FRACTIONAL FLOW

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The Price of Oil

Crude oil is the world’s biggest and most important traded commodity.

Figure 1: The chart shows the oil price (Brent) with some policies/decisions/events. The monetary and fiscal policies of the world’s largest economies, China [red text boxes] and the US [yellow text boxes] and supply events/policies [grey text boxes]. The red line shows the annual moving average of the oil price.

In some earlier articles, like this and this, I explored for relations between the oil price, the world’s credit creation and interest rates.

This is a continuation of my exploration of how the world’s credit creation affects the structural level of the oil price.

I found it now right to repeat one of my formulations from back in 2015:

  • Any forecasts of oil (and gas) demand/supplies and oil price trajectories are NOT very helpful if they do not incorporate forecasts for changes to total world credit/debt, interest rates and developments to consumers’/societies’ affordability.

As time passes more is learned and more data becomes available which in theory should help improve both the understandings and the sights.

This article presents results from applying statistical analysis (with data spanning more than 15 years) for any relations from developments in total credit/debt from the non financial sectors in 43 countries (in 2017 representing more than 90% of the worlds’s GDP) with data from the Bank for International Settlements (BIS) to changes in the oil price, refer also “Some assumptions, terms and acronyms used in the article” at the bottom.

Developments in total credit/debt is very much related to developments in interest rates, primarily the US Federal Reserve Bank’s (FRB) funds rate (as the US dollar is the world’s dominant reserve currency) which now is expected to be set higher, the London Inter Bank Offered Rate (LIBOR) and the US Treasuries 10 Years rate. A keen eye should also be kept on developments on the now flattening yield curve and exchange rate fluctuations.

It is also important to make good assessments about the abilities to the various balance sheets to take on and service more debt. This helps monitor developments in consumers’ affordability which forms the demand side of the equation.

  • The structural oil price is formulated from the interactions of fiscal and monetary policies and supply events/policies.
  • The oil price has shown and will continue to show wide fluctuations. It is the monetary and fiscal policies that give the dominant structural support for demand and thus the oil price (defines the price movements).
  • Suppliers have little control on demand, but could resort to supply policies to support a price floor.
    The price collapse in 2014 was a result of strong growth in supplies, primarily led by debt fueled US Light Tight Oil (LTO) extraction.
  • The strengthening of the US$ (oil is priced in US$) has now resulted in very high oil prices in local currencies, refer also table 1.
  • Broadly speaking, it now appears that the world’s non financial sector needs to add $8 – $10 Trillion annually in credit/debt to support growth in the oil price, refer also figure 8.
    Estimates based on data from the Institute of International Finance (IIF) and BIS show that in Q1 2018 the world’s total non financial debt was $188 Trillion with another $61 Trillion in the financial corporations, totaling $249 Trillion.
  • Since 2000 there has been 3 distinct credit/debt cycles for the 43 (refer also figure 7 and 8).
    The first ended in mid 2008 with the Global Financial Crisis (GFC) (duration about 7 years).
    The second ended with the collapse in the oil price in mid 2014 (duration about 5 years).
    The third started about mid 2015 and, as of writing, could be entering its fourth year.
  • The analysis found strongest correlation (above 0,72) between changes to the 43s total private and public credit/debt creation and changes in the oil price at a time lag of 3 months, refer also figure 10.
    • Why this matters? If the world’s credit/debt growth supports the oil price, a slowdown or reversal of the world’s credit/debt creation (deleveraging) should be expected to affect the oil (and energy) prices negatively.
      The results of the statistical analysis show there is an expected time lag of about 3 months from major changes in the world’s credit creation (leading indicator) to changes in the oil price. The correlations were strong with a time lag of 0 – 6 months from changes in the credit creation to changes in the oil price.
      The supply surplus starting in 2014, which collapsed the oil price, appears to be the driver for a period with lower credit creation, which suggest that the lowered oil price temporarily lowered the world’s demand for credit.
  • Changes in credit creation are the strong leading driver of changes in the oil price.
  • A simple illustration of the perspectives of the relations of the oil price, interest rate and total debt is now to look at how much the oil price has to grow to have similar effects on the world economy as an increase in the interest rate of 0,25% on the worlds’ total debt of about $250 Trillion, which continues to grow.
    An increase of the interest rate of 0,25 % adds $625 Billion to the world’s annual debt service costs. The world now consumes about 30 Gbo/a (crude oil and condensate) which means that an increase in the oil price of $20/bo has about similar effects on the world economy as an interest rate hike of 0,25%. Some major central banks, led by FRB, now plan for more interest hikes and Quantitative Tightening (QT) in the near future.
  • The above serves as a powerful illustration of the growing competition for how the consumers’ available funds will be prioritized between servicing growing debts or supporting a higher oil price.
    Historically, precedence was given to debt service and consumers reduced other (including oil) consumption.

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Written by Rune Likvern

Tuesday, 21 August, 2018 at 14:34

Developments in Energy Consumption and Private and Public Debt per 2016

For some time I have explored the relations in developments for total debt [private and public], interest rates, Gross Domestic Product (GDP) energy consumption and thus also the oil price.

My theory has been that there are relations between changes to total debt and energy consumption and thus energy prices. Changes to total credit/debt should thus be reflected in energy consumption. Price formation is also influenced by several other factors and most prominently supply and demand balances.

