The Danger Of Low Oil Prices For The Global Economy

Lambert here: I freely admit that I think of the energy markets at the super-micro level of the price for home heating oil, and along with the rest of the state of Maine, I’m convinced that the market is rigged. Much beyond that I can’t go, since I don’t drive, so I’d be very interested to know what readers think of this long, exhaustive, and interesting interview with John C. Edmunds, a Professor of Finance at Babson College. This remark from Edmunds caught my eye:

One of the reasons that the stock market is so negative on the outlook is that we…I’m a professor of finance so I say “we”…we don’t know what percentage of the capital assets in the world are tied to crude oil – exploration, production, transport, refining, and distribution. That might be 25 or 30 percent of the [total] capital assets in the world. It wouldn’t be as low as 10 percent.

So if somewhere between 10 and 30 percent of the fixed assets in the world are considerably less valuable than they used to be…I’m not saying they are worthless. I’m just saying that they are a lot less valuable than they used to be.

“I’m not saying they are worthless.” Good. Good to know. Be sure to read all the way to the end.

By Nick Cunningham, a Vermont-based writer on energy and environmental issues. Originally published at OilPrice.com.

Oilprice.com wanted to check in with Dr. John C. Edmunds, a Professor of Finance at Babson College, to get his thoughts on the OPEC deal, oil markets, and some developments in Latin America. He is an expert in international finance, capital markets, foreign exchange risk, and Latin American stock markets.

Dr. Edmunds holds a D.B.A. in International Business from Harvard Business School, an M.B.A. in Finance and Quantitative Methods with honors from Boston University, an M.A. in Economics from Northeastern University, and an A.B. in Economics cum laude from Harvard College. He has consulted with the Harvard Institute for International Development, the Rockefeller Foundation, Stanford Research Institute, and numerous private companies.

This interview has been edited for brevity and clarity.

Oilprice.com: I wanted to start off with the OPEC deal that was announced [on February 16], the production freeze. Notably, Iran declined to comment on whether or not they’d freeze production. So most people think that means they won’t, and that they will still pursue their pre-sanctions production levels. I was wondering what you thought of this deal and if it had any practical implications for the oil markets?

Dr. John Edmunds: Well, I would say that it has not come together yet. Pretty soon they are going to do something because there are countries that are really just flat out desperate. I wouldn’t mention Iran specifically, although, they have been years and years without full income. But the ones I’m aware of right now…Nigeria just announced that they couldn’t pay their school teachers.

Venezuela, that place is just flat out desperate. They have had nothing but oil for, well, since the 1920s. And they don’t even know how to grow food. So, if they can’t get the oil price up, they are going to need missions of mercy to come in and give them food while they figure out what to do in an era beyond oil.

My view is that crude oil is in a long downslide, in the short-term giving way to natural gas, and in the longer-run giving way to wind and solar and batteries and stuff like that. Alternative energy is coming on much faster than expected. And also most people think that alternative energy requires subsidies. No it doesn’t. It doesn’t. It is now cheaper.

So, we are in a really tough situation for oil producers. This meeting doesn’t make it worse but it doesn’t make it better.

OP: Do you see this as the extent to which they are going to go, or do you see this as sort of a stepping stone towards an actual production cut, maybe in June?

JE: Well they are going to try. I mean, each one of them will insist on a cut, and it will be like it used to be. What used to happen, if we go back a long time, Saudi Arabia would cut and everyone else would produce flat out and the Saudi cut was enough to make the price go back up.

If you go back to the 1930’s Brazil did that with coffee. Their position with coffee was so large that if they reduced their exports they could make the price go up and their smaller export quantity would then be worth more money. But coffee and crude oil have elasticity, that is, in the short run you can’t do much about it. In the case of oil, you can substitute over time, but in the short run your car is your car. You’re not going to get another car just because gasoline went up or down a little bit.

But, I would say I don’t really believe that it would be possible to put together a cartel. There are too many people that can do something around the edges or can violate and claim that they are not violating.

OP: So, you are saying that the influence of OPEC is kind of permanently weakening?

JE: Yeah. Well, they were losing market share after…pick a date…sometime in the 1970s when they were very strong. What is interesting about the world economy at the moment is that we are seeing the 1973 and 1979 moves, we are seeing those in reverse. When ’73 and ’79 occurred we had really deep recessions because everyone was just screwed.

Now, we are doing it the other way around. Oil is coming down and the benefit we can see with airlines, for example, and a few others. Some of the folks that use crude oil as a feedstock are doing better.

But as far as the stock market is concerned, we aren’t able to fixate on who is going to be better off. They are talking about who is going to be hurt.

OP: We have always been told that low oil prices have been good for the global economy. Why do you see low oil prices being a drag at this point? Is it just that they have gone down so far so fast?

