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

The Oil Price – Some (Mar-16) Observations and Thoughts

In this post I present some selected parameters I monitor which may help understand near term (2-3 years) oil price movements and levels.

It has been my understanding for some time that the formulations of fiscal and monetary policies also affects the commodities markets. Changes to total global debt has and will continue to affect consumers’/societies’ affordability and thus also the price formation of oil.

I have earlier asserted;

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 global credit/debt, interest rates and developments to consumers’/societies’ affordability.

  • The permanence of the global supply overhang could be prolonged if consumption/demand developments soften/weakens and it is not possible to rule out a near term decline.
  • Recent demand/consumption data for total US petroleum products supplied show signs of saturation which provides headwinds for any upwards movements in the oil price.
  • While prices were high many oil companies went deeper into debt in a bid to increase production of costlier oil. Many responded to the price collapse with attempts to sustain/grow production in efforts to moderate cash flow declines and thus ease debt service.
  • If the forward [futures] curve moves from a present weak contango (ref also figure 02) to backwardation, this would erode support for the oil price.
  • Some suggest that growth from India will take over as China’s growth slows.
    Looking at the data from the Bank for International Settlements (BIS) there is nothing there that now suggests India (refer also figure 05) has started to accelerate its debt expansion. The Indian Rupee has depreciated versus the US dollar, thus offsetting some of the stimulative consumption effects from a lower oil price.

The recent weeks oil price volatility has likely been influenced by several factors like short squeezes, rumors and fluid sentiments.

Near term factors that likely will move the oil price higher.

  • Continued growth in debt primarily in China and the US. {This will go on until it cannot!}
  • Another round with concerted efforts of the major central banks with lower interest rates and quantitative easing.

And/or

  • A tightening in the global oil demand/supply balance from whatever reasons.

I also believe that D E M A N D (consumption) developments now are more important than widely recognized and that demand/consumption developments will play a major factor in as from when oil prices will regain support to move to a sustainable higher level.

I now hold it 90% probable that the oil price will enter a new leg down, and that the low in January 2016 could be taken out.

Recently the total US petroleum demand growth had two components

  1. Growth in consumption, mainly driven by the collapse of the oil price
  2. Noticeable growth in petroleum stocks (primarily crude oil) since late 2014 driven by a favorable contango.

The combined effects from these grew annualized US petroleum demand by 1.3 Mb/d relative to January 2014 (ref also figure 01). US consumption growth has now stalled, which may suggest saturation from the lower oil price is about to be reached.

Figure 01: The chart above shows development in annualized [52 weeks moving averages] US total petroleum consumption [blue line] and storage build [red line] both rh scale. The black line, lh scale, shows development in the oil price (WTI). Consumption and storage developments are relative to Janaury 2014 (baseline). NOTE, changes in consumption and stocks are stacked, thus the red line also shows total annualized changes in demand.

Figure 01: The chart above shows development in annualized [52 weeks moving averages] US total petroleum consumption [blue line] and storage build [red line] both rh scale. The black line, lh scale, shows development in the oil price (WTI). Consumption and storage developments are relative to Janaury 2014 (baseline).
NOTE, changes in consumption and stocks are stacked, thus the red line also shows total annualized changes in demand.

In the last 6 months total US petroleum consumption developments have stalled and there are some relative changes amongst the products (ref below).

A weakened contango (ref also figure 02) will likely reduce demand for storage.

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Are We In The Midst Of An Epic Battle Between Interest Rates And The Oil Price?

What follows are the continuance of my research, discussions, observations and thoughts around the nexus of debts, interest rates and the oil price.
I now believe these relations are poorly understood and with total global debt levels at all time highs (and growing), years of low interest rates, which are kept low (by concerted efforts by central banks) while the oil price in recent months has collapsed may hide a SIGNAL that struggles with attention from too much noise.

  • A collapsing oil price while interest rates remain low is likely the proverbial canary.

Global Crude Oil Supplies, The Oil Price And Interest Rates

Figure 1: The green area [left hand axis] in the chart above shows the world’s development of crude oil and condensates supplies between 1980 and 2013. The pink line shows the development in the interest rate (yield) for US 10 Year Treasuries [right hand axis]. The price of oil (Brent), black line nominal, yellow line inflation adjusted in $2013 [both right hand axis]. NOTE: The oil price has been divided by 10 to accommodate it on the same scale as the interest rate [right hand axis]. The US 10 Year Treasury (US10T) interest rate has been in decline and is presently around 2.0%.

Figure 1: The green area [left hand axis] in the chart above shows the world’s development of crude oil and condensates supplies between 1980 and 2013.
The pink line shows the development in the interest rate (yield) for US 10 Year Treasuries [right hand axis].
The price of oil (Brent), black line nominal, yellow line inflation adjusted in $2013 [both right hand axis].
NOTE: The oil price has been divided by 10 to accommodate it on the same scale as the interest rate [right hand axis].
The US 10 Year Treasury (US10T) interest rate has been in decline and is presently around 2.0%.

Cause and effects amongst the oil price and interest rates are of course subject to (some informed and gripping) discussions.

  • The price of oil appears to have been the leading indicator.
  • Any (small) increase to the interest rate now will likely affect demand for oil and thus its price, thus further slowing investments for new supplies.

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