Changes to Total Global Debt Affects The Oil Price

In some posts on Fractional Flow I have presented some of my explorations of any relations between the oil price, changes to global total debt and interest rates. My objective has been to gain and share some of my insights of how I see the economic undertows that also influences the price formation for crude 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.

In this post I present results from an analysis of developments to the annual changes in total debt in the private, non financial sector of some Advanced Economies (AE’s), and 5 Emerging Economies (EME’s) from Q1 2000 and as of Q3 2014 with data from the Bank for International Settlements (BIS in Basel, Switzerland).

The AE’s are: Euro area, Japan and the US.

The 5 EME’s are: Brazil, China, India, Indonesia and Thailand which in the post are collectively referred to as “The 5 EME’s”.

Year over year (YOY) changes in total private debt for the analyzed economies were juxtaposed with YOY changes in total petroleum consumption in these based upon data from BP Statistical Review 2014.

• As the AE’s slowed growth in, and/or deleveraged their total private debt after the Global Financial Crisis (GFC) in 2008/2009, the EME’s continued their strong growth in total private debt and China accelerated it significantly in 2009.
• The AE’s petroleum consumption declined noticeably as from 2007, resulting from the combination of high oil prices and tepid debt growth and/or deleveraging.
• The EME’s remained defiant to high oil prices and continued their strong growth in petroleum consumption, which likely was made possible by strong growth in total private debt.
• Demand remains what the consumers can pay for!

All debts counts, household, corporate, financial and public (both government and local) and exerts an influence on economic performance (GDP, Gross Domestic Product).

A low interest rate allows for growth in total debt and eases services of the growing total debt load.

The countries analyzed represented an estimated 67% of the World’s GDP in 2014 (based upon data from the International Monetary Fund; IMF) and about 58% of the World’s total petroleum consumption in 2013 (based upon data from BP Statistical Review 2014).

The Euro area

The Euro area comprises 19 countries that use the Euro as their common currency.

The European Central Bank (ECB) started lowering its repo rate in 2001 to stimulate debt growth, which was kept low from late 2003 till 2006 which stimulated a strong growth in debt.

ECB then gradually raised the rate to slow the debt growth and after the GFC hit, it rapidly cuts its rate to 0.25%. Later the rate has been slightly negative as the Euro area deleverages.

One financial version of “The Red Queen” is deleveraging as GDP declines which some Euro countries are now experiencing.

The Euro area imports 98 – 99% of its petroleum consumption.

The decline in the Euro area’s total petroleum consumption started in 2006/2007 as the oil price grew and while the Euro area had strong growth in total debt. The decline in petroleum consumption accelerated while the oil price remained high and debt growth slowed and transitioned into a deleveraging.

Japan

Japan launched a massive QE program in early 2013, this coincides with when private sector again started to grow their total debt. Japan’s total debt has grown to 450% of its GDP.

Japan imports all its petroleum consumption.

Japan had a decline in oil imports and consumption while the oil prices grew and the private sector deleveraged. The Fukushima accident temporarily led to an increase of the Japanese oil imports.

US

The rapid credit growth that fueled the US housing bubble came to an end as loans that were defaulted on put the financial system under stress. The private sector started to deleverage (default is one way to deleverage) and it was not until 2012 the private sector led by corporate started to take on more debt. Then followed households. The debt growth in the corporate sector coincided with the acceleration of extraction of Light Tight Oil (LTO).

The US government, in concerted efforts with others, deployed several stimulative monetary and fiscal policies, like lowered interest rates, quantitative easings (QEs) and increased deficit spending to bring the economies back on their original growth trajectories.

In the US it was found that the correlation between YoY changes in total private debt and GDP was 0.64 for the years 1981 – 2014. This correlation was 0.59 if public debt was included.

The US has due to the rapid growth from Light Tight Oil (LTO) extraction experienced a corresponding decline in its oil import needs. The LTO extraction requires now an average oil price above $70/Bbl (WTI) to be profitable.

Early in the previous decade the Euro area and the US had strong growth in total private debt that also supported the growth in the oil price and consumption. After 2006/2007 petroleum consumption in the Euro area (refer also figure 03 and 07) started to decline, likely as a response to the growth of the oil price.

As the oil price continued its climb towards its high of $147/Bbl in the summer of 2008  and the private debt growth slowed, petroleum consumption declined, which contributed to a weakening of the support for the oil price. The oil price fell 70% from its high in 2008 as a response to a 3% decline in global demand.

In 2009 growth in the oil price returned supported by accelerating credit expansion in the emerging economies, led by China,  (refer also figure 12),  which allowed for both strong growth in oil consumption and resilience for the high oil price that resulted from this demand growth.

Petroleum consumption in the Euro area, Japan and the US declined, likely as a response from both the higher oil price and general deleveraging.

Euro area, Japan and the US YoY change in total private debt and petroleum consumption 2001 – 2013

The Euro area: Strong credit/debt growth had negligible effect on total petroleum consumption from 2001 to 2006. The growth in the oil price gradually reduced petroleum consumption, which accelerated as debt growth slowed and austerity policies were deployed. The reduction in petroleum consumption for the years presented is likely from a combination of efficiency gains and consumers’/societies’ affordability affected by changes in debt growth and austerity policies.

Japan: For the years 2001 – 2012 Japan’s private sector was in a deleveraging mode and petroleum consumption was in general decline which were accelerated by the growth in the oil price. The growth in petroleum consumption from 2011 to 2012 is likely a response to the accident at Fukushima.

The US: For the US petroleum consumption grew towards 2005. As the oil price grew, petroleum consumption declined, which fell faster with the price growth and the GFC in 2008. Consumers in the US are more exposed to movements in the crude oil price due to the lower taxation on petroleum consumption. As deleveraging set in petroleum consumption moved sideways.

