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ENERGY - Conequences of $68/bl Oil

Oil Crash 12-01-14 Richard Duncan

The price of oil is crashing – and with good reason. Supply is surging, while demand is weak. Moreover, within just a few decades, new technologies, including solar and probably hydrogen fuel cells, will make oil completely obsolete. Anyone born after the middle of this century will probably never know the smell of gasoline.

The price of oil fell by $10 a barrel last week. It’s now down 40% since June. This oil price plunge will have a significant impact on the global economy, so it is important to consider both its causes and its potential consequences.

THREE MAIN CAUSES

1. SHALE OIL: There are three main causes. First and foremost is shale oil. Thanks to the shale oil revolution, the United States is now producing almost 9 million barrels per day, the most in 30 years. By the end of next year, US production will be approaching 10 million barrels per day. So, even with most Iranian oil off the market due to sanctions, and with Iraqi oil production at somewhere near a quarter of what it could have been had there been peace in that country during the last decade, global output is increasing sharply. According to the International Energy Agency (IEA), global supply was 93.8 million barrels per day (mb/d) in September this year, up 2.8 mb/d from one year earlier.
2. WEAK GLOBAL DEMAND: The second reason is that global demand for oil is weak. Demand from China is growing much more slowly than had been anticipated due to the economic slowdown there. US demand for oil is actually declining – in large part due to government regulations requiring improved fuel efficiency standards for cars. Furthermore, global economic growth is weak and there has been a very sharp slowdown in the growth in global trade. The IEA estimates global oil demand will be 92.4 mb/d this year and 93.6 mb/d in 2015.
3. GEO-POLITICAL CLASH: In addition to supply and demand factors, I believe there may also be a third reason for this oil price crash: the desire of the United States to punish Russia for supporting pro-Russian separatists in the Ukraine. Russia is one of the world’s largest oil producers. Russian government finances depend heavily on oil sales. Therefore, the drop in oil prices is a severe blow to Russia. I believe it is well within the power of the United States government to push down the price of oil by selling oil futures short. The lack of transparency or oversight within the $700 trillion Over-The-Counter derivatives market would permit the US government to do this without being noticed. Since this tool is available to US policymakers (and perhaps this is just the kind of situation that explains why the government has not imposed transparency on this market), no one should be surprised that they would employ it.

CONSEQUENCES OF $68/BL OIL

Now, what about the consequences? Ultimately, the consequences will depend on two things:

• How far the price of oil falls and
• How long it remains low.

Since we don’t know the answers to those questions, let’s focus on the consequences if the oil price stabilizes where it is now, at $68 per barrel for Brent.

1. CONSUMER "TAX CUT": Consumers will be better off. Lower gasoline prices will be like a tax cut for the middle class, who will be able to spend more on other goods.
2. SMALLER US TRADE DEFICIT: The US trade deficit will become smaller as the cost of oil imports falls (although this will be partially offset since Americans are likely to use their savings from a lower gasoline bill to buy more consumer goods made overseas). A lower trade deficit will boost GDP.
3. SHIFT IN CENTRAL BANK STANCES: Lower oil prices will mean more downward pressure on consumer prices and a greater risk of deflation. The fear of deflation is likely to cause the Fed and the Bank of England to delay their plans to increase interest rates, while it may force the European Central Bank and the Bank of Japan to accelerate their asset purchases.
4. LOWER SOVEREIGN BOND YIELDS: In most countries, government bond yields have already fallen in response to the increasing disinflationary/deflationary pressures that will result from lower oil prices. Government bond yields in a number of European countries fell to record lows last week.
5. SOVEREIGN FISCAL PRESSURES: The finances of the oil exporting countries will suffer. The currencies of Russia, Norway, Venezuela and Nigeria have already fallen significantly, reflecting the deterioration in those countries’ economic prospects.
6. PRODUCTION BREAKEVEN COSTS: Lower oil prices are likely to put some high cost producers out of business. Canadian oil sands look particularly vulnerable. Some of the marginal shale oil producers in the US may also go to the wall. As bankruptcies occur, defaults on energy junk bonds are likely to rise significantly. At this stage, I don’t believe that the losses in the junk bond market will be significant enough to cause a new financial sector crisis. Nor do I believe that so many wells will shut down in the United States that US oil production will begin to fall. Production costs have been falling rapidly and are likely to continue falling. Oil prices will have to fall considerably further before most of the new shale oil production becomes unprofitable. Of course, the possibility that oil will fall much further can’t be ruled out. It was $20 per barrel not all that long ago.
7. REDUCED CAPITAL FLOWS: Finally, the reduction in the US trade deficit will mean a reduction in capital inflows into the US. (Capital inflows are the mirror image of the Current Account Deficit, since every country’s balance of payments must balance.) The reduction in capital inflows will reduce the upward pressure on US asset prices that has come from this source in the past.

