Resource World Magazine

30 www.resourceworld.com F E B R U A R Y / M A R C H 2 0 1 5 s p e c u l a t i o n s L e o n a r d M e l m a n B eginning in summer 2014, prices within the petroleum sector began to shudder, decline modestly, and then enter a full-fledged collapse. As noted on the accompanying chart, the price of a crude oil contract has plunged from the area of $100 this past summer down to a mid-January low in the mid-$40 range. Similar declines have taken place in heating oil and gasoline – to the delight of retail consumers, but to the consternation of many others. It is worth noting that despite the huge declines which have already taken place, many forecasts from those within the petroleum industry itself, as well as major investment houses are continuing to fore- casting further declines. As examples, we note that major brokerage house Goldman Sachs issued an early January forecast which called for prices to fall to near $40 per barrel and that in order to rebalance supply with demand, "…prices would have to stay lower for longer." Bank of America Merrill Lynch predicted a price in the range of $35 per barrel while buyers for North Dakota oil suggested retail prices could fall to $25.00 per barrel. (Oil prices in US dollars) In terms of general economic impact, I believe there are sound arguments to be made on both sides of the economic equa- tion. On one side, many would argue that the ultimate impact would be positive, given the dramatic savings to consumers across a wide spectrum of petroleum-related products that will most likely be translated into additional purchasing power available to be spent within the general economy. Particular industries which could benefit substantially would include tourism, res- taurants, various companies that use a great deal of fuel and even real estate. On the other hand, the rapid petro- leum price declines are almost certain to result in several important negative con- sequences which could truly result in serious economic, social and even interna- tional difficulties. First, there is the direct impact to workers, communities and supporting industries within the petroleum produc- tion world itself. Thanks to the oil boom which resulted when the industry had the delightful combination of high prices and new discoveries in several prominent areas such as the Alberta Oil Sands and the Baaken Field of North Dakota, genuine boom towns began to emerge with Fort McMurray, Alberta and Williston, North Dakota being prime examples. Huge numbers of workers were required and salaries soared. Bars and restaurants filled to overflowing. Construction projects of all manners were undertaken. However, the momentum has begun to reverse itself. Drilling has fallen, production plans are being scrapped and jobs are now being lost, with all attendant community consequences. Next, these price declines are already resulting in turmoil within the hi-yield bond mar- ket. Many junior oil companies financed their projects by float- ing bonds in that generally high-risk sector. With crude prices north of $100 per barrel, windfall profits seemed almost certain. At $45 per barrel, few of the new projects might ever be profitable, making it unlikely that principal and interest pay- ments can be made on these bonds and that could mean a flood of defaults, leading to disruption in the world's debt markets. Perhaps even more importantly, petro- leum price declines of the nature we have witnessed threaten to disrupt government operations and finances around the world. Taxes of all sorts from income to sales to royalties could fall into sharp decline, leav- ing governments short of funds to finance social welfare and infrastructure commit- ments. Russia and Venezuela appear to be particularly vulnerable. A significant question to resolve is the ultimate impact of declining petroleum prices in terms of gold and silver. My thoughts are these: if the positive factors noted above dominate and on balance national economies benefit, world econo- mies will gradually move ahead into a period of modest growth combined with minimal price inflation and that would likely be negative for the precious metals. However, if the economic and political dislocations noted above occur – and they overwhelm any temporary benefits from lower consumer prices – then the world may become a more uncertain, difficult and even crisis-laden place. That should accrue to the precious metals' benefit and we are already seeing a strong indications that fears may be growing as gold and silver have been rallying strongly through- out the first part of January. I believe this story has a long way to go and may domi- nate financial news throughout 2015 and beyond. n This material is taken from sources believed to be reliable and is provided for information only. Any investment decision should be made only after prior consultation with investment professionals. Leonard Melman is a financial and political writer who focuses on issues relat- ing to the resource sector. Mr. Melman lives in Nanoose Bay, British Columbia, Canada and can be reached at lmelman@shaw.ca contemplating collapsing oil

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