any extreme form of optimism

Mr. Stoeferle, how do you see the stress ratio between the rather flat global oil supply and the rising demand?

Ronald Stoeferle: The oil market was dominated by turbulences last year, due largely to frictions on the supply side. 2011 indicated how sensitively the market reacted even to minor production downtimes. The reason is that the current supply and demand are very closely matched, and the former cannot be expanded at will. I believe that the supply side will remain in the focus of the market participants in the future.

On the demand-side, we are still seeing a development in two speeds: while the OECD countries are battling a marginally increasing to declining demand, actual growth is generated in the developing countries, first and foremost China and India. 70% of this growth is expected to be generated by China and India. Overall, Asia is seen to be responsible for 90% of the additional oil consumption around the globe. We cannot detect any reasons pointing to a dramatic breach of this trend. In general I would assume that the energy efficiency in developed Western countries will need to improve significantly to make room for the less sensitive demand growth of the developing countries.

You spend quite some time in your new report with questions related to currency issues. What does the oil-gold ratio tell you?

Ronald Stoeferle: I got some really interesting charts about this ratio in my report. It basically illustrates that the purchasing power of the Dollar has been gradually eroded since 1971. Whereas the oil price has been stable in terms of gold, the dollar has lost more than 98% of its purchasing power vis-à-vis oil. One ounce of gold currently buys 15 barrels of oil, which is slightly more than the long-term median of 14. From this perspective, gold is fairly valued relative to oil. But it seems the almost 25 years of outperformance of oil are drawing to an end and gold is gaining in relative strength.

Could you tell us a bit about the development of the volatility of the oil price since the decoupling of the dollar with gold in 1971?

Ronald Stoeferle: Sure. As you know I am an “Austrian Austrian”. In contrast to traditional economists, “Austrians” do not regard the rising demand for oil or other commodities as determining factor for rising prices. Rather, they view the ongoing increase in money supply, which in our partial reserve bank system entails an expansion of credit, as the crucial factor of rising prices.

For Austrians, one thing is certain: the more monetary units circulate, the lower their intrinsic value. As a result, the substantial increase in oil prices in the past year has come as no surprise, as for Austrians it is not so much the demand for a good such as oil that determines a price increase, but simply the fact that, especially since 1971, more and more paper and digital money has been circulating globally.

In my report I’m showing for example, that while the average inflation-adjusted oil price had been USD 6.1/barrel within the framework of the Bretton Woods agreement, it embarked on a rapid increase once gold had been discarded as monetary basis. Since the end of the gold standard the price of one barrel of oil has averaged USD 20.6 per barrel. The featured long-term chart highlights the substantially increased volatility since the end of the Bretton Woods agreement in 1971. Prior to that, prices had been stable for a relatively long period of time.

Does Quantative Easing has repercussions for the oil price?

Ronald Stoeferle: Absolutely. The currently high levels of liquidity, global monetary expansion, QE basically all around the world and the low interest rates (and thus low opportunity costs) should continue to provide a positive environment for investments in commodities. However, I think that the artificially created prosperity should not be confused with real, healthy growth. Therefore, the development of the oil price from here on out should also strongly hinge on whether and when the third Quantitative Easing programme will be implemented.

The extremely high correlation of equity markets and the oil price can hardly be explained by the traditional supply/demand patterns. In fact, the monetary policy seems to become the most important determinant. The fact that the Federal Reserve will now maintain its zero-interest policy until 2014 should lend support to the entire commodity sector, but particularly to oil and gold.

Do we see the demise of the petrodollar?

Ronald Stoeferle: Let me quote the great Jim Rickards:

When the dollar collapse comes, it will happen two ways – gradually then suddenly. That formula, famously used by Hemingway to describe how one goes bankrupt, is an apt description of critical state dynamics in complex systems. The gradual part is a snowflake disturbing a small patch of snow, while the sudden part is the avalanche. The snowflake is random yet the avalanche is inevitable. Both ideas are easy to grasp. What is difficult to grasp is the critical state of the system in which the random event occurs.”

That basically says it all! As already published in my previous Oil and Gold Reports, the US dollar hegemony has been subject to increasing bouts of criticism. China, Russia, and India, but also Japan, are the countries that have gradually been switching the settlement of their bilateral trade in their own currencies or in commodities in order to circumvent the US dollar. This is a clear sign of a paradigm shift, especially since more than two thirds of the US currency is held abroad. Since Barack Obama took office, the US government debt has increased by 50%.

