Oil price fall is caused by tighter monetary conditions | Lars Christensen

Lars Christensen is one of the founding members of the Market Monetarism school of economic thought, having coined the term himself. Market Monetarists advocate that central banks target nominal GDP, instead of inflation, in order to achieve more responsive monetary policy and more stable economic growth.

Goldman Cuts 2017 Oil Price Forecast Due To Slower Market Rebalancing | Zero Hedge

Goldman Sachs has cut its long-term crude oil forecasts:

The inflection phase of the oil market continues to deliver its share of surprises, with low prices driving disruptions in Nigeria, higher output in Iran and better demand. With each of these shifts significant in magnitude, the oil market has gone from nearing storage saturation to being in deficit much earlier than we expected and we are pulling forward our price forecast, with 2Q/2H16 WTI now $45/bbl and $50/bbl. However, we expect that the return of some of these outages as well as higher Iran and Iraq production will more than offset lingering issues in Nigeria and our higher demand forecast. As a result, we now forecast a more gradual decline in inventories in 2H than previously and a return into surplus in 1Q17, with low-cost production continuing to grow in the New Oil Order. This leads us to lower our 2017 forecast with prices in 1Q17 at $45/bbl and only reaching $60/bbl by 4Q2017.

But these forecasts are premised on a Chinese recovery:

Stronger vehicle sales, activity and a bigger harvest are leading us to raise our Indian and Russia demand forecasts for the year. And while we are reducing our US and EU forecasts on the combination of weaker activity and higher prices than previously assumed, we are raising our China demand forecasts to reflect the expected support from the recent transient stimulus. Net, our 2016 oil demand growth forecast is now 1.4 mb/d, up from 1.2 mb/d previously. Our bias for strong demand growth since October 2014 leaves us seeing risks to this forecast as skewed to the upside although lesser fuel and crude burn for power generation in Brazil, Japan and likely Saudi are large headwinds this year.

While production growth continues to surprise:

…..This expectation for a return into surplus in 1Q17 is not dependent on a sharp price recovery beyond the $45-$55/bbl trading range that we now expect in 2016. First, it reflects our view that low-cost producers will continue to drive production growth in the New Oil Order – with growth driven by Saudi Arabia, Kuwait, Iran, the UAE and Russia. Second, non-OPEC producers had mostly budgeted such price levels and there remains a pipeline of already sanctioned non-OPEC projects. In fact, we see risks to our production forecasts as skewed to the upside as we remain conservative on Saudi’s ineluctable ramp up and Iran’s recovery.

We expect continued growth in low-cost producer output
Saudi Arabia, Kuwait, UAE, Iraq, Iran (crude) and Russia (oil) production (kb/d)

Tyler Durden has a more bearish view:

While there is much more in the full note, the bottom line is simple: near-term disruptions have led to a premature bounce in the price of oil, however as millions more in oil barrels come online (and as Chinese demand fades contrary to what Goldman believes), the next leg in oil will not be higher, but flat or lower, in what increasingly is shaping up to be a rerun of the summer of 2015.

Source: Goldman Cuts 2017 Oil Price Forecast Due To Slower Market Rebalancing | Zero Hedge

The Elusive Boost from Cheap Oil | Economic Research

Sylvain Leduc, Kevin Moran, and Robert J. Vigfusson in the FRBSF Economic Letter:

Why has consumption not responded more to cheap oil? Clearly, the U.S. economy was buffeted by headwinds over the past year, like weak foreign growth and the substantial appreciation of the dollar, that may have masked the positive effects of cheaper oil. Moreover, the decline in gas prices has been more muted than the drop in the price of oil. However, another possible reason is that the impact of changes in oil prices on the economy depends not only on the magnitude of the change, but also on its perceived persistence. Consumer spending is more likely to rise if people believe the decline in oil prices will last for a while; by contrast, if consumers think lower oil prices are not here to stay, they may simply decide to save what they don’t spend at the pump.