As the private sector started their debt growth in 2011, petroleum consumption inched upwards while the oil price remained high. The growth in US petroleum consumption accelerated with the decline in the oil price that started in the summer of 2014.

As crude oil is priced in US$, consumers in the Euro area and Japan are also exposed to fluctuations in their exchange rates.

The observed general pattern for the presented AE’s is that changes to growth in total debt and/or deleveraging in combination with high crude oil prices affect consumption.

This illustrates that support for a higher oil price and growth in consumption relates to affordability, that for some time may be remedied by growth in total credit/debt. Changes to public deficit spending should be expected to affect demand and price support, also for crude oil.

The 5 EME’s

The 5 EME’s analyzed using the same approach was: Brazil, China, India, Indonesia and Thailand. This represents a major portion of the BRICS and other big EME’s in Asia.

Only China will be presented in detail due to the size of its economy’s relative to the other EME’s.

China is now the world’s second biggest economy.

Few economies have been through such a debt fueled growth like the Chinese. China responded to the GFC by accelerating its debt growth, which rose by close to 60% from Q4 2008 to Q1 2009, thus alleviating some of the downdraft that hit the AE’s. In figure 12 is shown the development in the Chinese YoY relative growth in total private debt.

In recent years, China’s private debt grew at an annual rate of $3Trillion, or about 30% of its GDP. This compared to about $2 Trillion in the US in 2006 and 2007, refer also figure 06.

McKinsey has estimated that China’s total debt was about 282% of its GDP by mid 2014.

For comparison Brazil’s debt grew at an annual rate at around $150 Billion, India’s at $100 Billion during Q3 2014.

All the 5 EME’s are net importers of oil. Between 2008 and 2013 these 5 EME’s grew their total petroleum consumption with close to 30% or about 4.5 Mb/d.

Figure 12 shows that relative credit/debt expansion for the 5 EME’s were far stronger than in the Euro area and the US. Early in the 2000’s it appears as credit expansion from Brazil, China and India pulled the other and smaller emerging economies. China went massively counter cyclical in 2008/2009 and this may, with a delay of about one year, have pulled the other emerging economies.

This acceleration of the private Chinese credit expansion likely contributed to support demand for oil and its price. Note how the growth in the oil price in 2009 moves in harmony with the Chinese credit expansion.

As from 2014 (and as of Q3 2014) all these 5 EME’s has seen a slow down in the relative debt growth of the private sector. This also coincides with the collapse of the oil price that started in the summer of 2014.

The 5 EME’s YoY changes in total private debt and petroleum consumption 2001 – 2013

In the chart above note how growth in total petroleum consumption is concurrent with growth in total private non financial debt.

The EME’s growth in total debt allowed also for an increase their petroleum consumption, to bid up the oil price and for some time defy the higher price.

In recent years, most currencies has depreciated versus the US dollar, making the oil price in local currencies corresponding higher.

Consumers in some EME’s have for some time been protected from oil price increases through public fuel subsidies, which has ended according to the 2 articles linked below.

IMF applauds India for cutting fuel subsidy

Indonesia Scraps Gasoline Subsidies

Ending the petroleum subsidies makes the consumers more exposed to changes in the oil price.

Other

For what it is worth, a correlation analysis was carried out for the AE’s (Euro area, Japan and US) and the EME’ (Brazil, China and Indonesia) between YoY changes in total private debt versus YoY changes in total petroleum consumption, and it showed a correlation varying between 0.26 and 0.29.

The correlation analysis was not adjusted for fluctuations in the exchange rates and the differences in petroleum tax structures between the countries.

Summary

This study has demonstrated that there has been and are strong links between the magnitude of and directional changes in global total debt, oil consumption and the oil price. The global oil supply/demand balance will continue to use price as the arbitrator.

• The findings from this study suggests that a sustained higher oil price can be endured with a continued and strong growth in global total debt, which is more likely with sustained low interest rates.
• As the consumers and societies run out of room on their balance sheets for credit/debt expansion, for whatever reasons (interest rate hikes will shrink this room, so will decline in real wages, house prices and assets in general [the quality of whatever is put up as collateral]), it will affect the demand potential and thus the price formation of oil.

Looking at the recent trends for changes to global credit/debt, the likelihood of an increase of the interest rate, the potential for some near term growth in global oil supplies, I now hold it probable that the oil price will remain subdued for some time and hold some appreciation for some weakening of it.

To make it clear, what I attempt is to emphasize the economic undertows in the global economy, on the household level and the outlook for the global supply/demand balance for oil that shapes its future price trajectory. I deliberately play down any short term movements by speculative influences (like playing the forward curve, “dead cat bounces”, the rig count, stock changes, the scores of entrusted pundits given massive access by the media to present their {paid for} beliefs, which and with a few good exceptions, fails any encounter with hard data, facts and logic.

We are transitioning into a new paradigm where the rules of yesterday are up for some revisions.   

Any major geopolitical events or agreements/understandings by some oil exporters for control of the oil production will of course make my outlook change.

 

In the introduction I alluded to for any forecasts of the future oil price trajectories to be of any help, these need to be linked to future changes to total global debt, the interest rates and consumer’s/societies’ affordability.

To pursue economic growth while simultaneously deleveraging a global economy with too much debt, will probably produce some interesting (literally and very much in the Chinese sense) outcomes.

At some point, deleveraging goes global.

This time I found it appropriate to repeat Joules Burns’ apt reformulation to IEA’s Executive summary for IEA WEO 2014.

 ” …, but turmoil in many key [oil] consuming regions and the difficulties in formulating the right monetary policies mean the world may not be able to respond with adequate [oil]”

fractional flow