JE: Yeah, if it had been a gradual decline…this happened too fast. My feeling is that crude oil is in a long-term downtrend but right now it’s below the trend line because of this oversupply problem. Just looking at the futures market right now…the backend is almost $12 higher. So, I’m looking at $31 for March 2016, and for March 2017 almost $42.

So, that’s the easiest way to figure out the situation with storage. The person you want to be right now is somebody who’s got an empty tank. Because what you can do is sell crude oil for future delivery and take your sweet time buying it because nobody else has a tank, and you can just call around say “I’ve got an empty tank. If you’ve got crude oil that you need to put in a tank, I’ve got one. What are you offering me?” Because if you pump the stuff out of the ground you have no place to put it. You can’t pump it back into the ground and you also can’t throw it into the river and you can’t throw it into the ocean. So the producers are really in a tough spot in terms of getting the oil into pipelines, getting the oil into storage, getting the oil into refineries.

The refineries, by the way, are not running at 100 percent. They can’t anyway, no factory can run at 100% forever, but they are not even running above 90 percent. And the reason is that the final demand is not there either. The final demand is growing slightly, but not enough to soak up the oversupply.

You’ve got a million and a half barrels and the question is, “where are you going to put that?” So, they’ve got these tankers that don’t have to go anywhere, very large crude carriers that just sit there. And those are full. And if you want to build one and you start today, it will be done in two years. So…

OP: So we’ve got a worsening storage problem. Cushing is 90 percent full. If storage is so full, at what point do producers need to shut in production?

JE: We should dissect the term “shut in.” In the case of crude oil, I would say, shutting down is happening in several ways. One is no new investment in drilling. Any offshore drilling ship that is coming off a charter won’t get another charter. It will have an anchor for a while waiting for the markets to come back. If the market doesn’t come back sooner or later they are going to scrap it.

One of the reasons that the stock market is so negative on the outlook is that we…I’m a professor of finance so I say “we”…we don’t know what percentage of the capital assets in the world are tied to crude oil – exploration, production, transport, refining, and distribution. That might be 25 or 30 percent of the [total] capital assets in the world. It wouldn’t be as low as 10 percent.

So if somewhere between 10 and 30 percent of the fixed assets in the world are considerably less valuable than they used to be…I’m not saying they are worthless. I’m just saying that they are a lot less valuable than they used to be. If you own an oil rig right now in Oklahoma or North Dakota, um, good luck man. I’m not sure you are going to find any work for that thing very quickly.

OP: So, you are saying that the sharp fall in the value of these assets helps explain the volatility in the broader financial markets.

JE: Yeah, yeah, because a lot of that was bought with borrowed money, and that’s where we get into the bond market and the bank situation. A lot of banks loaned money to people that used to be called “wildcatters.” And people supplying those sectors…let’s say you ran a fleet of trucks that took lunch around to the workers. And you borrowed money for the trucks. Well you can’t pay that loan.

OP: Do you see a ripple effect in the banking system? Are banks in trouble here?

JE: Yes, well, specific banks have bad loans in their portfolio, which doesn’t mean that they are in trouble. It means that their earnings will be much lower than they were supposed to be.

OP: I’ve read that energy debt is a small part of the banks’ portfolio. So, it’s not as if these banks will go belly up?

JE: No, they won’t fail. It wouldn’t be 2008. It’s not time to run down and pull your money out of your bank and put it under your mattress. The system is much more solid. But if you own stock in a bank, particularly in what are called the “super regionals,” some of them have too much stuff in their portfolios that’s linked to that.

Let’s go to Houston in the 1980s. Crude oil goes down and whole suburbs were emptied. After ’08, if you are a lending officer at a bank, you’ve got like 5 people looking over your shoulder. And you should! You could do a lot of damage!

So, the market is acting crazy because first of all they don’t know how far down this goes. They don’t know how long this stays low. They know that it has already stayed low long enough to do a lot of damage to a lot of people. It’s not a good day to be trading – not a good month – to be trading stocks, but it actually kind of makes sense that it’s shaking out.

OP: I want to get back to the banks and oil companies. There have been a lot of bankruptcies and defaults, a few dozen so far, and the credit redetermination period is coming up. I was wondering if you see lenders cutting credit to the oil patch and how that will affect the rate of bankruptcies and how that will affect the state of oversupply?

JE: I would say lenders would have to cut back because their method involves an engineering estimate of recoverable resources with the price. They’ve got a standard methodology. So that’s going to come out with a lower number.

So the base of lending is going to come down and some people are going to be over that. The bank is going to say, “Sorry your review came in lower. You need to give us $5 million and we need it pretty quick.” And then the borrower says: “Sorry I don’t have it.”