Therefore the open criticism vis-à-vis US politics is becoming louder even as we speak1. And the fact that China wants to achieve full convertibility for the yuan in the long run is becoming clearer by the day. This would be a big step towards a new global leading currency. China is preparing for the post-USD era at full speed. The yuan should outrank the US dollar in terms of global relevance within but a few years. The plans are more than just ambitious, but China has a track record of showing that it is possible to achieve ambitious goals if the political will is there. At the moment only 0.4% of all foreign exchange transactions are settled in Chinese currency. The US dollar has recently accounted for 43% of total transaction, the euro for close to 20%, and the Japanese yen for 10%. This means that the yuan is clearly underrepresented in view of the already central relevance of China for the world’s economy.

Currently, numerous smaller agreements are being signed that reveal the overall long-term strategy. I assume that this is how China wants to gradually boost demand without achieving outright convertibility right away. Within the framework of the new five-year plan, China wants to settle almost 50% of foreign trade in yuan by 2016. It wants to invoice in yuan in the bilateral trade transactions with African or Latin American countries that are rich in resources. Iran for example is said to supply oil for yuan. In addition, the PBoC has allowed almost 70,000 companies to invoice its foreign business worth almost USD 70bn in yuan.

Numerous further examples indicate the fact that the dollar scepticism is growing:

  • India wants to pay in gold for Iranian oil2. And, according to reports in the media, China may soon follow suit. The two countries together account for almost 40% of Iranian oil exports and are at the same time by far the biggest consumers of gold.
  • In October, China reported that it had signed a free trade agreement with the ASEAN3 members, in the framework of which transactions would be settled in yuan. China also announced that a central bank for the entire ASEAN region would be set up and the yuan should be the reserve currency. In addition to the ASEAN countries, Japan and South Korea would also be invited to participate in the central bank. Since the bilateral free trade agreement ratified in 2010, trade between China and the ASEAN members has increased substantially. The ASEAN group has meanwhile become the third most important trading partner for China, after US and the EU. By 2015 ASEAN wants to create a common market for its 600mn citizens.
  • At the beginning of January, Iran and Russia agreed not to trade in US dollar anymore, but instead to resort to rouble and rial.

  • India and Japan signed a currency swap agreement worth USD 15bn in order to facilitate bilateral trade.

  • In July 2011, China and Iran agreed on a barter set-up for Iranian oil and Chinese goods4.
  • Japan and China, too, want to circumvent the US dollar even farther5. In December Prime Minister Wen Jiabao and the Japanese Prime Minister Noda agreed to promote trade in yuan and yen. China has become Japan’s most important trading partner (USD 340bn per year). Both countries hold the highest volumes of US Treasuries, which is why the symbolic meaning of this agreement cannot be over-emphasized.

You think that a closing of the Strait of Hormuz is rather unlikely. How do you came to that conclusion?

Ronald Stoeferle: You always have to ask “Cui bono?” I think that Iran would score an own goal with a blockade. The fact that all important tanker terminals are located on the side of the Persian Gulf means that a blockade of the strait would affect the Iranian oil exports just as much. Iran is hugely dependent on the oil sector. The sale of oil accounts for more than 60% of tax revenue and 80% of export revenue. Due to the lack in refinery capacity Iran also has to import the majority of its petrol and heating oil.

However, a blockade would come with dramatic short-term consequences. China would be particularly hard hit. More than 40% of the Chinese oil imports pass through the Strait of Hormuz. This means that Iranian oil is more important to China than Saudi Arabian oil is to the US. I do not think that Iranians want to upset one of their most important trader partners.

Moreover, when comparing the military capacities, we do not believe that Iran is able to block the strait for an extensive period of time. According to the Economist Intelligence Unit, Iran may have a large (about 520,000 soldiers), but outdated army. The military budget amounts to about USD 13bn (by comparison, the US defence budget is USD 554bn)6. The strait does not favour large war ships by definition, in the New York Times a US military official has called a military confrontation in that region a “knife fight in a telephone booth”.

By comparison, the US clout is enormous. The Fifth Fleet is based in Bahrain and usually comes with 1-2 aircraft carriers, 6 cruisers, and 7 destroyers. Capacities are being expanded as we speak. In addition, the UK has dispatched the HMS Daring, one of the world’s most modern anti-air warfare destroyers. The Iranian air force would probably have a hard time trying to defend itself in this uphill battle.

Why should people pay attention to peak oil – and what is said in your report about this topic?

Ronald Stoeferle: I am writing in detail about the different views of “Cornucopians” and “Neo-Malthusians”. Julian Simon is one of the most famous representatives of the “Cornucopians” and has severely criticised the classical Malthusian scenarios. According to (Neo-) Malthusians, a global collapse is unavoidable due to the limited nature of our natural resources, if the prevalent growth trends of the world population and the global economy cannot be broken by (political) intervention7. Malthusians hold that population growth leads to the over-consumption of commodities and ends up in a collapse.