Figure 4: Estimated share of permanence in oil price movements

Source: Economic Research | The Elusive Boost from Cheap Oil

Where oil goes, stocks will follow

Patrick Chovanec

From Patrick Chovanec, Chief Strategist at Silvercrest Asset Management:

…..so far this year stock market sentiment has taken many of its cues from the price of oil. On any given day, if you knew which way oil prices moved, you probably could tell which way the stock market moved. While we believe this linkage fails to recognize the critical distinctions we have so often highlighted, it can’t be ignored in anticipating future market movements, at least in the near-term. The recent firming of oil prices reflects some important developments. After more than a year, we are finally seeing the initial signs of capitulation on the supply side: U.S. oil output has topped out and the most vulnerable OPEC members are agitating for cutbacks. Nevertheless, accumulated crude oil inventories remain at record high levels, which makes us wary concluding that the oil market has reached a hard bottom. While we think the oil price, and the producer industry, will gradually recover, we also think “consensus” expectations of a dramatic +20% gain in S&P 500 operating earnings this year, driven by a large and sudden rebound in the energy and materials sectors, continue to be overly optimistic. With this in mind, we are likely to see more sentiment-driven volatility in U.S. stock prices ahead, even as the U.S. economy continues on its path of slow growth.

Keep a weather eye on the flattening yield curve and shrinking bank interest margins. If these continue to shrink, “slow growth” could easily become “no growth”.

Janet Yellen on financial market turmoil

Federal Reserve chair Janet Yellen before the House Financial Services Committee:

Janet Yellen

“…..As is always the case, the economic outlook is uncertain. Foreign economic
developments, in particular, pose risks to U.S. economic growth. Most notably,
although recent economic indicators do not suggest a sharp slowdown in
Chinese growth, declines in the foreign exchange value of the renminbi have
intensified uncertainty
about China’s exchange rate policy and the prospects for
its economy.

This uncertainty led to increased volatility in global financial markets and, against the
background of persistent weakness abroad, exacerbated concerns about the outlook for
global growth
. These growth concerns, along with strong supply conditions and high
inventories, contributed to the recent fall in the prices of oil and other commodities. In
turn, low commodity prices could trigger financial stresses in commodity-exporting
economies, particularly in vulnerable emerging market economies, and for commodity-
producing firms in many countries
. Should any of these downside risks materialize,
foreign activity and demand for U.S. exports could weaken and financial market
conditions could tighten further…..”

…No rate rises any time soon.

Crude testing support

Crude futures (Light Crude December 2015 – CLZ2015) are testing support at $44.50 per barrel. Follow-through below $44.00 would signal another test of primary support at $40. Supply continues to exceed demand with the Saudis and Russians cranking up production and cutting prices to secure key markets in the US and China. Breach of $40 would offer a (long-term) target of $30*. Recovery above $50 per barrel is most unlikely unless there is a serious disruption to supply.

WTI Light Crude December 2015 Futures

* Target calculation: 40 – ( 50 – 40 ) = 30

Oil market showdown: can Russia outlast the Saudis?

Dalan McEndree writing in Oilprice.com :

While the sharp decline in crude prices has saved crude consuming nations hundreds of billions of dollars, the loss in revenues has caused crude exporting countries intense economic and financial pain. Their suffering has led some to call for a change in strategy to “balance” the market and boost prices. Venezuela, an OPEC member, has even proposed an emergency summit meeting.

In practice, the call for a change is a call for Saudi Arabia and Russia, the two dominant global crude exporters, which each daily export over seven-plus mmbbls (including condensates and NGLs) and which each see the other as the key to any “balancing” moves, to bear the brunt of any production cuts…….

Despite the intense pain they are suffering in the low price Crudedome, both the Russian and Saudi governments profess for public consumption that they are committed to their volume and market share policies.

This observer believes the two countries cannot long withstand the pain they have brought upon themselves — and this article only scratches the surface of the negative impact of low crude prices on their economies. They have, in effect, turned no pain no gain into intense pain no gain and set in motion the possibility neither will exit the low price Crudedome under its own power.

Read more at Oil market showdown: can Russia outlast the Saudis? | Oilprice.com

IEA: At Least Another Year Before Oil Markets Rebalance | OilPrice.com

From Art Berman at Oilprice.com:

In its August Oil Market Report (OMR), the IEA revised 2nd quarter 2015 demand upward 370,000 bpd from its July estimate but also revised supply upward by 140,000 bpd. Total liquids supply is 96.53 million bpd and demand is 93.5 million bpd……

IEA Quarterly Oil Production Surplus

….The world continues to have an over-supply problem that is slowly improving but it will take another year before the market comes into balance.