Meanwhile the [bank] auditors are going to say, “You gotta write that one down.” The auditor will err in the direction of caution. And that means they have to cancel their dividend or cut back on some salaries and executive perks. [The bank] would not fail. But what it means is that bank profits are going to be well below what they would have been…the decline [in oil prices] happened too fast.

OP: The banks will be hurt, but they will be OK. But from the oil patch perspective, we will probably see more bankruptcies, I’m assuming. What will that mean for the current state of production?

JE: Well, you’ll see more bankruptcies of third and second tier exploration and production companies and some junior integrated oils, but the big ones are going to be bulletproof because they are getting their money from the bond market.

The ratings agencies are also running scared. They got crucified after the financial crisis because they gave some ratings that they shouldn’t have given. So, you come in, you should have an “A,” they’re gonna give you a “BBB.” You should have a “BBB,” they are going to give you a “BB.” Well that’s “junk.” That means many buyers can’t buy that bond. Some portfolios have to sell it.

For the junk bond market, what I’m seeing, the people I talk to are telling me that it’s time to start picking over the trash. They are throwing it all out equally. Suppose you are running this ETF. And a retail investor sells the ETF. And you’re the portfolio manager. You’ve got to sell something because you have to reduce the size of the portfolio. Well, how do you do that? The only bond that you can sell is the one that’s not in the oil sector. Any bond in the oil sector, nobody will buy it or the bid will be so ridiculously low. So, it’s called “contagion.” You get bonds in one sector decline, which drags down bonds in the other sector that really shouldn’t have been dragged down.

But the feeling that somehow this would spread to other parts of the economy, I really don’t see that. I’m with you. This is hopeful. I don’t drive much but it costs me $17 to fill my tank instead of $30. A guy who drives something with a bigger engine and filling his tank twice a week and it used to cost $60 and it’s now costing, let’s say, half of that. He’s got extra money in his pocket. That’s supposed to come out. He’s supposed to take his family out to a restaurant or something. We are seeing it, but it’s not happening very fast. It’s like they don’t believe it themselves. Instead of using that money to spend they are using that money to build up some cash in the cookie jar or pay off the credit card or something. The public is being very cautious, and that hurts.

OP: I wanted to shift gears a little bit and talk about Venezuela. [On February 17] President Maduro decided to raise fuel prices for the first time in a long time, and alter the exchange rate. I saw a pretty eye-popping number: the state-owned oil company PDVSA only transferred $77 million in funds to the central bank, which is a tiny fraction of what it brought in a year ago, and less than it brought in two years ago. So it seems to be a pretty bad situation. I was wondering what your perspective is on what happens next in Venezuela?

JE: It’s going to get a lot worse. And I feel…I wish I didn’t have to say that because I have a lot of Venezuelan friends. I’ve spent a lot of time in Latin America. Venezuela, if you go back to the 1960s, was the richest country in Latin American on a per capita basis. And now, it’s pretty much the poorest, with the possible exceptions of Honduras and Haiti, and nobody is poorer than they are.

Maduro is trying to be the second coming of Chavez. He’s got all the same whacko ideas but without the charisma. He’s hurting and he has around him people that he’s selected for ideological reasons rather than for competence.

I don’t know what I’d do if they made me the actual dictator of the place. Everyone there [in the pre-Chavez era] was either in some sort of extremely rudimentary subsistence agriculture or they were somehow tied to the oil business. Or they were working in an import-substitution industry that isn’t economically viable but is surviving on tariff protection and stuff like that. They were basically a big oil well and a bunch of people sitting around regretting that most of the money was going to one neighborhood in Miami – half of it was Venezuelan millionaires who have hardly ever really been to Venezuela. It’s sad, but that’s why they got Chavez.

What will happen now…they don’t really have a consensus. Although the government lost the recent election and lost control of the Congress…they have a Congress but it’s pretty much powerless. So what Maduro is doing is sending ambassadors around to every other oil-producing country and saying “please guys, let’s get together and cut production.” I mean, what else is he supposed to do?

There is nothing that he can do that would help right now, except try to get a higher oil price. I don’t see how he’s going to do it. Everybody knows that if anybody cuts…that’s a schmuck.

There’s a whole bunch of players in this business: countries, individual producers, individual producing countries, governments, and all kinds of people who desperately need money right now.

OP: Venezuela has something like $10 billion in debt coming due this year. Do you see them defaulting?

JE: Well, what they will try to do is some sort of refinancing. They are going to squeeze bondholders. They are going to say “we’ll give a higher coupon at a later maturity date.” And a lot of people will take that because if you insist on getting pay now they are just going to default.

OP: OK, so shifting to Brazil. I saw that Shell this week completed the takeover of BG Group and Shell’s CEO was in Brazil extolling the potential of Brazil. I was curious what your take was Shell going big in Brazil on their offshore sector?