According to “Simon’s Axiom”, however, the quality of life and life expectancy have increased dramatically in the past decades not in spite of, but because of population growth (average life expectancy has tripled since the Industrial Revolution). Temporary problems, the axiom claims, create a threatening level of pressure, which is released through creative innovations that spawn improved solutions.

Simon points out that, as a result of a short-term shortage in a resource, new and improved resources have been discovered in the long run. He uses the shortage of firewood in the 16th century, of coal in the 19th century, and of oil nowadays as examples. All these crises triggered the discovery of new technologies, which in turn spawned new energy carriers8.

The value of resources is de facto always contingent upon human inventiveness. For example, the oil under the Arabic peninsula was useless for the ancient Egyptians since they did not have the technology to make use of it. It was only after the combustion engine had been invented that oil turned into a precious resource.

According to the hypothesis, rising commodity prices lead to an intensified quest for substitutes, which results in a price decline, causing reserves to remain constant in terms of time until depletion. The crude oil constant currently supports this notion. We have been at 35 to 40 years worth of statistical oil reserves for decades. This is on the one hand due to the newly discovered reserves in the form of oil (off-shore, oil sands, and shale oil), on the other hand the market mechanism induces lower consumption , due to higher prices among industrialised countries.

According to Simon, the “fossil window” will remain open as long as new technologies will be able to cover the energy needs. As an example, one chart in my report illustrates the vast availability of oil sands. The same holds true for shale oil, shale gas etc.

But, as already pointed out in the two previous special reports, I believe that we may either soon see peak oil for conventional crude or that we have indeed already seen it. Without a doubt peak oil is more than just fearmongering. The production profile of certain fields, regions, and countries has the same structure all over again, i.e. that of a bell curve. According to Robert Hirsch more than 64 countries have reached their maximum production level on a sustainable basis (i.e. peak oil). IEA reported in its Energy Outlook 2010 that peak oil had been reached for conventional oil in 2006. According to an article by Professors King and Murray9 in the renowned Nature Magazine peak oil in this category had been reached in 2005. This would explain the volatile price action – a substitute for demand.

Therefore I still believe that, much like Julian Simon forecasted, high oil prices cause shifts in efficiency and technology. Or as Mark Twain said, “The reports of my death are greatly exaggerated“. Therefore, I assume that (as highlighted in the chapter on the skyscraper-index) an extrapolation to infinitely high oil and gas prices may end in a (c)rude awakening.

Which kind of consequences does a high oil price have for the business activity? Is there a price limit from which on it is rather likely to slide into a recession?

Ronald Stoeferle: I think that the oil price will be rising or remain high until the economy “feels the pain”. In the US, the average petrol price increased to a new all-time-high in January. The high petrol price acts like an additional tax for US consumers. An increase of 10 cents per gallon equals an additional burden of USD 14bn per year for US households. Therefore we expect the high petrol prices in the US to affect the economy in due course. In Europe, too, the increase in the oil price could soon manifest on the national accounts, with the Brent price recently setting a new all-time-high in euro.

Are oil price subsidies a problem? And which develoment does the domestic consumption within OPEC countries take?

Ronald Stoeferle: Definitely, this is a longterm problem. In 2010, global governments spent USD 409bn in order to subsidise fossil energy carriers. OECD countries accounted only for a tenth of that volume. In most repressive regimes, generous subsidies on fuel and food are a favourite way of securing the support of the people. In Saudi Arabia, 1 litre of petrol currently costs about 13 cents, which of course leads to wasteful consumption and high demand.

Worryingly, the share of domestic consumption in total Saudi Arabian production has been on a continuous rise. At the moment, some 29% of Saudi Arabian production is consumed domestically. At the beginning of the 1990s, that percentage was 13%. If the development were to continue at the same speed, less than 50% of Saudi Arabian oil production would be available for exports ten years from now. This would on the one hand cause the budget to blow up, on the other hand Saudi Arabia is the only significant swing producer and thus essential to global oil supply. In the absence of any major discoveries or massive capacity expansions, the rising domestic consumption in Saudi Arabia could cause shortages in the long run.

The long-term effects of the subsidies are devastating. The high preference for the present over the future displayed by the regimes causes a lack of long-term investment in refineries, new oilfields, and infrastructure. In addition, the recipients of subsidies tend to expand consumption and thus cause the dilemma to deteriorate.

Is the spare capacity as high as assumed?

Ronald Stoeferle: I don’t think so. According to data provided by EIA, the oil spare capacity of OPEC amounted to 2.6mn barrels/day in 2011 to 2011. Last year, Saudi Arabia had to step up its production in order to offset the lost volume in Lybia. Saudi Arabia is credited as holding 75% of total reserve capacity – a good reason to look at the production development in the Kingdom in more detail.

