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.
NOTES:
· 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.
![Figure 1: The chart above shows the developments in petroleum consumption in Japan, Italy, Portugal, Spain, United Kingdom and US for the years 1999 - 2013 (stacked areas and right hand scale) together with the oil price [Brent spot] yellow dots and left hand scale.](https://runelikvern.files.wordpress.com/2020/05/cc4bb-fig-1-some-oecd-countries-oil-consumption-1999-2013.png)
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: The chart above shows the relative developments in total private non financial debts for Spain, United Kingdom, Italy, Portugal, the US and Japan [the same countries as in figure 1] from the end of 1999 [end of 1999 was used as baseline = 100] and as of Q1 2014 plotted against the right hand scale. The oil price [Brent spot] for the same period is shown against the left hand scale.](https://runelikvern.files.wordpress.com/2020/05/e15a1-fig-2-some-oecd-countries-relative-developments-in-private-debt-1999-q12014.png)
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.
![Figure 3: The chart above shows the developments in petroleum consumption in China, India, Indonesia, Malaysia, Thailand, Saudi Arabia, Russian Federation, Argentina and Brazil for the years 1999 - 2013 (stacked areas and right hand scale) together with the oil price [Brent spot] yellow dots and left hand scale.](https://runelikvern.files.wordpress.com/2020/05/c7aa6-fig-3-some-non-oecd-countries-oil-consumption-1999-2013.png)
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.
![Figure 4: The chart above shows the relative developments in total private non financial debts in the Russian Federation, India, Brazil, China, Indonesia, Argentina, Saudi Arabia, Malaysia and Thailand [the same countries as in figure 3] from the end of 1999 [end of 1999 was used as baseline = 100] and as of Q1 2014 plotted against the right hand scale. The oil price [Brent spot] for the same period is shown against the left hand scale. Note the scaling of the right hand y-axis to that of the OECD countries in figure 2.](https://runelikvern.files.wordpress.com/2020/05/16664-fig-4-some-non-oecd-countries-developments-in-private-debt-1999-q12014.png)
Note the scaling of the right hand y-axis to that of the OECD countries in figure 2.
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
![Figure 5: The 6 panel graphic above shows global bank credit aggregates and the most important borrower regions. The chart at upper left shows that global bank credit more than doubled from 2000 to 2013. In the US [upper middle chart] the growth in bank credit slowed from around 2007 (the subprime/housing crisis) and overall credit growth was continued by increased public borrowing for deficit spending. In the Euro area [upper right chart] the total debt levels led to a slowdown in growth of bank credit post 2008 (or the Global Financial Crisis; GFC) and more recently it appears as deleveraging has started [default is one mechanism of deleveraging]. In the Euro area petroleum consumption is now down around 13% since 2008. Asia Pacific [lower left chart] which includes China, continued a strong credit growth and thus carried on the global credit growth. Latin America [lower middle chart] which includes Brazil, continued together with Asia Pacific the strong total global credit growth. Global GDP in 2013 was estimated at above US$70 Trillion.](https://runelikvern.files.wordpress.com/2020/05/ee734-fig-5-bis-global-bank-credit.png)
In the US [upper middle chart] the growth in bank credit slowed from around 2007 (the subprime/housing crisis) and overall credit growth was continued by increased public borrowing for deficit spending.
In the Euro area [upper right chart] the total debt levels led to a slowdown in growth of bank credit post 2008 (or the Global Financial Crisis; GFC) and more recently it appears as deleveraging has started [default is one mechanism of deleveraging]. In the Euro area petroleum consumption is now down around 13% since 2008.
Asia Pacific [lower left chart] which includes China, continued a strong credit growth and thus carried on the global credit growth.
Latin America [lower middle chart] which includes Brazil, continued together with Asia Pacific the strong total global credit growth.
Global GDP in 2013 was estimated at above US$70 Trillion.
The main take away is that global credit continued a strong growth post the 2008 Global Financial Crisis. This also allowed for growth in consumption of higher priced petroleum.
The oil companies used the signal created from growth in demand/consumption of the higher priced oil to take on more debt to go after and develop costlier sources for oil.
The oil companies have been expanding their balance sheets with more debt betting that the consumers would continue to assume more debt to afford the costly oil which would allow the oil companies to retire their debt.
Debt and GDP
The red dots connected by a red line shows development in global total debt in US$ Trillion on the left hand scale.
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.
![Figure 7: The chart above shows the developments in the oil price [Brent spot] and the time of central banks’ announcement/deployment of available tools to support the financial markets which the economy is very dependent on. The global financial system has by others been compared with the operating system for a computer. NOTE 1: The Fed sets the Federal Funds Rate which greatly affects financial interest rates. NOTE 2: The chart only shows the timing of major moves from the Fed. This was to avoid crowding the chart with information. This approach was chosen for designing the chart due to the size of the US economy, together with the fact that the US$ serves as the world’s dominant reserve currency and the central banks coordinates their efforts.](https://runelikvern.files.wordpress.com/2020/05/fd56a-fig-7-oil-price-and-fed-policies-2006-to-sep-2014.png)
The global financial system has by others been compared with the operating system for a computer.
NOTE 1: The Fed sets the Federal Funds Rate which greatly affects financial interest rates.
NOTE 2: The chart only shows the timing of major moves from the Fed. This was to avoid crowding the chart with information.
This approach was chosen for designing the chart due to the size of the US economy, together with the fact that the US$ serves as the world’s dominant reserve currency and the central banks coordinates their efforts.
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.
Summary
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:
Global Credit Growth, Interest Rate and the Oil Price – are these related?
