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Slippery Slope for Oil

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Lower demand, lower prices, much lower free cash flows.

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According to the Wall Street Journal, "Gas use in Europe's largest economies fell as much as 16% this winter despite unusually cold conditions, according to IHS Global Insight."

It's hard to be bullish on commodities after reading these types of statistical datapoints, especially when you consider that Europe isn't the world's foremost producer of things(China is), and thus natural gas there primarily goes to heat homes. (Here, watch UNG, USO and DIG.) Of course, there's another side to this story. Gazprom will be cutting capital expenditures to cope with lower demand and lower gas prices (natural gas prices lag oil prices).

Gazprom, despite being government-controlled, isn't a unique case. Oil and gas companies are facing lower demand and sharply lower prices, and thus, much lower free cash flows are causing them to slash production and capital expenditures. Capital expenditures are easier to cut out of the 2. Those are the future revenues -- and thus, future problems -- which, at least from today's perch, pale in relevance to management.

Lowering production is a bit trickier for both oil and gas companies, as that impacts current revenues. Oil- and gas-rich nations like Russia, countries in the Middle East, and Venezuela, all face a similar problem: They stand on one leg -- petrochemicals -- and that leg is being undermined by a global decline.

However, their social obligations have ballooned during time of prosperity - cutting production lowers already-declining revenues, while social obligation costs don't decline.

What does this all mean? Lower demand for petrochemicals in the short run is becoming a certainty. Lower production in the short term isn't certain, though it's very possible (OPEC, to my surprise, did reduce production so far, but will it be able to maintain it?).

In the longer run, the supply of petrochemicals won't be robust; it will decline. It will take high oil and gas prices to cure that problem, as it always does.
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