JE: I would say it makes sense from Shell’s point of view provided that their assessment is that in the long run oil would get back over, let’s pick a number, let’s say back over $80 or $100.

In the case of Brazil, it’s a democracy, it’s a complicated political situation. It’s a shithouse mess right now, but it will not be always. Also, you have a very large and diversified economy outside of the oil sector and outside of iron ore. They are still the number one producer in coffee, the number one producer of cacao. They are number one or number two in soy beans. They produce corn. They produce aircraft. They produce some high-tech stuff. They’ve got a lot of people there with PhDs. So it’s not this huge place with subsistence farmers and an oil well offshore.

I consider the pre-salt…the deposits of crude oil are offshore and under a huge overburden, sometimes as much as 25,000 feet. When you get it, it’s really sweet crude. But, so what? There’s plenty of crude closer to the surface. If oil had gone to $200 per barrel, the scandal with Petrobras would have never come out. The crude oil really is there. And so what? If it was on the moon it would be about as useful.

OP: Yeah. So, does it make sense, in this era right now, to try to bet the farm on the pre-salt?

JE: Well, also, [Brazil is] chaotic, but they are not going to shoot you. They are western…the language is not completely inaccessible. So, it’s a reasonable place because it’s big. Big in terms of the amount of crude they have. Big in terms of how many people you can sell it to right there. Big in terms of how many people you can hire.

OP: Shell’s CEO just said that he thought that the Brazilian government and Petrobras should sort of loosen the rules on the state-owned company being the operator on these fields. Politically, do you think that is likely or unlikely that such a thing would occur?

JE: I would say maybe not right now but probably pretty soon. And the reason is that Mexico did it. And in that case it is more obvious because one of the reasons for 1910 revolution was the strong position of the foreign railroad companies and oil companies…

They had a guy in 1937, Lazaro Cardenas, who nationalized the oil industry. And he’s a national hero. He’s like Abraham Lincoln or something. So, the idea that they would let foreigners into the oil business…

OP: So the last thing that I wanted to ask about was just the state of the global economy. Everything looks pretty volatile right now. I was wondering if you see a recession or what do you forecast for the next year or so?

JE: No, actually I don’t see a recession. What I see is further distortion in the direction of asset inflation because interest rates are going down. They asked Janet Yellen about negative interest rates in the U.S., which I didn’t really think we would have, and her answer – she’s very circumspect and she says exactly what she’s supposed to say – she didn’t close that door. So I take that to mean that we might get even lower interest rates in the dollar market, even lower interests in the euro market, and it can’t get much lower in Japan.

What that would mean is that you have asset price inflation in a lot of places that haven’t had it yet. But you could also have further skewing of the distribution of income. In other words, you get more and more people just concerned about eating three times a day, and more and more people picking out whether they want the $50,000 wrist watch or if they are going to go ahead and buy the leer jet. That’s bad, but it’s not a recession.

Everyone says that central banks are tapped out, that they have done everything that they can do. That’s not true. There’s a lot of stuff that they can do that’s within in their mandate.

What they are really saying is that it would be nice if we could have some fiscal policy but we are not going to get that so [laughs]…we are not going to get anything in Washington. I’ve been saying for quite a while that they couldn’t vote to leave a burning building [laughs].

Well, it’s an interesting situation and I decided that I’m going to enjoy it because otherwise I’d be crying.

OP: Well, Dr. Edmunds, thank you so much.

JE: It’s really good to talk and I’d love to talk so more. It’s a fascinating situation.

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About Lambert Strether

Lambert Strether has been blogging, managing online communities, and doing system administration 24/7 since 2003, in Drupal and WordPress. Besides political economy and the political scene, he blogs about rhetoric, software engineering, permaculture, history, literature, local politics, international travel, food, and fixing stuff around the house. The nom de plume “Lambert Strether” comes from Henry James’s The Ambassadors: “Live all you can. It’s a mistake not to.” You can follow him on Twitter at @lambertstrether. http://www.correntewire.com

31 comments

  1. abynormal

    First, Brazil can be number 1 in multiple resources but good luck while everything around it falls on top of them: Dec. 18, 2015: “Brazil’s construction sector will remain in recession in 2016 as the direct and indirect implications of Operation Lava Jato weigh on the industry. With contracting effectively halted and existing projects in a state of flux whilst the investigation is ongoing, construction activity has stalled. Indirectly, with the scandal having fed through to major economic weakness and political turmoil, consumer related construction is also slowing.

