This is another installment of my work in progress about credit, interest rates and the oil price. Though many of the mechanisms for some time (as in several years and in some circles) have been well understood, nothing beats having the cover of data/reports from authoritative sources.
In this post I present the observations and results from the research of the developments in some selected OECD countries and emerging economies (non OECD) in their petroleum consumption together with the relative developments in their total non financial debt since 1999.
This may put into context how emerging economies were able to grow their petroleum consumption as the oil price grew and remained high. Likewise provide some insights into some of the mechanisms at work that caused a decline in petroleum consumption for the selected OECD countries.
The selected countries presented and the world had the following changes in their total petroleum consumption between 2005 and 2013 based upon data from BP Statistical Review 2014:
OECD countries: – 4.04 Mb/d (decline)
Emerging economies: 8.39 Mb/d (growth)
Growth in world petroleum consumption: 6.94 Mb/d
The numbers illustrate that the emerging economies’ total growth in petroleum consumption was greater than the world’s from 2005 to 2013. These emerging economies effectively bid out OECD for a portion of its consumption to meet its own growing demand.
· How was this accomplished?
· Were the emerging economies about to decouple from the advanced economies?
· What caused petroleum consumption for the OECD countries to decline?
I set out to explore what could be the likely causes by looking into the relative changes in total non financial debt of these countries armed with data from the Bank for International Settlements (BIS, in Basel, Switzerland) placed together with the changes in their petroleum consumption as from the end of 1999 with data from BP Statistical Review 2014.
It turns out that changes in petroleum consumption for these countries closely follow relative changes to total private non financial debts. Then add changes in sovereign/public debt.
Demand is not what one wants, but what one can pay for.
And expectations for demand drives investments for supplies.
Credit is a vehicle which allows for demand to be pulled forward in time and to some extent negates any price growth and allows for investments to meet expected demand changes.
Credit works both sides of the demand and supply equation.
· The charts show that relative changes in total non financial debt does not imply anything about the leverage ratio (often expressed as a percentage of Gross Domestic Product [GDP]). For changes in percentages of total debt to GDP refer to figure 6 from BIS.
· Some countries exhibit a meteoric rise in their relative and absolute total private non financial debt levels, which most likely is due to initially low nominal debts (lots of available room on their balance sheets).
· Relative changes in total non financial debt are nominal and in the respective countries local currencies.
· The data used are for private, non financial sector and does not include sovereign/public debt.
· As the data from BIS in the public domain represents 40 economies, the scope of the study focused on those more important (as in size) and thus believed to be more representative.
Some selected OECD countries
The OECD countries looked into being: Japan, Italy, Portugal, Spain, United Kingdom and US. These represent more than 60% of OECD’s total petroleum consumption in 2013.
Total petroleum consumption in these OECD countries had a high in 2005. Total petroleum consumption in these OECD countries declined more than 4 Mb/d (or around 13%) from 2005 to 2013.
Of these countries only the US saw a growth in petroleum consumption from 2012 to 2013. According to BIS data the US was the only country that had growth in total non financial debt (in addition to running a deficit) from 2012 to 2013, refer also figure 2.
Figure 2 illustrates the relative developments to the private, non financial sector balance sheets. As of 2008 this expansion slowed and/or reversed (exception being Japan).
Post 2008 many sovereigns took over (where the private sector left off) and expanded their balance sheets (through deficit spending). This while austerity measures were put in place and the interest lowered to ease the burden of the total debt load. These measures likely also contributed to slow the decline of petroleum consumption in the face of the higher oil price, refer also figure 1.
Some selected emerging economies (non OECD)
The emerging economies (non OECD) looked into being: Argentina, Brazil, China, India, Indonesia, Malaysia, the Russian Federation, Saudi Arabia and Thailand. These represent more than 61% of non OECD’s total petroleum consumption in 2013.
These emerging economies grew their total petroleum consumption with 8.4 Mb/d (around 43%) from 2005 and as of 2013.
Growth in the world’s total petroleum consumption from 2005 and as of 2013 was around 7 Mb/d (around 8%). In other words, the emerging economies absorbed all the world’s growth in petroleum consumption and outbid the OECD countries for a portion of their consumption.
The growth in total debt is secured against the expected growth in future income. The use of debt (which primarily now acts as an economic growth steroid) creates some self reinforcing feedbacks that encourage the assumption of more debt. This can go on until it does not. Several countries are now living through the experience created by the headwinds from the total debt load (public and private).
Russia started from a (very) low base post the dissolution of the Soviet Union. Credit growth in Russia closely follows (with some time lag) the movements in the oil price.
Note the strong credit growth in Saudi Arabia following the growth in the oil price.
Figure 4 shows how the selected emerging economies have aggressively expanded their private balance sheets. It is not possible to deduct anything from the chart about how much room there still is left on the selected countries balance sheets. What is certain is that the balance sheets will run out of room at some point.
