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Page added on January 24, 2016
How low oil prices went from blessing to curse
There was a time, and it was not so long ago, that western economies would enthusiastically welcome a sharp drop in oil prices.
This no longer seems be the case.
With oil prices almost halving in the last 12 months – and falling even more in the last 15 months in one of the largest and fastest plunges in history – the phenomenon is now seen by many as more as a curse than a blessing.
Here are the three main reasons why, in rising order of importance; followed by how this perception is likely to change at some stage in the not so distant future.
- With the surge in US energy production, particularly from shale, the West is no longer as much as a net importer as it once was. So while consumers are unambiguously better off both in Europe and the United States, there are pockets of considerable pain for producers (as well as some banks). The results include output reductions as these companies’ profits evaporate, employee layoffs, sharp curtailment in capex programs and, in the case of highly leveraged companies with debt maturing, acute financial stress. The economy wide effects are amplified by consumers that are yet to rush out and spend the considerable income windfall that accrue to them. Instead, and partially reflecting the financial insecurity associated with years of low economic growth and anemic wages, they are saving an important part of it.
- When thinking about general price developments, the main focus in the West has shifted from the historical worry of too much inflation to more recent concerns about too little inflation. The challenge of “low-flation” in the United States is amplified by an outright threat dis-inflation threat in Europe. As Mario Draghi, the President of the European Central Bank, re-iterated last week, European policymakers are worried that the sharp oil price fall will accentuate deflationary forces and entice consumers to postpone purchases in anticipation of even lower prices in future.
- The disorderly manner in which oil prices have dropped has been as notable as the extent to which they have fallen. This has imparted a volatility impulse to financial markets as a whole; and, with the Federal Reserve decoupling from other central banks by embarking on an interest rate hiking cycle last month, these markets do not feel as protected by central banks as they once did. The result is a bout of financial instability as markets transition from a low volatility regime due to effective central bank policy repression, to one of higher volatility whose impact is amplified by pockets of market illiquidity. With that, there is increased risk of bad market technical contaminating real economic activity – accentuated by the possibility of some over-exposed banks.
Over time, however, the impact of lower oil prices is likely to balance out a lot more. Most advanced economies (and some emerging countries too) will come out significant net beneficiaries. Their consumers and a notable part of their industrial base will have the possibility – if not probability – of translating their windfall gains into higher economic activity. And this could well be significant … that is provided the short-term transition challenges are managed well.
Mohamed A. El-Erian is the former CEO/co-CIO of PIMCO. He is Chief Economic Advisor at Allianz and member of its International Executive Committee, Chair of President Obama’s Global Development Council and author of the NYT/WSJ bestseller “When Markets Collide.” He authored the book to be published on January 26th, “The Only Game in Town: Central Bank, Instability and Avoiding the Next Collapse”
Follow him on Twitter: @elerianm. And get all of his content on Facebook.
15 Comments on "How low oil prices went from blessing to curse"
Brian Richards on Sun, 24th Jan 2016 3:45 pm
Actually, I can name a few other categories of those who are being negatively affected by the lower oil/NG prices. I especially feel for oil industry workers who are finding themselves out of work. And those persons who rely upon oil and NG royalty interests for income, such as some elderly persons I know. I don’t feel any sympathy for banks anymore. Nor am I a bit concerned about Mr. El-Erian, who is probably relaxing in his multi-million dollar NYC penthouse or Palm Beach estate, contemplating the choice between prime rib or caviar for lunch, and demonstrating his delayed recognition of the obvious.
makati1 on Sun, 24th Jan 2016 7:18 pm
I would say that low oil pries are good because they may just end the Age of Petroleum sooner than unexpected. That would be a very good thing for the planet and those of us that live on it.
Pop a cold one and pass the popcorn. Enjoy the events as they unfold. There in nothing you can do to change them at this point except be prepared.
rockman on Mon, 25th Jan 2016 6:40 am
mak – The problem is lower prices will increase demand and push us further down the decline curve. But we’re talking about the speed. I doubt the volume of fossil fuels burned in the future years down the road will vary much regardless of oil prices. Periodically low prices increase consumption and high prices reduce consumption. But averaged out we’ll kept consuming fossil fuel with little to nothing done to change the dynamic.