    Latest Updates And Structural Trends

    We are maintaining our forecasts for Brazil’s construction sector to remain in recession in 2016 following an estimated contraction of 7.6% y-o-y in 2015. Quarterly data supports our outlook, with -8.5% growth recorded in the first nine months of 2015. With worse to come in the broader economy and ongoing implications from the Lava Jato scandal directly impacting construction activity, we see no support for a recovery in 2016.

    Brazil’s residential and non-residential building segments will remain in recession in 2016. With projects still stalled at Petrobras, we see limited sign of improvement in industrial construction, while the weak economy, rising unemployment and high interest rates are all weighing on residential construction.” http://www.fastmr.com/prod/1109816_brazil_infrastructure_report.aspx

    Second, JE is another example of a yaking eCONomist laughing at the ever widening GapS…that don’t ever a have a ‘direct’ effect on their delusions: “you have asset price inflation in a lot of places that haven’t had it yet. But you could also have further skewing of the distribution of income. In other words, you get more and more people just concerned about eating three times a day, and more and more people picking out whether they want the $50,000 wrist watch or if they are going to go ahead and buy the leer jet. That’s bad, but it’s not a recession.”

    “The curious task of economics is to demonstrate to men how little they really know about what they imagine the can design.” ~~~Friedrich Hayek

    1. PWC, Raleigh

      Thank you for your comment. All of it was valuable, but the reminder about kool-aid-soaked academic economists is most valuable of all. It’s all shits and giggles at their dinner parties, but the truth is: Their bullshit has a body count, in terms of real live human beings being harmed and suffering wastefully.

  2. ambrit

    One subject not mentioned is the decline in good jobs connected with the ‘Oil Patch.’ I know several people who have had to struggle to get by after losing previously ‘good’ ‘middle class’ jobs in oil exploration and production. One was a Petroleum Geology man. Prior to the oil ‘dislocation,’ he had two houses and a solidly “Middle Class” existence. Now he’s trying to sell one house to get from under the mortgage, but not getting any offers that would free him from the original indebtedness. Imagine selling a house and still owing money on it. Now he is teaching his specialty at a middle of the pack university, making a third of his oil patch salary.
    In the ‘Oil Patch’ itself, along the Gulf Coast, the fall out from this round of layoffs is rippling out in all directions. My son in law, who designs and trouble shoots ship navigation systems, is now working mainly on systems for super yachts. Previously, he was working on systems for offshore crewboats and drilling rigs. Luckily for them, he says, the company he works for has a big backlog of private personal craft contracts. (Also, our daughter, as befits someone who grew up with semi poor hippie parents, has been stashing away some significant amounts of cash. They have a decent buffer, and they have not had to tap into it yet. [Fingers and toes crossed.])
    A bit further down the totem pole, I have seen several people who worked hard for mid level, and drilling deck level jobs settling for anything that comes along, now that they have been laid off. One man I sort of know snagged a job as supply chief for an offshore drilling rig in Brazil two years ago. He took a course in Portuguese to land this job, since he had to deal with local Brazilian suppliers. Now he’s a floor salesman at a local sporting goods store. “I got the pink slip just under a year into the job. I felt like jumping off the rig,” he told me.

    1. abynormal

      since you brought it up…”“If we agree that the education, employment and retirement continuum is no longer a linear “cradle to grave” construct, then several tools for managing this reality are increasingly proving redundant. Job descriptions used for hiring are one such example. Hiring managers often write these as a reflection of their own experiences, ignoring the fact that we are entering an era where the emphasis should be less on ready competence and more on transferable skills.” ~Gyan Nagpal

      1. ambrit

        “If we agree..” sums it up well. From where I stand, the ‘agreement’ suggested feels like an imposition from above. Humans think well in terms of ‘linear..constructs.’ Why else have societies? How else to manage and complete tasks?
        One primary reason for ‘job descriptions’ not mentioned in the quote you supply is that a primary task of hiring managers is the restriction of access to jobs. In the old days, signs saying “No —-s Need Apply” fulfilled that task. Now, the manipulation of prerequisites for the job on offer does the task in a more subtle manner. A second quibble is that before, someone actually involved with the job was pulled in to assist in the hiring process. Now, the HR is a separate and self contained position. Requirements become rote, actual competency becomes less predictable. Transferrable skills does not automatically translate into competency. Absent a company training program that does more than just test for indoctrination to corporate norms, much less an apprenticeship program, initial hire fails become guaranteed. Then, it becomes a percentage game.
        This last century, the work experience had implicitly promised a secure retirement. Now this ‘social contract’ has been torn up by Capital. That said, there is no longer a reason for Labour to honour their end of the ‘social contract.’
        There will be new Levellers and new Luddites. Maybe a new Civil War to go along with them too. (Civil Wars do not have to be armed conflicts.)

        1. jsn

          The real genius of the “American Dream” was that it dispersed the working class into vast, remote suburbs that are currently being ghetoized by lack of jobs. Once your nest egg is in the wilderness and you lose your job, it’s damn hard to get organized.

