Here is a look at the Brent crude market in dollars:
Figure 1: This is a good chart because it shows the trends of our time: the increased costs of bringing more oil onto the market (the bottom arrow) and the declining ability of the users to pay for that oil (the top arrow). Chartz by TFC Charts (click on for big)
The overseas charts are similar but that the indicated ability (desperation) to pay is a bit greater in euros and sterling.
This trend is not surprising because the bulk of the oil use has zero money return, it is simply waste. It is this long-running non-remunerative waste at very large cost that is the source of our current ‘crisis’. We don’t wish to end the waste because we believe it ‘leads to something better’ like a trail of breadcrumbs. At the same time, the waste is pricing itself out of business. We have to come up with more reasonable ideas of ‘something better’ … or else.
The top indicator suggests credit is being stripped from the world economy. Prices are declining for fuel at the same time and for the same reasons prices are declining for houses. Prices have been puffed up with credit: the effect has been to make credit itself too expensive. The price of crude seeks a market clearing price, this price is descending because there is less credit available. Contrary to popular (stock market) beliefs, there are no closets full of spare change waiting to be put toward buying expensive fuel. Any funds set aside are for the use of bankers and executives of the various industries, not for anyone else.
The bottom arrow indicates that credit is being pressed into service to bring the more expensive, hard to find- and extract fuels to the marketplace. What is underway is the clash of borrowers. One set of borrowers are the broke customers, the other set represents the collateral worth of the same broke customers to the oil producers! If this is confusing, it is not meant to be: oil producers must sell what they lift and refine. Ultimately, the users pay for everything … provided they have access to funds.
As credit availability continues to decline — not necessarily in a straight line — the ability to extract crude from deep water, arctic and tight-oil reservoirs diminishes. This shows up as a diminished rate of increase, leading to an out-and-out decline in fuel on the market.
Producers fall underwater with products that are too pricey for their markets, they have credit crises of their own, as was the case with Swiss refiner, Petroplus.
Access to fuel is currently rationed by access to credit: no credit = no fuel. When credit intermediation fails, there will be rationing by brute physical access to fuel. Shortages caused by fuel being too costly to lift will be permanent. An energy crisis in 2012 is not the energy crises in 1973 or in 1979-81. During these previous intervals, there were shortages that ended after credit- or political adjustments. What is underway now is the leap from the net-energy cliff. Energy return in 2012 is a bubble: energy investment + credit investment = energy return.
High nominal prices are self-limiting: they accelerate the credit-stripping process which puts more stress on the finance sector. A vicious cycle that takes hold leading to flight out of increasingly dangerous fuel markets. This is what happened during the 2008-2009 price crash, market participants could not exit their large crude positions fast enough.
What is ‘off the chart’ is the line that indicates borrowed funds spent for fuel are not being spent elsewhere. Also off the chart is how much of the current crude price is leverage.
As during 2008, should the price rise high enough (or the ability to pay decline enough) something important will break. It is impossible to say what this might be, but many countries are in serious trouble. High energy prices are an up-front tax on most forms of economic activity (waste). Should prices spike, due to warfare or loss of supply, they won’t remain high for long. Rather, the higher the price on ‘the upside’ the sharper the downside crash will be. If prices simply decline from the current $125/barrel, there is not likely to be any crash at all.
We might even get to see some more ‘green shoots’!
Meanwhile, here is Morgan-Stanley:
Morgan-Stanley
Global Barrel Bill, 2012 Edition
March 16, 2012
Spyros Andreopoulos & Sung Woen Kang
The renewed oil price run-up makes us revisit our barrel bill framework, first introduced last year.
We define the barrel bill as the value of aggregate oil imports by net oil importing economies as a share of these countries’ combined GDP. At around $2.3 trillion, the wealth transfer from oil importers to oil exporters in 2011 reached all-time highs in dollar terms. As a share of aggregate oil importers’ GDP, the barrel bill has surpassed the 2008 level of 3.2%. Put differently, over 2010 and 2011, the barrel bill has more than fully recovered the 1.2% of oil importers’ GDP drop that it suffered between 2008 and 2009. In terms of aggregate oil exporters’ GDP, the value of global oil trade last year was around 23.3% – compared to the all-time high of 23.7% in 2008.