Read more at IEA: At Least Another Year Before Oil Markets Rebalance | OilPrice.com.

Goldman Sachs Doubles Down On Lower-For-Longer Scenario | OilPrice.com

ZeroHedge quotes Goldman Sachs’ Jeffrey Currie:

….Not only will the macro forces keep prices under pressure, but historically markets trade near cash costs [near $50/bbl] until new incremental higher-cost capacity is needed (even the IEA has revised 2015 non-OPEC output growth from existing capacity up by 265 kb/d since March). In addition, low-cost OPEC producers are likely to expand capacity now that they have pushed output to near max utilization. At the same time Iran has the potential to add 200 to 400 kb/d of production in 2016 and with significant investment far greater low-cost volumes in 2017….

Read more at Goldman Sachs Doubles Down On Lower-For-Longer Scenario | OilPrice.com.

Global economy: No surprises

The global economy faces deflationary pressures as the vast credit expansion of the last 4 decades comes to an end.

$60 Trillion Global Credit

Commodity prices test their 2009 lows. Breach of support at 100 on the Dow Jones UBS Commodity Index would warn of further price falls.

Dow Jones UBS Commodity Index

The dramatic fall in bulk commodity prices confirms the end of China’s massive infrastructure boom.

Bulk Commodity Prices

Crude oil, through a combination of increased production and slack demand has fallen to around $60/barrel.

Crude Oil

Falling prices have had a sharp impact on global Resources and Energy stocks….

DJ Global Energy

But in the longer term, will act as a stimulus to the global economy. Already we can see an up-turn in the Harpex index of container vessel shipping rates, signaling an increase in international trade in finished goods.

Harpex

The latest OECD export statistics show who the likely beneficiaries will be. Primary producers like Brazil and Russia have suffered the most, while finished goods manufacturers like China and the European Union display growth in exports. The US experienced a drop in the first quarter of 2015, but should rebound provided the Dollar does not strengthen further.

OECD Exports

Australia and Japan offer a similar contrast.

OECD Exports

Oil-rich Norway (-5.8%,-13.3%) has also been hard hit. Primary producers are only likely to recover much later in the economic cycle.

Grantham: Lower oil price is new normal | Macrobusiness

By Houses & Holes
Reproduced with kind permission from Macrobusiness.com.au

From Jeremy Grantham:

1234

The simplest argument for the oil price decline is for once correct. A wave of new U.S. fracking oil could be seen to be overtaking the modestly growing global oil demand.

It became clear that OPEC, mainly Saudi Arabia, must cut back production if the price were to stay around $100 a barrel, which many, including me, believe is necessary to justify continued heavy spending to find traditional oil.

The Saudis declined to pull back their production and the oil market entered into glut mode, in which storage is full and production continues above demand.

Under glut conditions, oil (and natural gas) is uniquely sensitive to declines toward marginal cost (ignoring sunk costs), which can approach a few dollars a barrel – the cost of just pumping the oil.

Oil demand is notoriously insensitive to price in the short term but cumulatively and substantially sensitive as a few years pass.

The Saudis are obviously expecting that these low prices will turn off U.S. fracking, and I’m sure they are right. Almost no new drilling programs will be initiated at current prices except by the financially desperate and the irrationally impatient, and in three years over 80% of all production from current wells will be gone!

Thus, in a few months (six to nine?) I believe oil supply is likely to drop to a new equilibrium, probably in the $30 to $50 per barrel range.

For the following few years, U.S. fracking costs will determine the global oil balance. At each level, as prices rise more, fracking production will gear up. U.S. fracking is unique in oil industry history in the speed with which it can turn on and off.

In five to eight years, depending on global GDP growth and how quickly prices recover, U.S. fracking production will start to peak out and the full cost of an incremental barrel of traditional oil will become, once again, the main input into price. This is believed to be about $80 today and rising. In five to eight years it is likely to be $100 to $150 in my opinion.

U.S. fracking reserves that are available up to $120 a barrel are probably only equal to about one year of current global demand. This is absolutely not another Saudi Arabia.