So there it is, the miracle of the strong economic growth in the emerging economies was fueled by aggressive private credit expansion. This helps explain how these could grow their total petroleum consumption while the oil price grew and remained high.
Developments in Global Total Bank Credit
The chart above has been lifted from the BIS report; Global liquidity: where it stands, and why it matters.
The main take away is that global credit continued a strong growth post the 2008 Global Financial Crisis. This also allowed for growth in consumption of higher priced petroleum.
The oil companies used the signal created from growth in demand/consumption of the higher priced oil to take on more debt to go after and develop costlier sources for oil.
The oil companies have been expanding their balance sheets with more debt betting that the consumers would continue to assume more debt to afford the costly oil which would allow the oil companies to retire their debt.
Debt and GDP
The chart in figure 6 has been lifted from BIS 84th Annual Report (p 10).
The chart illustrates how total global debt levels have grown in absolute and relative terms since the Global Financial Crisis (GFC).
In the advanced economies (AE) the sovereigns (public) took over credit growth where the private non financial sector left off.
In the emerging economies (EME) it was primarily the private non financial sectors that maintained the growth in debt (refer also figure 4).
Growth in global total debt levels makes it harder for the economies to sustain higher interest rates.
“A new policy compass is needed to help the global economy step out of the shadow of the Great Financial Crisis. This will involve adjustments to the current policy mix and to policy frameworks with the aim of restoring sustainable and balanced economic growth.
The global economy has shown encouraging signs over the past year but it has not shaken off its post-crisis malaise (Chapter III). Despite an aggressive and broad-based search for yield, with volatility and credit spreads sinking towards historical lows (Chapter II), and unusually accommodative monetary conditions (Chapter V), investment remains weak. Debt, both private and public, continues to rise while productivity growth has extended further its long-term downward trend (Chapters III and IV). There is even talk of secular stagnation. Some banks have rebuilt capital and adjusted their business models, while others have more work to do (Chapter VI).
To return to sustainable and balanced growth, policies need to go beyond their traditional focus on the business cycle and take a longer-term perspective – one in which the financial cycle takes centre stage (Chapter I). They need to address head-on the structural deficiencies and resource misallocations masked by strong financial booms and revealed only in the subsequent busts. The only source of lasting prosperity is a stronger supply side. It is essential to move away from debt as the main engine of growth.”
My bolds and text copied from here.
Stated simplistic in another way: Economic growth (GDP) is primarily about FLOWS (growth in debt) and less about STOCKS (of money also known as debt).
Countries with stagnant/low credit expansion experiences stagnant economies, refer also figure 2, making it harder for them to bid for commodities (like oil) that becomes pricier due to supply issues.
The chart shows how the oil price has responded together with deployments of Fed policies/tools.
The low interest rates and expansion of the central banks’ balance sheets allowed for carry trades (link to primer about carry trade) and there are good reasons to believe that some of this added liquidity (cheap dollars), provided by the Fed, also found their way to emerging economies and thus supplied liquidity that supported their economic growth.
If/when the carry trade reverses, this will also affect the demand for oil.
The Fed plans to end its asset purchase program in October and the Fed now speaks about a possible increase in the Fed Funds Rate in early 2015. Further, according to Fed’s press release (Sep. 17th, 2014) their policies are also aimed to shrink the Fed’s balance sheet.
Central banks by keeping the interest rates low and adding liquidity were also hoping to entice consumers to continue to borrow and thus stimulate demand, also for higher priced oil. Getting the added liquidity out to the main street consumers has been like pushing on a string. Main street consumers had little room left on their balance sheets and have seen declines in their real disposable income, making it even harder to take on more debt (the capacities on their balance sheets is contracting).
On the supply side the oil companies bought more debt in a bet that consumers would continue to take on more debt, as consumer debt growth effectively is a source of funding (from revenues) that would enable the oil companies to retire their growing debt load.
The above illustrates that the growth in total global debt levels, that ran at an annual average rate of $5 Trillion since 2007 (according to data from BIS and IMF), has acted as high water lifting the economies abilities also to mitigate a higher oil price.
The combination of low interest rates and added liquidity (from the central bank asset purchase programs or quantitative easing [QE]) works both sides of the supply and demand equation, also for oil.
Low interest rates allow those weighed down by debt to allocate more spending away from debt service towards other purchases like necessities as petroleum products.
Consensus estimates on world GDP developments now show slowing growth.
Affordability has its own dynamics which is tightly connected to credit growth and thus demand.
What about Oil Supply and Demand?
Presently the global supply situation for oil shows improvements thanks to a high oil price, allowing for extraction of costlier oil like light tight oil (shale oil) primarily in the US and growth in extraction from the oil sands in Canada. Supplies from North America is expected to continue to grow in the near future.