JuanP on Mon, 25th Jan 2016 6:47 am
Plummeting commodities save China $460 billion a year. https://www.rt.com/business/330044-china-economy-oil-commodity/
Davy on Mon, 25th Jan 2016 6:57 am
“Kyle Bass Warns Of “A Lot More Pain To Come” Before This Is Over”
http://www.zerohedge.com/news/2016-01-24/kyle-bass-warns-lot-more-pain-come-over
“Given our views on credit contraction in Asia, and in China in particular, let’s say they are going to go through a banking loss cycle like we went through during the Great Financial Crisis, there’s one thing that is going to happen: China is going to have to dramatically devalue its currency….to focus on Emerging Markets more broadly and specifically The BRICs.”
“we still have three tough innings to go, maybe four,” he warning that emerging markets will “see a lot more pain before things are okay.”
“China, lastly, is “the big one,” according to the hedge fund manager. Bass cited the country’s non-performing loan growth as the key issue to watch. China many years ago attached its currency to the dollar: they hitched their wagon to our star very smartly because back then our goal was to depreciate our dollar through inflation. So we issued debt to the rest of the world to depreciate the dollar. And so now the real problem is China has hitched their wagon to our star, and their currency has effectively appreciated about 60% versus the rest of the world since 2005 and it’s killing them… China’s effective exchange rate moving up versus the rest of the world made their goods and services a little bit more expensive each year and now that labor arbitrage is gone. And if that labor arbitrage is gone, and the banking system has expanded 400% in 7 years without a nonperforming loan cycle, my view is we are going to see a non-performing loan cycle.”
Davy on Mon, 25th Jan 2016 7:09 am
“BIG BAD CHINA”
https://sobata416.wordpress.com/2016/01/11/big-bad-china/
“Along the same lines, individuals account for at least 80% of trading on the mainland exchanges. In other words, there are many speculators and few investors.“
“China’s aggregate debt level is one of the highest in the world, although it may not seem to be at first glance. China’s government debt-to-GDP ratio is 55%. To put that in perspective, the US and Japan are at 89% & 234%, respectively. Even so, it is always prudent to consider a country’s debt composition. China’s mounting debt comes into focus when we account for non-financial corporate debt (125% of GDP), financial institution debt (65%) and household debt (38%). The grand total is an astounding 282% of GDP, or $28.2 trillion:”
“China’s debt load is a global risk because of how tightly managed its economy is. The government has allowed unprofitable companies to stay in business. Though defaults have been very limited, China must allow these companies to fail eventually. Otherwise, it will continue to suffer from high debt servicing costs ( ~30% of GDP).”
“Government investment has been a big part of China’s economy. Massive amounts of stimulus went into factories, leading to overcapacity in sectors such as coal and steel. This is making it very difficult for companies that operate within those sectors to make profits – both domestically and abroad. Fiscal stimulus also went into housing and infrastructure, which are both clearly overbuilt.”
“Likewise, it has been lowering its Reserve Requirement Ratio and selling its foreign reserves in an attempt to prevent excessive devaluation of the yuan (CNY). They are down more than $400 billion (from a peak of ~$4 trillion) since mid-2014:”
“FX is also a risk because China has a lot of USD-denominated debt. In mid-2015, non-bank borrowers held ~$1.2 trillion worth of it. This is an issue because Dollar debt becomes more expensive when USDCNY rises, which is exactly what the markets expect to happen.”
“China is also important because it is a massive source of demand for many commodities. Thus, its weakness is spreading to undiversified economies such as Russia, Brazil and South Africa. Recessions in those countries might not carry over to the rest of the world. Nevertheless, it is important to consider the amount of debt they have taken on since the financial crisis. In the US, credit is already tightening. If borrowing costs rise for the emerging markets, especially China, then we may see a wave of defaults with untold consequences.”
makati1 on Mon, 25th Jan 2016 8:17 am
Rockman, did you notice that fewer young people are buying cars or even getting driver’s licenses? That driving in China or India does not even come close to the miles per driver in the US? That incomes are decreasing to the point where the decision will be “food or gas”? Guess which will win?
The price of oil will not dictate consumption. Past performance is no guarantee of future use. The poor do not use much oil. And the number of poor is growing all over the world contrary to the propaganda we see daily.
When your retirement savings is losing value even if you don’t spend it, and you retirement plan drops with the market casino, how can consumption increase? There is a tax of about $0.40 to $0.50 per gallon in the US. That sets a bottom on the price of gas. And you know the governments are desperate for money, so, if anything, it will go up.
