As a substitute for conservation, credit expansion represents the ultimate self-defeating strategy.
Figure 1: What is the price can consumers afford by the operation of their consumption economies? $100 per barrel has been causing economies to hemorrhage, in EU, US, Japan even China. Problems have been masked by monetary easing (additional credit) in China, US and elsewhere.
What price is needed by oil extractors to bring new product to the marketplace, $100+ per barrel?
Oil Markets Are Slumping!
Syed Rashid Husain (Memri Economic Blog)With markets mellowing, prices falling and demand simply unstable, an interesting debate is raging all around. Saudis (as indeed other producers) can’t afford an oil price slump – which media headlines are staring in front. Pundits are up in arms, saying the Kingdom will act sooner, rather than later, to avert the downslide. It has no other option, implying the producers are least bothered by the woes of the consumers and the state of the global economy.
Oswald Clint, analyst at Sanford C. Bernstein thinks Saudi Arabia may reduce its oil output sooner than it did after the financial crisis in 2008, basing the argument on the premise that the Saudi authorities need oil prices above $85 a barrel to meet their spending obligations. Expenditures are rising. Only the power plants and electricity distribution networks upgrading required by 2020, would need more than $100 billion. The recent payouts announced for the citizens by King Abdullah in Saudi Arabia and the other oil rich Arab states are cited by other pundits too as a prime motivation to keep the prices high.
According to the IIF report, Saudi Arabia last year needed an oil price of $68/barrel to balance its budget. This year (2011) it needs $88 and by 2015 will need $110.
When price declines are due to demand destruction the bid cannot be supported by creating artificial scarcity. If oil is unaffordable @ $80 per barrel it will be unaffordable @ $90 per barrel or $100. High demand at today’s price is also artificial, driven by excess credit. The decline in demand accompanies the shrinking of credit. Cutting supply cannot increase credit.
Taking place right now in the Eurozone and elsewhere is ‘Morte d’Credit’: it bleeds out on the floor in Greece, Italy and France. There is no one lending at any scale in the EU. The only way to raise funds in the Eurozone currently is to sell assets, that is, to sell existing loans. This selling cannot support high prices: if high prices were self-supporting there would be no reason for the sales!
Productivity — money return per unit of output — diminishes inversely to each increase in fuel price. $112 petroleum produces the same amount of goods and services as does the $12 version. The price increase represents the diversion of funds from remunerative output toward petroleum price setters: producers and speculators.
Producers can ‘suggest’ a price but only return on economic activity can meet that price.
Financing the petroleum scarcity premium costs more than what using the petroleum is able to return. Because of the decades-long support for automobile waste, non-waste uses for petroleum do not exist. Without the waste, petroleum stays in the ground. Cutting energy supply ultimately defeats the ends of producers: they cannot force economies built around waste to somehow shape up or ‘waste better’ in order to afford higher prices.
This fantastic presumption is identical to the hopeful ‘growth out of austerity’ meme. Rather, the economy will ‘shape down’, reconfiguring itself in unorthodox ways to eliminate the waste along with all the ‘phony productivity’ and ‘growth’ promoted by economists, politicians and businessmen, which runs along with that waste.
Price-setter producers turn around and increase their own consumption because they can afford to do so, enabled by the credit excesses of their customers!
Here are the European energy dependency states from the European Energy Portal. . The most important suppliers of crude oil and natural gas were Russia (33% of oil imports and 40% of gas imports) and Norway (16% and 23% respectively).
| EU Member State | Gross Energy consumption1) |
Net imports2) | Energy Dependency3) |
||
| 1 | Cyprus | 2.6 | 3 | 100% | |
| 2 | Malta | 0.9 | 0.9 | 100% | |
| 3 | Luxembourg | 4.7 | 4.7 | 98.9% | |
| 4 | Ireland | 15.5 | 14.2 | 90.9% | |
| 5 | Italy | 186.1 | 164.6 | 86.8% | |
| 6 | Portugal | 25.3 | 21.6 | 83.1% | |
| 7 | Spain | 143.9 | 123.8 | 81.4% | |
| 8 | Belgium | 60.4 | 53.5 | 77.9% | |
| 9 | Austria | 34.1 | 24.9 | 72.9% | |
| 10 | Greece | 31.5 | 24.9 | 71.9% | |
| 17 | EU 27 | 1825.2 | 1010.1 | 53.8% |
In default
Has received EU/IMF bailouts
Insolvent or facing major institutional failure
No indication of insolvency or institutional failure … yet
1) Gross energy consumption in Million tonnes oil equivalent (Mtoe). Defined as primary production plus imports, less exports.
2) Net imports means imports minus exports.
3) Imports divided by gross consumption.
4) Denmark is a net exporter of energy and is the only EU member that is not energy-dependent.
Figure 2: list of topmost energy deadbeats among the EU members including the gross dependence on crude oil, natural gas including and electrical generation from various sources. Malta and Luxembourg are tax havens within the Eurozone.