Some of the oil producing countries have experienced various political disturbances (civil war, sanctions) causing them to produce below capacity.
Presently and in the face of a declining oil price the global supply of oil appears to be adequate and has potential to grow in the next few years.
The biggest uncertainty appears now to be about developments in oil demand, which again is related to financial/monetary policies like; the future pace of global credit expansion, developments in interest rates, developments of central banks’ balance sheets, carry trade, just to name a few.
The Crude Oil Price
The simplistic approach to explain changes in the crude oil price has been by referring to supply and demand 101 economics. Few have ventured beyond and looked at what really creates demand and supply.
As total debt levels grow (both on the demand and supply side), more of the wealth creation is used to service the growth in total debt. Credit/debt is and has been added, also to service the growing total debts. At some point it becomes challenging to solve the effects of the total debt load with more debt, at which point growth in total debt slows and probably reverses (deleveraging).
From what I have presented on this subject in this and previous posts it appears the global economy is approaching an inflection point where it becomes harder to support a high/growing demand for costlier oil.
Rock is fast approaching the proverbial hard place and something will have to give.
Presently and for the near future, I hold it more likely that demand will soften while capacities for supplies improves, thus exerting a downward pressure on the oil price.
Could oil (again) become subject to price control?
Several analysts have estimated that many oil exporting countries and oil companies now need an oil price of $100/bbl to balance their (fiscal) budgets. Less global credit creation bears with it the possibility to weaken oil demand and thus price support.
Oil exporting countries, of which OPEC represents the most dominant entity, is likely to become faced with the option of establishing and defending a price floor (de facto price control).
The question becomes what will this price floor be? $100/bbl?, $70/bbl? Other?
It is impossible for an outsider to know what strategies OPEC and other big oil exporters will deploy. It is all about what their short term needs and long term objectives are.
Whatever the potential price floor becomes, there are likely very good rationales behind the deployment of the policies to both establish and defend it.
For a cartel like OPEC it is about market dominance. A nonrenewable and unique commodity like oil (fossil sunlight) has a very special utility for all economies. A cartel exists to maximize their long term income potential (wealth creation). Market dominance may be accomplished through several strategies and along different timelines. There are all reasons to believe that OPEC (and other big exporters) are very much aware of and closely monitors production developments in other regions, their reserve status and costs of developing the incremental oil barrel from shales, oil sands, the Arctic, deep water, major public and private oil companies’ balance sheets, total global debt levels, et cetera.
Deploying a policy that defends a high oil price (say $100/bbl) makes alternative costlier supplies profitable and as OPEC supports (like in guarantees) a higher price by reducing their own supplies, they will also forego revenues, which likely will affect their fiscal spending irrespective of the size of their foreign reserves (which offers some cushion). Such a policy will allow public and private oil companies to repair their balance sheets and remain viable competitors.
By holding back production OPEC will preserve more reserves for the future and as supplies from other producers declines, demand remains high (in relative terms) OPEC as it increases supplies will likely point at the market as the arbitrator for any price growth.
Policies deployed involving the reduction in oil supplies from OPEC (and other oil exporters) may be viewed as a proxy for a lower oil price.
A lower price floor (say $70/bbl) will be very much appreciated by struggling consumers as it offers some relief. This will also create temporarily goodwill for OPEC (who has been a favorite scapegoat for high oil prices). A lower price will temporarily make it harder to sustain investments in capacities for costlier incremental oil barrels (as well as alternative sources for energy production) that depends on a high price.
Oil companies will find it harder to repair their balance sheets with a lower oil price and a lasting, low oil price will impair their financial capacities to invest and bring costlier oil to the market.
There are likely additional elements in this equation.
In this post I have presented documentation to how global credit expansion/contraction and central banks’ policies in the recent years likely have influenced oil prices, oil supplies and the shift in demand patterns between advanced economies (OECD) and emerging economies (EME, non OECD).
For some years it has been my conviction (from studying the hard data, discussions, etc) that any developments in oil supplies, oil prices, etc needs to be understood in the context with financial and monetary developments.
Credit expansion (debt growth) has facilitated the growth in oil consumption and supplies and for some time provided some tolerance for a higher oil price.
It appears that the global economy is now approaching a cross road which very likely will weaken demand for oil. A weaker demand bears with it the prospect of a lower oil price, which for some time may bring out of sight the underlying structural reality that the incremental oil barrels are increasingly costlier.
Previous posts where I have explored the relations between credit, interest rates and the oil price:
 BP Statistical Review downloads
 EIA oil price
Recent economic theory and practice has been;
“One which has borrowed so extensively from the future to fund the present that there is no future left.”
– Comment on ZeroHedge
“The power of accurate observation is commonly called cynicism by those who have not got it.”
– G.B. Shaw