    2. Steve H.

      – One was a Petroleum Geology man.

      This hit me hard. One of my best friends died a couple of years ago. Over 50, had gone all-in on permaculture living, but it wore down after years, no one left there but him and a back injury from flipping over a wheelbarrow. He’d made his cash in the oilfields, so he went to grad school in geology, specializing in shale fields. But while he was there he was slicing ice core for paleoclimate studies, working on a beautiful campus, and he was doing well.

      He would’ve been getting his degree about now, with a fresh piece of paper and $60+k in debt. I graduated with an M.S. in Environmental Science just after Bill Clinton slashed the EPA budget by a third, and the market was flooded with seasoned professionals needing work. At least I got to work in a lab later, and help punch a toxic corporation in the teeth. He was taking the least worst option with cash as the sole payoff for a nasty decision. He would’ve been devastated.

      When I told this to my wife, she said, “Ever since the oil crash, I’ve been secretly thankful that Zayin died when he did. Died happy.”

      1. ambrit

        Your wife has the best view of his life. He died happy. Sorry he’s gone, but he obviously left friends to carry on. That’s a good thing. He did ice core analysis! Shows us just how far afield our interests can carry us.
        My Dad was originally a high pressure and temperature piping man. Worked at Huntsville in the early ’60s. He worked in the Caribbean and South America building sugar mills for AID. That’s where he told me he discovered that “The Ugly American” wasn’t just a book. He ended up a plumber. Life doesn’t just throw us curveballs. Oft times it also ties our hands behind our backs.
        Sorry for the mini rant.
        Felicitations to you all.

  3. Ddf

    One reason why lower oil prices have less of an impact than expected could be the high share of profits in GDP and the fact that since the crisis, profits have been used more to fund dividends and buy backs than to fund investments, as documented for instance by the Fed in IFDP 1150. In other words, the difference between the propensity to save of oil exporters and importers, the main reason why lower oil prices tend to increase global demand, may not be as large as it once was. In addition, the speed of the price decline is unprecedented, partly reflecting in my view the reduction of long positions in the futures markets and a likely “definancialization” of oil. So the full impact could take more time to play out: in the US for instance the data shows that the negative impact of lower oil prices on investment tends to happen faster than the positive impact on consumption. And in terms of the relationship between equity valuations and oil prices, correlation does not imply causation. Rather both oil and equity prices could be jointly driven by a common factor. In his most recent blog post Bernanke makes this point and identifies the common factor as expectations of global demand. I’d argue that it could be equally expectations of a weaker Fed put: when the Fed funds rate hit the zero limit, the Fed effectively switched to an operational target consisting of risk asset prices i.e. The Fed implemented policy by providing a floor to the market. But now that the Fed views spare capacity as disappearing and nflation as accelerating, the Fed is moving back to an interest rate operation target. No more or less of a put option and Mr. Market does not like it.

      1. Ddf

        Dividends and buy backs. Data backing this point is the fed FOF, available up to q3 2015. All explained in the Fed paper mentioned. Broader point here is that income going to labor tends to generate more demand than income going to profits. Because of labor market slack and low bargaining power of labor, the decline in oil prices could have supported profits more than wages and hence have less of an impact on aggregate demand than expected.

  4. tegnost

    “In addition, the speed of the price decline is unprecedented, partly reflecting in my view the reduction of long positions in the futures markets and a likely “definancialization” of oil”
    wondering what you mean by definacialization? The article stated that long buyers in futures are getting better return so i’m curious for more clarity on that.oops, reply to Ddf

    1. Ddf

      financialization: since the early 00s, relative to the physical quantity of oil produced, oil based derivatives have increased by a v large factor, difficult to quantify for lack of comprehensive data. In the early 00s futures prices were below spot so when futures contracts expired and future prices converged to spot, investors made a capital gain (positive roll yield). That and a small but negative correlation with the S&P saw institutional investors become structurally long, through derivative contracts. But in doing so they drove futures prices above spot and the roll yield became negative. So they moved to longer dated contracts with a smaller roll yield or to calendar spreads. That pulled up spot prices and gave rise to new supply, a build up of inventories and the excess supply we are in. Price action since 2014 seems to have led institutional investors to decrease their structural longs. There is no great way of measuring this, for instance before the crisis it seems a lot of oil derivatives were traded OTC rather than on futures exchanges so no data but if you look at the CFTC data on speculative net longs or longs you can see post crisis a relationship with spot prices. That’s what I meant by definancialization, a liquidation of long positions. Good overview in Black Gold and Fool’s Gold: speculation in the oil futures market by John Parsons

  5. Jay

    RE: “I don’t drive, so I’d be interested what readers think . . . ”

    I have the feeling that the rapid increase in gas prices during the 2000’s not only devastated the economy, but also permanently changed Americans’ relationships to their cars. They joined car pools to get to work, and eschewed Sunday drives or unplanned grocery trips. They switched to discount grocery stores and drastically reduced discretionary spending. And those were the people who didn’t go under. The rest don’t have a pot to piss in and never recovered. For the rest, as the interviewer said, “Instead of using that money to spend they are using that money to build up some cash in the cookie jar or pay off the credit card or something. The public is being very cautious, and that hurts.” Absolutely right. What’s the first bit of advice they give when a recession is looming: Get Out of Debt.