To me, demand appears to be the one that is poorly understood and demand has been, is and will continue to be what one can pay for.

All transactions involving products and services require some amount of energy thus currency/money becomes a claim on energy.

During the last decades the world was in a gigantic experiment with debt expansion, most recently fueled by low interest policies which allowed to pull demand forward and for some time negate higher prices when demand ran ahead of supplies.

Debt expansions can go on until they cannot, as some economies already have experienced. In the recent decades, growth in total debt was higher than the growth in GDP (ref figure 1) and there is a strong relation between changes to total debt and GDP.

Figure 1: The chart above shows [stacked areas] developments in total private and public debt in Japan (black/grey), Euro area (yellow), US (blue) and China (red).
In the chart is also shown [stacked lines] developments on the Gross Domestic Product (GDP) for the same 4 economies.
NOTE: All data are market value, US$.
The GDP (lines) have been stacked. The bottom line shows Japan, next is (Euro area + Japan) and the top line [China] also shows the total for the 4 presented economies.
Data on private and public debt from Bank for International Settlements (BIS).
Data on GDP from the World Bank [WB]. WB GDP data for 2016 were not publicly available as this was posted.
Note that total GDP for these 4 economies declined from 2014 to 2015.

In this post I also present a closer look at developments in energy consumption and total debts [private and public] for China, Italy, Japan, Spain, United Kingdom and USA.

As of 2016 these 6 countries had about 47% of the total global energy consumption and 42% of the total global petroleum consumption.

As the private sector debt growth slowed/reversed the public sector took over and it appears that public debt growth is not as potent to stimulate growth in energy consumption [and possibly GDP], but sustains or slows the decline in total energy consumption.

Part of the explanation for this may be that much  of the increased public deficit spending is directed towards social programs (more unemployment benefits etc.) which at best may sustain demand.

The 6 countries are presented in the sequence of how I perceive how far they are into the debt deleveraging cycle.

There are other forces at play here as well, as oil companies entered into a bet that high oil prices would be sustained by consumers continuing to have access to credit/debt, which would allow the oil companies in an orderly manner to retire their steep growth in debts required to develop the costlier oil. The debt fuelled growth in investments gradually created a situation where supplies ran ahead of demand, thus collapsing the oil price in 2014.

To me the sequence of events is:

Changes in credit/debt => Changes in energy consumption => Changes in GDP

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Will growing Costs of new Oil Supplies knock against declining Consumers’ Affordability?

In this post I present developments in world crude oil (including condensates) supplies since January 2007 and per June 2016. Further a closer look at petroleum demand (consumption and stock changes) developments in the Organization for Economic Cooperation and Development (OECD) for the same period and what this implies about demand developments in non OECD.

The data used for this analysis comes from the Energy Information Administration (EIA) Monthly Energy Review.

  • The OECD has about half of total global petroleum consumption.
  • Since December 2015 OECD total annualized petroleum consumption has grown about 0.2 Mb/d [0.5%].
    [Primarily led by growth in US gasoline and kerosene consumption, ref also figure 6.]
  • The OECD petroleum stock building was about 0.4 Mb/d during Jan-16 – Jun-16, which is a decline of about 0.6 Mb/d from the same period in 2015. This implies a 2016YTD net decline in total OECD demand of 0.4 Mb/d.
  • World crude oil supplies, according to EIA data, have declined 1.3 Mb/d from December-15 to June-16, ref figures 1 and 2.
  • The above implies that non OECD crude oil consumption/demand has declined about 1 Mb/d since December 2015.
    This while the oil price [Brent Spot] averaged about $40/b.

This may now have (mainly) 2 explanations;

  1. The present EIA data for crude oil for the recent months under reports actual world crude oil supply, thus the supply data for 2016 should be expected to be subject to upward revisions in the future.
  2. Consumption/demand in some non OECD regions/countries are in decline and this with an oil price below $50/b.
    If this should be the case, then it needs a lot of attention as it may be a vital sign of undertows driving world oil demand.
    Oil is priced in US$ and US monetary policies (the FED) affect the exchange rate for other countries that in addition have a portion of their debts denominated in US$ thus their oil consumption is also subject to the ebb and flows from exchange rate changes.

Figure 1: The stacked areas in the chart above shows changes to crude oil supplies split with North America [North America = Canada + Mexico + US], OPEC and other non OPEC [Other non OPEC = World - (OPEC + North America)] with January 2007 as a baseline and per June 2016. Developments in the oil price (Brent spot, black line) are shown against the left axis.

Figure 1: The stacked areas in the chart above shows changes to crude oil supplies split with North America [North America = Canada + Mexico + US], OPEC and other non OPEC [Other non OPEC = World – (OPEC + North America)] with January 2007 as a baseline and per June 2016. Developments in the oil price (Brent spot, black line) are shown against the left axis.

It was the oil companies’ rapid growth in debt [ref US Light Tight Oil (LTO)] that brought about a situation where supplies ran ahead of consumption and brought the oil price down.

YTD 2016, only OPEC has shown growth in crude oil supplies relative to 2015.

Unit costs ($/b) to bring new oil supplies to the market is on a general upward trajectory while the consumers’ affordability threshold may be in general decline.

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