Saudi Arabia has probably made the wrong decision for two reasons:

First, unintended consequences: a price decline of this magnitude has generated a real increase in global risk. For example, an oil producing country under extreme financial pressure may make some rash move. Oil company bankruptcy might also destabilize the financial world. Perversely, the Saudis particularly value stability.

Second, the Saudis could probably have absorbed all U.S. fracking increases in output (from today’s four million barrels a day to seven or eight) and never have been worse off than producing half of their current production for twice the current price … not a bad deal.

Only if U.S. fracking reserves are cheaper to produce and much larger than generally thought would the Saudis be right. It is a possibility, but I believe it is not probable.

The arguments that this is a demand-driven bust do not seem to tally with the data, although longer term the lack of cheap oil will be a real threat if we have not pushed ahead with renewables.

Most likely though, beyond 10 years electric cars and alternative energy will begin to eat into potential oil demand, threatening longer-term oil prices.

Exactly right, though in my view the equilibrium price will be more like $50 than $30 for the next half decade.

Don’t miss the full report.

Oil prices: Where to now?

The latest newsletter from Absolute Return Partners suggests that the fall in oil prices is temporary and oil will soon recover to around $100/barrel:

“All I know is that the price of oil won’t stay below the production cost for a long period of time (as in years). Hence I think we will see the oil price at $100 again, and it won’t take many years, but it could be an extraordinarily bumpy ride.”

The chart below depicts crude oil prices (WTI) from 1987 to 2014, adjusted to current (November 2014) prices.

Nymex WTI Crude adjusted to November 2014 prices

What it shows is that, prior to 2004, crude oil prices seldom exceeded $40/barrel. If, for most of the 17-year period, prices were below $40/barrel and supply continued unabated, then production costs must be even lower. Some of the more accessible oil fields may be nearing the end of their life, but production costs for major producers such as the Saudis could not have changed much (in real terms) over the last 10 years. That means true production costs are a lot lower than ARP’s estimate.

I tend to side with Anatole Kaletsky who views $50/barrel as the likely ceiling for crude oil prices — and not the floor.

A 3-Sentence Explanation Of What Crashing Oil Prices Mean For America | Business Insider

Charles Schwab’s Liz Ann Sonders offers some simple maths that puts it all into perspective. In three sentences:

Consumer spending represents 68% of the US economy. Oil and gas capex represents about 1% of US GDP and less than 9% of US total capex (which in turn represents about 12% of US GDP). Therefore, the benefit of lower energy prices to the consumer and many businesses greatly outweighs the significant hit to energy companies and/or energy-oriented capex, especially in energy-oriented states.

Read more at A 3-Sentence Explanation Of What Crashing Oil Prices Mean For America | Business Insider.

Will falling commodity prices cause deflation?

Some readers expressed concern about falling commodity prices, especially crude oil, and whether this will cause global deflation. This confuses the cause with the symptom.

Crude

Falling prices are largely benign except where caused by a contraction of the money supply. Commodity prices may fall when there is an excess of supply over demand, but this is soon absorbed by changes in consumer behavior. Discretionary spending will rise in response to the savings, so that aggregate demand is unaffected.

A contraction in the money supply, however, is far more serious. Slow growth in the monetary base (below growth of real GDP) results in less money chasing the same goods, driving down prices. Supply and demand in this case are unchanged, but prices fall because of a contraction in the money supply. Wages, however, are sticky and do not fall in line with prices, leading to falling profits, cuts in production and job layoffs. Falling income from lower profits and fewer jobs leads to a contraction in aggregate demand, causing further cuts to production and income.

Contraction of the money supply also places pressure on banks to reduce lending. This danger was highlighted by Irving Fisher in the 1930s. Contracting credit reduces not only new investment but forces existing borrowers to liquidate some of their assets, mainly stocks and property. The surge of selling, and limited availability of credit, drives down asset prices. A feedback loop results, with falling asset prices prompting banks to further contract lending — in turn causing more price falls. That is the central bankers’ equivalent of a perfect storm. The graph below shows how close we came in 2009 to a deflationary spiral.

Working Monetary Base

Slow growth in the monetary base caused a sharp contraction in bank lending (below zero) in 2009. Only prompt action by the Fed averted a 1930’s-style collapse of the financial system.

The Fed indicated in October that it will curtail QE and no longer expand its balance sheet to support money supply growth. Should we expect another contraction of the money supply as in 2008?