Credit is collapsing both in the US and particularly in the European Non-Union (ENU). The high oil price is the likely culprit. High price at high volumes requires immense credit support. This demand for new credit cannot be met by credit issuer (now) while debts taken on cannot be serviced (also now). The credit constraint in the house of the issuer means the ability to monetize debt diminishes. The outcome is deflation (also now).
Neither European banks and central banks nor governments are able to increase their debt issuance. Finance-related debt service costs and those related to importing energy have become unaffordable. The West’s addiction to high priced petroleum ‘crowds out’ credit at the point of its creation: funds stream toward fuel consumption rather than toward debt financing. This is ultimately fatal, because there is no organic income support for debt without (new) debt financing of (old) debt.
Wasting oil by pointlessly driving in circles represents a credit black hole whose event horizon cannot be escaped by any means other than the stopping of the driving! There is zero ‘return on waste’ to service the debts taken on to obtain the oil. At some point anything other than the lowest price for crude is a constraint on credit. This ‘waste-to-credit shrinkage’ dynamic is underway right now in the Eurozone and soon to emerge elsewhere.
An alternative is a very high price crude delivered at sharply diminished volumes. This would represent the end of economies of scale on the parts of producers and consumers, with crude oil becoming a ‘luxury good’ only available to a few with liquidity to offer in exchange … shortages.
Shortages taking place because of a too-low price will be permanent.
Out of the ruin come two new governments — one in Greece and the other in Italy — have bought some more can-kicking time and another stock market flurry.
Figure 2: Dow E-mini stock futures continuous (this and other charts from Estimable TFC Chartz). Stocks have farther to go before they reach that mythical ‘point of no return’, when the hammer of credit evaporation meets the anvil of unreasonable ‘recovery’ expectations.
The poor countries cannot expand their balance sheets so the central bank must attempt expand its sheet.
Let’s assume for a minute it can: to do so it must take on liabilities to the account of some other entity: the EFSF cannot be this entity because it is a fake, with no resources or ability to tax or enforce policy. The only countries with resources are rich countries. Like the EFSF, these countries’ wealth is an illusion. ‘Rich’ is relative: even the US (IMF) lacks the resources to bail out Italy and Spain … not to mention France. What remains is the silly theater of pretense leading to the inevitable bank run(s). These are underway already, the sign that the ECB cannot expand its balance sheet or issue new credit.
The best it can hope to do is keep pace with redemptions for as long as it can. This ‘keeping pace’ cannot create new money or support a high bid for crude oil.
The ENU suffers high interest rates because ‘Europe’ cannot borrow on its own account in its own currency like Japan or the United States. These entities enjoy low rates because there are no absolute limit to the amounts of debt that can be created in a borrower’s own currency. Debt service is monetized/guaranteed. The only limit to borrowing is practical, that being the credibility of the borrowers themselves.
Europe has the currency but no account upon which to borrow. Europe pretends to be a family, it is instead an orphanage! It has no choice but to borrow on the accounts of each of the children.
As the orphans are shunted out the door or climb out the windows, the bills for the orphanage accumulate toward the accounts of the remaining orphans.
It is fatal for Germany (or its more steady cousins) to stay with the euro, it is also fatal to race the rest out the door. As Charles Hugh Smith suggests, all roads lead to destruction by the accumulated costs of the Eurozone orphanage!
This leaves out that management of the orphanage has been up to now to the benefit of orphan Germany and its mercantile economy.
There are two cures. One is absolute and unconditional: stringent conservation. The other is to keep the euro but demand the ENU members issue their own currencies.
– There would be no other European business other than energy conservation, it would be the new beginning and end of unified Europe. Any country not embracing stringent conservation would be automatically ejected from the euro (which would mean they would not be able to buy fuel with depreciated national currency). Since some fuel is better than none (and a bit more better than a lot less) there would be incentive for countries to remain with the union.
– The euro would be a reserve currency, used to settle accounts between nations in the EU. National currencies would not be used for this. The euro could be backed by gold as were European Community Units of Account.
– The national currencies would float to the levels needed to allow economic activities to take place within the various countries. Earnings would be in national currencies alongside euros within countries as well as in euros across national borders.
– (Parity) Exchange rates between the various countries and the euro would be adjusted by central banks within the EU. The purpose would be to whittle euro-denominated debt while reducing the stress occurring from current liquidity starvation. Conservation is easier when there is remunerative economic activity taking place rather than revolutionary activity taking place in the streets.
– The nations treasuries rather than the ECB and finance would provide liquidity with national currency liabilities existing only so far as nations can bear their weight. The presumption would be that all countries are different rather than versions of Germany or German industrial wannabes. Members would swap their currencies for euros so as to buy fuel, the high euro rate would serve to keep national currency inflation under control.
– A low euro price will not satisfy the sheiks but the alternative is collapse and a big hole in the petroleum market or the boutique producer approach: oil for the rich. At any price, the level of production is likely to be very low as most of the -$40 oil was pumped and burned for nothing a long time ago …