Oil revenue recycling 1: Goods: Of the US$2.3 trillion barrel bill, around 50% will, over time, return to oil-importing economies in the form of export revenue: oil exporters spend around half their oil revenue on goods imports from oil importers (the ‘average propensity to import out of oil revenue’). Indeed, we think it is likely that this share will increase as oil exporters bid to maintain social stability (that is, the marginal propensity to import out of oil revenue may soon rise). In any case, the net wealth transfer — after accounting for this wealth transfer back to oil importers — is thus much smaller than the gross transfer.
Oil revenue recycling 2: Assets: This leaves around $1.1 trillion unspent. While some of this will no doubt be spent on domestic goods and services (or on goods and services from other oil-producing economies), it is fair to assume that the lion’s share will be saved, that is, invested – mainly in assets from the oil-importing economies. If this flow of saving is US$1 trillion, it would be equivalent to 1.8% of global equity market capitalisation.
The funds sent to petroleum exporters do not leave the economy. This is important because it removes a confusing ‘thrift paradox’ or hoarding effect. Funds withheld from circulation means a reduction of velocity. In recessionary environment, the effect of decreased velocity is modest because there is little velocity, anyway. Funds are investments in exporters’ own domestic energy consumption. What takes place is a strong positive feedback loop as investments direct fuel supplies that would otherwise be exported toward local waste/external financing, instead.
Exporting countries are dependent upon foreign exchange and external debt, just like Greece. Hallelujah!
– Fuel wasted domestically by exporting countries means what remains in the ground is worth more. More (borrowed) funds are thence always available to finance more domestic waste.
– Regardless of the direction of the nominal price, the real price of fuel relative to other goods and services always increases.
– This dynamic remains in force until the amounts to be exported fall to zero. At that point the domestic consumption ALSO falls to zero because of an immediate cutoff of external credit! Isn’t being Greek fun?
Funds being used to finance consumption in the exporting countries: here is Jeffrey Brown’s and Sam Foucher’s ‘Net Oil Export’ concept! This blinding realization has been popping up more frequently in mainstream analysis (even though Brown and Foucher don’t get any credit).
What moderates the feedback loop is the accelerated depreciation of the exporters’ currencies and dollar preference and/or the sweeping of producers’ currencies from foreign exchange markets. So far, depreciation is not widespread and the high nominal dollar price (and lower dollar worth) mitigates against dollar preference. As nominal dollar prices decline post-demand destruction there will be increasing dollar preference and local currency revulsion as is taking place right now in Iran.
Figure 2: continuous quote of Nymex gold. The bullish trend continues as with crude with a correction taking place, probably for the same credit-related reasons. Less credit ‘in the world’ means less support for high gold prices. This is exactly the same mechanism that is beating down the price of houses and real estate in many parts of the world.
Note the correction that occurred in 2008. This 30% correction taking place at today’s elevated prices would drop gold prices to the $1,300-1,350 level. There are several forces working on the gold and silver markets.
– Gold is a natural resource, unlike petroleum it isn’t burned up driving in circles: it is both durable and valuable!
– Like the other natural resources it is increasingly in short supply. The ‘easy gold’ has already been mined, the ‘end of gold’ is likely drawing near as more and more credit is needed to mine and process gold bearing ores.
– There is a general consensus about gold’s worth, it is good security. ‘Good as zinc’ doesn’t have the same ‘ring’ to it.
– Central banks and the BIS are (probably) buying gold and will continue to do so as the motive for purchasing government securities is fear of finance instability. The context sets the frame for how securities are perceived. Halloween masks are poor security for government-issued currency: fear isn’t sexy.
– The accompanying question is whether gold is any sexier than other securities? ‘Monetary gold’ has its own baggage.
– Nominal prices are likely to decline but the real worth will increase as other assets are likely to decline faster.
What is the conclusion? Hard to say moment-to-moment but broke is broke.