The assumption regarding the OPEC reserve capacity is based on the fact that Saudi Arabia can expand its production at short notice to 12mn barrels per day. However, data shows that the country has never exceeded 10mn barrels/day on a sustainable basis. In 2011 average production was at 9.6mn barrels/day. In order to make up for the Libyan downtimes representatives of the Arabic country had promised to increase production to above 10mn barrels/day. However, the data at hand for 2011 reveal that production peaked at 9.94mn barrels/day in August 2011 (according to EIA). This means there is no proof that Saudi Arabia can actually step up its production, which puts a question mark behind the actual existence of the reserve capacity. OPEC stands by it and wants to double reserve capacity by 2015; to this end, the organisation wants to invest USD 300bn. I fear that we will only find out in an actual emergency whether the spare capacity exists at the estimated volume.

In your report you have a „skyscaper index.“ What is this? And does it signal a drop of the price?

Ronald Stoeferle: Let me explain the concept. The “skyscraper index” is a reliable warning signal of the end of an economic cycle. Even if the indicator, created by Andrew Lawrence and developed further by Mark Thornton, looks like a contrived correlation at first glance, it turns out to be a close reflection of the boom & bust cycle. The construction of the highest building does of course not cause an economic slump, but it illustrates the economic connection between construction booms and financial crises. The skyscraper megalomania is thus tangible proof of the astuteness of the theory of economic cycles as put forth by the Austrian School of Economics.

The construction of the highest building in the world symbolises inefficient resource allocation and an irrational assessment of the future. The dire situation starts with (too) low interest rates, the expansion of the money supply, and excessive speculation. This results in an extrapolated sense of euphoria, economic arrogance, and megalomania as well as a “this time it’s different” mentality at the end of the cycle, each of which is supposed to justify the enormous investment outlays required for the construction of the highest building in the world. Due to the long planning and construction period of such projects, the skyscraper is only completed once the boom has yielded to the bust phase. These flawed entrepreneurial decisions and misallocations are mercilessly uncovered in this phase. According to the Austrians, the bursting of the bubble and the recession are the unavoidable consequence of these bad investments.

A substantial part of the skyscrapers currently under construction is located in China and India. According to Barclays10, the construction boom in India and China anticipates a significant slowdown in the economic expansion of the emerging countries. India is currently only home to 2 of the 276 skyscrapers that are higher than 240 metres. However, 14 more skyscrapers are scheduled for completion within the next five years, among those the “Tower of India”, the second-largest building in the world. In China, more than 50% of the 124 skyscrapers that are currently under construction will be completed within the next six years. According to Barclays China could therefore be faced with an economic collapse, should the skyscraper index hold again.

The world’s highest skyscraper is currently in the planning stage in Azerbaijan. The “Azerbaijan Tower” will be 1,050 metres high and thus overtop the Burj Khalifa by 222 metres. The skyscraper will be built on one of 41 artificial islands in the Caspian Sea. Azerbaijan wants to become the “Dubai on the Caspian Sea”. Construction is to commence in 2013, and the tower is scheduled for completion in 2019. Total costs have been calculated to amount to USD 100bn.

I am highly sceptical about such megalomaniac projects. If skyscrapers are built because of the high demand for space and high property prices, they can be very profitable over their useful life. However, if the project is just a symbol of the “greatness and pride of a nation”, alarm bells should be ringing. The extrapolation of eternally high oil and gas prices may end in tears. Given that the oil and gas sector accounts for more than 50% of the country’s GDP, one could interpret this situation as long-term warning signal for the oil price.

Thank you very much for taking your time, Mr. Stoeferle!


1Please refer to our Special Report Gold 2011, “China on the way to a global currency?”, Erste Group, July 2011

2“India to pay gold instead of dollars for Iranian oil”, Debka

3Member states: Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, VietNam

4“Iran, Russia, Replace Dollar with Rial, Ruble in Trade, Fars say”, Bloomberg

5“China, Japan to Back Direct Trade of Currencies”, Bloomberg

6Economist Intelligence Unit, Iran risk: Alert – Dire Straits

7Please refer to “From Malthus to the greenhouse effect – Agriculture and the world food supply as a prediction problem”, Markus F. Hofreither

8Please refer to “Alles wird gut, Julian Simon und die Pessimisten“, (“Everything will be ok, Julian Simon and the pessimists”), NZZ Folio 1995

9The Oil Age, “Nature Magazine: peak oil production reached in 2000”

10Barclays Capital, Skyscaper Index,”Bubble building“, 10 January 2012


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