The answer is: NO. When we look at the graph of the Fed balance sheet below, we can see that total asset growth [red] is slowing. But bank deposits at the Fed — excess reserves that earn interest at 0.25% p.a. — are slowing at an even faster rate. That means that the actual amount of money flowing into the banking system is not contracting, but increasing.

Fed Total Assets and Excess Reserves

The following graph shows a net growth rate (of Total Assets minus Excess Reserves on Deposit) of more than 20 percent. Expect growth to slow over time, but the Fed can adjust the interest rate payable on excess reserves to ensure that it remains positive.

Fed Total Assets minus Excess Reserves

Deflation is a far bigger problem for the Euro. After a “whatever it takes” surge in 2012, the ECB attempted to contract its balance sheet far too soon — withdrawing treatment before the patient had fully recovered. They also do not have excess reserves on deposit, like the Fed, which could soften the impact.

ECB Total Assets

The result has been faltering economic growth and price levels falling dangerously close to deflation.

ECB Total Assets

The ECB appears to have recognized its error, indicating that it will expand its balance sheet if necessary to avert a monetary contraction. If they learn from their past mistakes, the ECB should be able to avoid any threat of deflation.

It’s Time To Drive Russia Bankrupt — Again

Interesting view from Louis Woodhill on Forbes:

Over the past 64 years, real gold prices have averaged $544.91/oz in 4Q2013 dollars, and real crude oil prices have averaged $38.85 bbl. This means that an ounce of gold will typically buy about 14 barrels of oil.

If we fully stabilized the dollar today, we could expect gold prices to fall toward $550/oz, and oil prices to fall toward $40.00/bbl. The huge dollar premiums that gold and oil currently command reflect the value that these easy-to-store commodities have as hedges against dollar instability. If we reformed our monetary control system to guarantee the real value of the dollar, we would eliminate this risk. The risk premiums currently enjoyed by oil and gold would then decline toward zero, as the new monetary system gained credibility.

Are the current gold and oil premiums simply a hedge against an unstable dollar?

Read more at It's Time To Drive Russia Bankrupt — Again.

Bad Has Never Looked So Good – Russia

Again from Energy Burrito at Oilprice.com:

…the Russian ruble has been gradually depreciating throughout this year amid rising geopolitical tension in Ukraine. It has now dropped 12% versus the US dollar in 2014.

Yet while a falling ruble hurts Russian imports as they become increasingly more expensive to buy, Russia reaps the rewards when it comes to exports. And it is seeing the greatest benefit from its largest export: oil. To the tune of 7 million barrels a day.

Hence, while crude prices in US dollars have dropped 12% in value since the beginning of July, crude oil in rubles has only dropped 3.4%. For Russian coffers, it is good for the ruble to be bad…

Read more at Bad Has Never Looked So Good.

Depleting Putin’s war chest

From Quartz:

The “First Law of Petropolitics,” coined by New York Times columnist Tom Friedman… states that when oil prices are high, the leaders of petro-states can become demanding and belligerent; when they are low, they are more prone to be pussycats.

Oil prices at elevated levels explain Russian belligerence. The graph below shows Brent Crude prices adjusted by the (US) consumer price index to reflect growth in real crude prices over the last decade. To bring crude prices down to pre-2005 levels will be no small feat.

Real Crude Oil Prices

Read more at How the US might persuade the Saudis to co-conspire in unleashing an oil weapon against Putin – Quartz.

The future of natural gas – an interview with Raymond Learsy – On Line Opinion

Raymond Learsy: Let me show you this. It is from a study that MIT made ….. it goes into a great deal of detail that natural gas will result in demand reduction and displacement of coal-fired power by a gas-fired generation. And because of its more limited CO2 emissions further de-carbonization of the energy sector will be required and natural gas provides a cost effective bridge to such a low carbon future. In other words, natural gas, the way it’s structured, it’s enormous availability (we are finding more and more of it since these articles have been written), and it’s extraordinary low cost, present a very real danger to other forms of hydrocarbons…..At $2.50 an MMBtu, the amount of energy that is delivered by that quotient of natural gas, the price of oil would have to be around fifteen dollars a barrel.

via The future of natural gas – an interview with Raymond Learsy – On Line Opinion – 13/6/2012.