Central Banks’ Balance Sheets, Interest Rates and the Oil Price
Data sources:
[1] BIS Long series on credit to the private non-financial sector
[2] BP Statistical Review downloads
[3] 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
Fractional Flow 
Another excellent analysis!
So in a broader sense we are using credit as a temporal allocator of resources from the future to the present to maintain the global growth trajectory (at least nominal economic growth). In the process we are saving our children but stealing our grandchildren’s future resource availability (maybe energy/resource flow contribution is a better word) and at the same time impacting the biosphere (overpopulation, ocean acidification, climate change, biodiversity loss etc). In a sense we are trapped on both sides of the spectrum with regards to future energy contribution and a sustained habitat for humanity and other ecosystemically important species. Growth seems to be the only political accepted way forward and to change that in a radical way to mitigate these problems is probably biologically and culturally improbable/impossible.
In the end, unless we use our ability of “high intelligence” (rational analytic ability) and collectively change behavior/culture (which is highly unlikely), all this will certainly mean less consumption and overall more poverty where poor people turns poorer, middle class turns to poor and wealthy to middle class. We must either shrink our population or drastically reduce our consumption. Probably both. How do we transition form an “efficient” consumption society to a local resilient renewable society when we all are interlinked in this global web of interconnectedness? Going completely off oil tomorrow would probably end in starvation for the majority of people in a couple of weeks….
History has showed that species that are not able to moderate their too rapid growth and live ecosystemically balanced with nature do not survive over evolutionary time. Homo sapiens is the first species in the history of the earth who have to solve/adapt to these challenges of being ecosystemically balanced with nature by using cerebral cognitive intelligence whereas other organisms and species have done this through natural selection. Only time will show how this unfolds…
P.S! I must confess that I am amazed at the ability of the global economy to finding new creative ways (through technology) to dissipate energy.
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Thanks for your response!
Could it be that intelligence increasingly is becoming confused with wisdom?
In many ways we should be grateful for the central banks interventions as this IMHO has bought our systems some time.
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Rune,
Very interesting. This seems to closely mirror some of the data/conclusions drawn in the 16th Geneva report, and the two reports complement one another nicely.
It will be interesting to watch this play out.
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Hello Sam,
I and several others are in the process of reading the report Deleveraging, What Deleveraging? The 16th Geneva Report on the World Economy and discussing it (scroll down for download link).
Our common response to it was that there is no mention of the role of “cheap energy” for the economies to operate and grow organically. We agree there are lots of nuggets in the report when it comes to describe the financial dynamics and the role debt has played.
From the report,
“Chapter 3 provides some conceptual frameworks that can help guide the interpretation of debt dynamics and the ongoing poisonous interaction between financial crisis and output dynamics. First, we outline the nature of the leverage cycle, a pattern repeated across economies and over time in which a reasonable enthusiasm about economic growth becomes overblown, fostering the belief that there is a greater capacity to take on debt than is actually the case. A financial crisis represents the shock of recognition of this over-borrowing and over-lending, with implications for output very different from a ‘normal’ recession.”
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Rune
I’m about 100 pages into it at the moment, but have to admit that I’m finding it rather hard going as I’m a geophysicist by training, and much of the subject matter is something I’m not overly familiar with. I definitely agree with you that the lack of any mention of energy is a fundamental omission. I found the following paragraph somewhat enlightening:
In analogy to corporate debt overhang, debt overhang in the banking sector
is a situation in which the scale of the debt liabilities (relative to the value of
bank assets) distorts lending decisions, with viable projects not receiving funding
since banks seek to scale down balance sheets and reduce debt levels through
asset disposals in addition to replenishing capital levels through new equity
injections.
As one could easily swap out the words “bank” and “lending” for “oil companies” and “drilling”. It certainly is a pity that the oildrum shut down when it did, as things appear to be getting interesting again.
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Sam,
I am not an economist by training. I have my background from engineering/science.
I (in cooperation with others) have studied the financial statements and balance sheets to several oil companies and have observed the same thing as you describe. Several oil companies are struggling with their returns (Return On Actual Capital Employed, ROACE) and organic net cash flows because they grew total debt in a bid to grow (perhaps encouraged by several authoritative projections for a growth in both the oil price and oil demand) likely not aware that the debt they assumed was in reality based upon consumers abilities to continue to go deeper into debt.
Several oil companies have been upfront about this and stated they will only pursue developments that has an estimated breakeven of, say $45/bbl. This I believe may be frustrating for several of the hard working professionals that have put a lot of hard work and efforts into making a development happen, just to discover that the company cannot sanction the development as it is constrained by both cash flows and leverage.
Low interest rates have eased the consumers’ debt burden, but households’ incomes are declining.
Consumers in general are likely to start to shrink their balance sheets (that is pay down debt) as declining incomes without debt reductions increases leverage. Then add the effects from any growth in interest rates, changes to exchange rates (the Fed appears now to pursue a policy that will make the US dollar stronger [already happening]). This makes several oil importing countries facing a higher oil price in their local currencies.
Then add consumers’ with diminishing abilities to take on more debt to compensate from price growth (in their local currencies).
It certainly is about to get interesting (in the Chinese sense) and if The Oil Drum was still active publishing, I find it likely that emphasis would have shifted much towards connecting the energy and financial dots.
What is interesting is the recent publication of several reports from central banks and/or organizations closely linked to banking and the financial world that describes/documents how debt was extensively used for global economic developments.
What is missing in these reports are the links to energy (which some refers to as “indistinguishable from magic”) and/or resources (real capital) in general.
As some put it “Debt allowed us to build a bigger mousetrap and heat machine.”
Rune
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