Inflation will be further stoked by growing oil supply crunch

    TORONTO, Jan. 23 /CNW/ - CIBC (CM: TSX; NYSE) - To pay for its
multi-trillion dollar bailout and stimulus packages, the Obama administration
will print money at an unprecedented rate, a course that will drive up
inflation and drive down the greenback while shifting a large part of the
financial burden onto foreign investors, finds a new report from CIBC World
Markets.
    The report predicts that like Argentina in the late 1980s and Zimbabwe
today, the U.S. government will simply create more money to fund its plans.
"If the central bank prints it, someone will spend it," says Jeff Rubin, chief
economist and chief strategist at CIBC World Markets. "Already U.S. money
supply is growing at a nearly 20 per cent rate in the last three months and
the printing presses are just warming up. And there's no shortage of more
troubled assets to monetize along with $1.5 trillion-plus federal deficits to
keep money supply growth chugging along in the future.
    "As it buys up spread product, the Fed will leave Treasuries to be mopped
up by foreigners. Since outsiders, like the People's Bank of China, now own
over 50 per cent of America's debt, there has never been a better time to
reflate. Why default on your taxpayers when you can default on someone else's?
A 10-year Treasury bond will, of course, mature at par, but who's to say the
greenback won't sink 40 per cent against the Yuan over its term like it did
against the Yen between 1971 and 1981?"
    Mr. Rubin notes that while the prospect of reflation may seem incredulous
on the cusp of negative U.S. CPI numbers, past deficits that were a mere
fraction of what they are today in relation to the size of the American
economy, were readily monetized. And without fail, that monetization led to an
explosive bout of subsequent inflation.
    "The huge World War II deficits saw inflation peak at almost 20 per cent
in 1947," adds Mr. Rubin. "When the printing presses were turned up to pay for
the Korean War, inflation moved from negative territory to over nine per cent
within the space of nine months in the early 1950s. And when Arthur Burns
greased the Fed's presses after the Vietnam War, inflation soon made a
triumphant return back to double-digit territory.
    "Headline U.S. CPI inflation will grab a negative handle in the next few
months but it will be running north of four per cent in less than a year."
    Adding to these inflationary forces in the next year will be increased
pressure on oil prices. While global demand is expected to be down about one
per cent in 2009, oil supply is also declining. The plunge in oil prices
caused by the recession has put the brakes on a number of new supply projects
that were expected to address the depletion loss of nearly four million
barrels a day this year alone.
    "The IEA (International Energy Agency) recently estimated that the
industry will have to spend well over half a trillion dollars annually to meet
future demand and counter depletion," says Mr. Rubin. "No one is going to
finance those money-losing mega-investments at oil prices anywhere near $40
per barrel. If yesterday's record high prices haven't spurred supply growth,
what chances do oil prices a third or a quarter of those record levels have?"
    A year ago, Mr. Rubin estimated that production would grow from about 86
million barrels per day in 2008 to around 88 million by decade's end, based on
data for 200 pending new projects. However, recent announcements of project
cancellations and postponements not only cancel out the expected two million
barrel per day increase in global production by 2010, but they are likely to
actually drive production down a million barrels per day below last year's
levels.
    In Canada, a region the IEA expects will be the single largest source of
new crude supply, almost three times as important as Saudi Arabia over the
next 20 years, cancellations or delays in recent months have already affected
about one million barrels per day of planned oil sands capacity. Now, rather
than grow by close to 400,000 barrels per day by 2010, total Canadian
production is likely to rise by only a third of that.
    "That's only the tip of the iceberg since the vast majority of
cancellations have been on projects whose first flow dates are well after
2010," adds Mr. Rubin. "If oil prices were to stay at current levels,
production, instead of plateauing around 88 million barrels per day by 2012 as
we had previously forecast, would decline at an accelerating pace between now
and 2015. By 2015, production would decline to around 76 million barrels per
day, a level of roughly 10 per cent lower than last year's level. Unlike past
oil shocks, there is no longer any newly discovered $10 per barrel North Sea
oil to meet a rebound in demand."
    He notes that higher prices will ultimately change that supply outlook by
reversing some of the cancellations announced in the wake of oil's price
plunge. Global demand snapped back at around a three per cent pace after the
two declines in oil consumption seen in the early 1980s. Even a 2-2 1/2 per
cent bounce back would leave the world facing even tighter supply conditions
than it did in 2007 when oil prices moved from $60 to $100 per barrel.
    "Back then, demand was about 1.5 million barrels per day more than
supply. This imbalance, not only led to a very rapid inventory drawdown, but
also attracted speculative activity in oil markets. By our estimates, we
expect to see an even larger imbalance, almost two million barrels per day,
between recovering demand and shrinking supply as early as 2010.
    "When that happens, global oil inventories will plunge, and global oil
prices will once again spike. That may well reverse some of the supply
destruction that is currently taking place, but not before world oil prices
print triple-digit levels again."

    The complete CIBC World Markets report is available at:
    http://research.cibcwm.com/economic_public/download/sjan09.pdf

    CIBC World Markets is the corporate and investment banking arm of CIBC.
To deliver on its mandate as a premier client-focused and Canadian-based
investment bank, World Markets provides a wide range of credit, capital
markets, investment banking, merchant banking and research products and
services to government, institutional, corporate and retail clients in Canada
and in key markets around the world.