  6. Jim

    So I am not a contributing member of society per the 1% Romney’s quote) .. but for weeks now I have read how BAD low priced oil is … Obviously it is for the 1% … but nobody freaking cares about us down here on the bottom looking up to see whale dung.

    it would be so nice to get a perspective about the less fortunate live … not the egocentric greedy centric people that make money in the millions and billions … so you lost a bet … suffer like the rest of us, but get your crying baby face out of the press and eat it … I and a lot of people lost everything a lifetime of work accrued in 2007 AND a job. So I left americant and moved out of the country over there roars ago. By the way, I am not bitter, I’m happy now.

    Hope you rich oil centric selfish minded finally got a taste of how bad it hurts …. enjoy some same same.

  7. ChrisFromGeorgia

    If oil had gone to $200 per barrel, the scandal with Petrobras would have never come out.

    Note the synchronicity with the Madoff ponzi scheme, albeit delayed through the time-space continuum.

  8. Paul Tioxon

    For those of us that don’t care what happens to the oil industry, other than it dies as quickly as possible, save your time and read the money shot quote from the very first question.

    “Venezuela, that place is just flat out desperate. They have had nothing but oil for, well, since the 1920s. And they don’t even know how to grow food. So, if they can’t get the oil price up, they are going to need missions of mercy to come in and give them food while they figure out what to do in an era beyond oil.

    My view is that crude oil is in a long downslide, in the short-term giving way to natural gas, and in the longer-run giving way to wind and solar and batteries and stuff like that. Alternative energy is coming on much faster than expected. And also most people think that alternative energy requires subsidies. No it doesn’t. It doesn’t. It is now cheaper.”

    The solar revolution is a political and economic revolution and I urge all readers and policy makers to join the revolt. We have lived in the Age of the Auto and Oil Co-Hegemony and its over. Yes, a lot of capital assets are tied up with oil, including its biggest consumer, the auto industry. And yes, much of the economy and assets are tied up with our auto culture. Roads, parking lots, gas stations, tire and batteries stores, mechanic and body shops, towing and downtown parking buildings, (We have more housing for cars in every downtown city than we do housing for the people who wind up homeless). Jiffy Lube, car wash, Earl Sheib paint your car, Aamco rebuilds your transmission, inspections stickers from the state and auto licensing as well. The auto has been the largest make work project in human history and its going away. Then what? Fordism led to the great middle class and what will take it place? You better hope that one of the democrats with massive solar energy policies gets into office and keeps shutting down coal fired power plants and the hedge funds ramp up the mountains of capital necessary to build out solar panel factories and installation companies pronto.

    1. two beers

      one of the democrats with massive solar energy policies

      You assume that there’s more than one [d]emocrat with a massive solar energy policy. I’m curious where you got that idea?

      1. Paul Tioxon

        Do your own reading for yourself or stick your snide comments up your ass. I can’t tell if you are snide or just not very well read, your choice.

    2. thoughtful person

      Alternative energy is coming on much faster than expected. And also most people think that alternative energy requires subsidies. No it doesn’t. It doesn’t. It is now cheaper.”

      The point is subsidies are no longer needed for alternative energy to compete even with relatively low priced oil. A big part of the reason the Saudi’s have opened the floodgates is demand destruction. We’ve seen an increase in efficiency in a number of areas (8.5 watt LED [now $1.75 each at my local lowes] replaces a 13 watt CFL [now $2.50] which replaced a 60 watt equiv traditional incandescent bulb for one example). Between this and the fact that alternative (or renewable solar, wind etc) “is now cheaper” than oil means we are seeing a huge drop in oil demand – demand destruction.

      While for climate reasons it would be smart (January set another record hot month globally, beat 2015 which was also a record), to get off crude asap, we are seeing the fossil fuel industry acting like deer in the headlights, and opening the floodgates in a desperate attempt to drive down prices to where solar, wind etc will again be less competitive. The prices I’ve heard they need to get to are 19 to 25$ / barrel [Lovins at RMI is quoting these numbers]. So there’s a way to go. And solar wind etc are not going to get more costly as they scale up…so that oil price may need to come down further.

