The Oil Price, Total Global Debt And Interest Rates

In several posts I have presented my exploration of any relations between total global debt, interest rates and the oil price.

Sometimes I am left with the impression that when societies’ are looking for a scapegoat for its ills, their reactions bring forth memories from a scene of the movie “Casablanca”, where Captain Renault confronted with solving a crime commands his men; “Round up the usual suspects!”.

For many years one of these “usual suspects” has been and will continue to be: The Oil Price.

However, looking at time series of developments in total global debt and interest rates makes me wonder if not more light should have been directed towards developments in total global debt and interest rates to obtain profound understandings of the fundamental forces that drives the oil price through its ebbs and flows.

In the post “It is the Debt, Stupid” from December 2011 (in Norwegian and refer figure 6) I illustrated how much a 1% increase in the interest rate for public debt in some countries equated to as an increase in the oil price (this was admittedly a simplistic and static comparison, and the exercise was intended to draw attention to the level of debts which made many economies more sensitive to interest hikes than to oil price increases).

Starting in 2014 there has been a steady flow of reports, worth studying, that focused on the growth in total global debt levels, like the 84^th BIS Annual Report 2013/2014 and VOX CEPR (CEPR; The Centre for Economic Policy Research) with its “Deleveraging, What Deleveraging?”, The 16th Geneva Report on the World Economy.

In February 2015 McKinsey published “Debt and (not much) deleveraging” which also presents some deep insights into developments of debt by sector for some countries.

The chart above contains plenty of information about total global debt levels, debt and developments to the growth rate of debt by sector and not least, how total global debt has grown faster than Gross Domestic Product (GDP).

The short version is that post the Global Financial Crisis (GFC) of 2008, which was triggered by too much debt, the global economy was brought back on its trajectory by the use of more debt stimulated by low interest rates.

Table 1 illustrates several relations:

• Estimated interest costs on total global debt has been and is far above the world’s total bill for crude oil for the period presented, ref also rows 6 and 9.
• The growth in total global debt makes the economy gradually more sensitive to interest hikes than to increases in the crude oil price, ref also row 10.
  Note that from 2000 to 2014 interest rates came substantially down (ref also row 5 and figure 2 below) as the economies grew more sensitive to increases in the interest rate due to the strong growth in total global debt.
  Lowering the interest rate both allowed to reduce debt service costs and also for growth in total debt.
• The productivity of the additional debt is low and appears to be in decline. In the recent decades, debt has grown much faster than GDP.
  (With the productivity of debt is here meant how much 1 US$ additional debt adds to GDP. Globally in 2014, 1 US$ added in debt grew GDP with US$ 0.30.)

In this post I referred to the recent collapse in the oil price while interest rates were low as the proverbial canary.

The situation where total global debt grows faster than GDP is not sustainable. How much wiggle room there still is left through lower interest rate and redefinitions of what should be included in GDP estimates is now anybody’s guess.

One thing should by now be clear, this can continue until it cannot!

At some point policies will be deployed to reduce the huge debt overhang (deleveraging). What remains to be seen is as this process starts in earnest if the deleveraging will be beautiful or ugly.

Where is the oil price headed?

Trying to predict the future trajectory of the oil price after its recent collapse is given a lot of attention by media, allowing scores of pundits and analysts their five minutes of fame to sustain the noise and suppress the SIGNAL.

If I with certainty knew what the oil price would become in the near future, I certainly would not publish that in the public domain.

However, looking at the oil price formation and demand development, including the perspectives of total global debt (and changes to this), the interest rates and the present (low) oil price reveals something about the supply/demand balance and expectations for its near future developments, gives away some clues of what to expect.

The strong growth in the oil price as from the start of this century coincided with a period with aggressive global credit/debt expansion accommodated by a decline in the interest rate.

The market acted as a clearing house that used price arbitrage to balance demand and supplies.

To me the big unknown for the short term (next 1 – 2 years) will continue to be: Developments to demand.

Demand will continue to be what one can pay for.

In this post (and several others) I have persistently drawn attention to the relations of the growth in total global debt and how that has “forced” the interest rates down. Debt growth and low interest rates allowed also for growth in demand/consumption of oil and for some time sustained a high oil price. The high oil price stimulated the supply side to go after more costly oil to extract.

Light tight oil (LTO, shale oil) has demonstrated that it could fast ramp up production when the price justified that. LTO, because of its agility, will likely for some time play an important role as a supplier of the incremental barrel as the price allows.

The global supply potential of oil appears to be well understood with realistic short term (the next 1 – 2 years) projections.

A big unknown is if all oil suppliers (net exporters) have the stamina to let the market sort things out, or if some of the suppliers will reach some understandings/agreements to accelerate this process and at some point start withholding supplies and thus provide support for a higher oil price.

The recent strong stock builds of oil (in the US) serves as some indicator of consumption that still lags supplies.

Supplies equals consumption plus stock changes equals demand.

 

One important factor that allows to pay for demand are developments in global credit/debt expansion. A collapsing oil price while interest rates are low may suggest a slowdown in global credit expansion.

The Federal Reserve (the Fed) has communicated its intention of hiking the interest rates (fed funds rate) later in 2015. This will affect the estimated $9 Trillion in dollar denominated debt and divert more of local currencies into servicing this debt.

A higher interest rate from the Fed will likely strengthen the US dollar, thus increase the diversion of more local currencies towards the service of the dollar denominated debt.

 

The deployment of future monetary policies (future trajectory of total global debt and interest rates) will influence demand for oil and thus its price.

A less accommodating global monetary policy will affect oil demand and cause the oil price to remain subdued until the supply/demand balance dictates otherwise.

Cause and effects of the relations between total global debt levels, interest rates and the oil price are of course subject for some well informed debates.

If, for whatever reasons, some of the oil suppliers agrees to withhold some supplies to pull forward support for a higher oil price, it will become interesting to see if and how that will affect interest rate policies and total global debt levels.