The world is entering a depression. I don’t think much of today’s lifestyle will survive the next 10 years. Maybe not even 5.
There will be millions of suburban houses abandoned in the near future because they will not be livable, just like the cities. They are served by the same utilities that will fail. No electric equals no heat for most homes. No electric means no well water.
What will happen? A lot of multi-generational living where an extended family shares one house instead of 6 or 8 houses. A lot like the 3rd world is now.
Maybe I will be proved wrong, but, I doubt it. Oil can be free but if you have no way to use it…
rockman on Mon, 25th Jan 2016 11:18 am
mak – Not so much that consumption will increase beyond current levels. But consumption will CONTINUE. And a lot of former poor are buying cars. And while many of them, like the Chinese buyers won’t drive nearly as many miles as the average US driver, their consumption will still be an addition. Remember today the world is consuming as much oil as it ever had in its entire history. Been flat for a year or so but hasn’t decreased. And the EIA, for what it’s worth, expects to see that amount increase by 1.5 million bopd by the end of 2016.
JN2 on Mon, 25th Jan 2016 12:02 pm
rock, Q4 2015 consumption up 1.5% on Q4 2014. IEA. Flat but trending upwards 🙂
shortonoil on Mon, 25th Jan 2016 1:44 pm
Between 10/2014 and 10/2015, the last full year for which the EIA provides data, gasoline consumption increased by 1.1% in the US. For gasoline prices over the same period declined by 25.9%.
http://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=MGFUPUS1&f=M
http://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=PET&s=EMM_EPM0_PTE_NUS_DPG&f=W
This is paralleling the same behavior that has been exhibited recently for crude in general. That is, a signification decline in price with little or no increase in consumption. Petroleum, and its products are no longer responding to a declining price as they have done historically . We believe that this is occurring as a result of the entropic decay of the petroleum production system as its natural depletion cycle continues to progress. The full analysis can be found below.
http://www.thehillsgroup.org/
Rick Bronson on Mon, 25th Jan 2016 8:45 pm
Wow, for 25.9% decrease in gas price, there is only 1.1% increase in consumption.
And that too 0.8% can be attributed to the increase in US population. So only 0.3% has increased because of recovering economy.
That means USA has already hit the peak demand. With 1000’s of Hybrids and Plugins sold, the gas consumption will never increase significantly.
marmico on Tue, 26th Jan 2016 2:06 am
Wow, for 25.9% decrease in gas price, there is only 1.1% increase in consumption.
But a 4.3% increase in miles driven.
http://www.advisorperspectives.com/dshort/updates/DOT-Miles-Traveled.php
rockman on Tue, 26th Jan 2016 6:24 am
Using %’s is fine. But consider that for every $0.25 decrease in gasoline price saves US drivers about $750 MILLION per year. And that 1.1% increase in consumption represents about 32 MILLION gallons per year
shortonoil on Tue, 26th Jan 2016 7:35 am
“Using %’s is fine. But consider that for every $0.25 decrease in gasoline price saves US drivers about $750 MILLION per year.”
That $750 million in savings would constitute about $2.23 per person per year. Defaults in the HY energy sector for 2016 are expected to amount to $1,015.00 per per person. Lower oil prices are destroying wealth at a phenomenal rate. The Etp Model projects that trend to continue into the foreseeable future.
http://www.thehillsgroup.org/
Davy on Tue, 26th Jan 2016 12:02 pm
“A Constant Short Squeeze Threat: Oil Shorts Are At All-Time Highs”
http://www.zerohedge.com/news/2016-01-26/constant-short-squeeze-threat-oil-shorts-are-all-time-high
“While market participants will hardly need the caution, having experienced historic moves in the oil complex over the past few days including the biggest two-day surge in seven years at the end of last week, one reason why oil remains so remarkably jumpy on even the tiniest hint of supply rationalization as demonstrated this morning by the latest comments by the Iraqi oil minister, is that the short interest in both WTI and Brent is at nosebleed record highs and continues to rise with every passing week.”
“On WTI, the in-the-money short positions are really dominating at the front end of the curve while out-of-the-money long positions are dominating at the long end of the curve: the front end of oil curve could thus be more exposed to some profit-taking.”
“deflation fears could turn around rapidly and give more room to reflation and inflation talks” which considering all central banks are now actively blaming low oil prices for their monetary incompetence, is indeed notable.”