      The fossil fuel industry and all it’s massive investments will be in found in the scrap yards of the mid 2000’s (or sooner), just as the whaling fleets of the mid 1800’s were replaced by the petroleum industry by the late 1800’s.

      1. Paul Tioxon

        So true, the Saudi oil minister is more worried about peak demand. A lot oil is going to be left in the ground, not out of concern for the climate or its death dealing affects on us, but because no one will want to buy it anymore. That time is decades from now, but the sooner the better.

  9. Blink 180

    Lambert here: I freely admit that I think of the energy markets at the super-micro level of the price for home heating oil, and along with the rest of the state of Maine, I’m convinced that the market is rigged.

    Is it possible that the “oil glut” itself is a fraud, i.e. that Uncle Sam is surreptitiously causing the oil market to “back-up” by putting his boot down somewhere further down the supply chain, presumably in order to put the hurt on uppity oil-producing states like Venezuela and Russia?

    That would produce exactly the market conditions we’re seeing (retail prices staying high even while wholesale prices plummet.)

  10. Jim Haygood

    ‘There is nothing that he can do that would help right now, except try to get a higher oil price.’

    Cunningham totally ignores that Venezuela is still running an absurdly overvalued multiple exchange rate system, which (in conjunction with heavily subsidized food and fuel prices) has set up all kinds of destructive arbitrages that suck the shelves dry.

    He should head down to Caracas with a fistful of hundreds to perform some ‘research.’ Hola, bella!

  11. Russell Scott Day/Founder of Transcendia

    “Stop Grieving for Yourself, (you’re not even dead yet.)” Was my song with the new guitar like thing I made the other day.
    I wrote a poster the other day saying Wealth starts with Agriculture and ends with Agriculture.
    There would be jobs making Natural Gas from Hog Wastes in Not Conscious forever.
    Since the HR people want people like them with their University scroll on the wall, and debt for wage slavery status like they got, meritocracy is done. May as well be dead as far as they are concerned.
    The people in their 40s are the worst in that they were so perfectly propagandized. Bunch of blockheads about the drug war, which denies Americans where tobacco and cotton were king anything to grow but pigs and corn.
    You want transformational products and systems like the car. Nothing made from military investments appears to get into the markets in a very timely way. In this way the Military Industrial Complex, only serving its own and under little pressure to perform when like In-Q-Tel the CIA Front Venture Capital Company, they keep getting money from the government.
    Robots, like the Exoskeletons are way behind for civilian applications such as even the last stage of Sheetrock delivery, or brick laying or cutting up chickens. DARPA could give a damn.
    Lot of suburbs used to be farmland, and the faster they return to growing something, the better off people will be. If only to give the kids something to do since mowing lawns and delivering papers are now adult jobs.

  12. WatchingEthosInFreefall

    Oil production can’t ‘give way’ to alternative energies, because it requires oil to produce and distribute them. It is still the most portable and compact form of energy. As more alternative energy is produced, it will be consumed and demand will still increase for both more energy and the oil to produce more alternative energy, and so on. So in my estimation, this guy’s opinion is negligible if he doesn’t grasp this rather basic structural point.

  13. Lune

    These two statements are contradictory:
    “So if somewhere between 10 and 30 percent of the fixed assets in the world are considerably less valuable than they used to be…”

    “Yes, well, specific banks have bad loans in their portfolio, which doesn’t mean that they are in trouble. It means that their earnings will be much lower than they were supposed to be.”

    If 10-30 percent of global fixed assets are in the oil industry, and they are now considerably less valuable, then that is a *huuge* amount of bad debt that will need to be written down. By definition, that will lead to a banking failure.

    So either oil assets aren’t a huge part of global assets, or we will have a banking crisis. My money is on the latter.

    1. abynormal

      Top 10 holdings (as of Jan. 31, 2016)
      Name….Ticker Market….Value(in Millions)% of Investment
      Securities(1)
      Enbridge Energy Management, L.L.C. (equity) EEQ $ 7.2 4.2%
      TransCanada Pipelines Limited (fixed income) 6.3 3.7%
      CMS Energy Corp. (fixed income) 6.2 3.7%
      ONEOK, Inc. (equity) OKE 6.1 3.6%
      Source Gas LLC (fixed income) 6.0 3.5%
      Duquesne Light Holdings, Inc. (fixed income) 5.7 3.3%
      The Williams Companies, Inc. (equity) WMB 5.4 3.2%
      WEC Energy Group (fixed income) 5.2 3.1%
      Energy Transfer Partners, L.P. (equity) ETP 5.1 3.0%
      ONEOK, Inc. (fixed income) 4.7 2.8%
      Total $ 57.9 34.1%

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