This has been an exciting few weeks in the oil markets and the drama could increase during the weeks ahead. But just imagine the extraordinary upheavals that will occur (in the markets and in geopolitics) when the realization eventually sets in that new technologies will make oil practically worthless sometime before the middle of this century. That realization still appears to be some time off, however. Between now and then, we are likely to see a number of other big swings in the price of oil, both up and down.

ENERGY - Conequences of Reduction in Liquidity Flows

SUMMARY

• FLOWS REDUCTION: $316bn hit to the cartel’s revenues which previously:
  • Boosted liquidity,
  • Spurred asset prices and helped to
  • Kept borrowing costs down,
  • The $316bn figure would be much higher if other big oil exporters including Russia, Norway, Mexico, Kazakhstan and Oman are taken into account.
• 40% fall in Brent crude since mid-June will reverse trend and for the first time in 20 years Opec nations will be sucking liquidity out,
• ASSET BUYING REDUCTION: In 2012 Opec petrodollar flows into liquid investments such as US Treasuries, high-grade corporate bonds and equities stood at $500bn. Next year, they could drop below $100bn if prices average $78 a barrel,
• US$ LIQUIDITY SQUEEZE : The US is importing less oil than it used to, meaning fewer dollars are being sent abroad: some analysts have said this could lead to a shortfall in dollar liquidity,
• SHIFT IN INVESTMENT PATTERNS: The main impact of the reduction of petrodollar flows will be less on liquidity than on investment patterns. What a sovereign wealth fund might put their money into will be different to what an asset manager might favour.
• FORCED ASSET SELLING: If stressed oil producers are forced to sell assets to fund gaps in their domestic budgets, that “could in theory be a good deal messier”

Flow of OPEC Petrodollars Set to Dry Up 12-03-14 FT

The flow of Opec petrodollars into global financial markets is set to dry up as the collapse in the oil price delivers a $316bn hit to the cartel’s revenues.

Big oil producers have pumped the windfall they enjoyed from soaring oil prices over the last decade into a huge range of global assets, from US Treasuries and high-grade corporate bonds to equities and real estate.

Qatar, for example, bought the Harrods department store and Paris Saint-Germain, France’s top football club, while Abu Dhabi’s sovereign wealth fund bought a stake in the glitzy Time Warner building in New York.

The flow of petrodollars into the global financial system boosted liquidity, spurred asset prices and helped to keep borrowing costs down.

But the 40 per cent fall in Brent crude since mid-June will reverse this trend, as the shrinkage of the oil producers’ cash pile removes a pillar of support for global markets.

“This is the first time in 20 years that Opec nations will be sucking liquidity out of the market rather than adding to it through investments,” David Spegel, global head of emerging market sovereign and corporate research at BNP Paribas.

BNP estimates that if oil production remains at its current level and oil prices stay at about $70 a barrel for the next year, Opec nations will receive $316bn less in oil export revenues than if oil prices were at their three-year average of $105.

George Abed, director for Africa and the Middle East at the Institute of International Finance, said at their peak in 2012, Opec petrodollar flows into liquid investments such as US Treasuries, high-grade corporate bonds and equities stood at $500bn. Next year, they could drop below $100bn if prices average $78 a barrel, he said.

This “comes on top of other trends that seem to be sucking liquidity out of the global system”, he said.

One of the key factors in the slowing flow of petrodollars is the surge in US oil production. The US is importing less oil than it used to, meaning fewer dollars are being sent abroad: some analysts have said this could lead to a shortfall in dollar liquidity.

The $316bn figure would be much higher if other big oil exporters including Russia, Norway, Mexico, Kazakhstan and Oman are taken into account.

Oil prices have fallen amid a surge in US shale production and weakening oil demand in China. Brent slipped further last week after Opec decided not to cut output to shore up prices.

George Magnus, economic adviser to UBS, said the main impact of the reduction of petrodollar flows will be less on liquidity than on investment patterns as wealth is transferred from oil-producing countries to consumer nations such as Japan that benefit from a lower oil price.

“What a sovereign wealth fund might put their money into will be different to what an asset manager might favour. We should expect a lot of churn,” he said.

Jason Shoup, analyst at Citigroup, said that the decline in petrodollar growth was “likely to equate to less demand” for bonds.

The shift could also have some bearing on when borrowing costs for governments, companies and consumers start to rise. With consumers spending more, the withdrawal of the Federal Reserve’s quantitative easing programme could become “that much more palpable,” he said.

However, Alan Ruskin at Deutsche Bank downplayed the impact of petrodollars on US markets as less Opec money has been flowing into the country in recent years.

In a note to clients, he said the size of annual inflows of petrodollars into US dollar and asset markets was “modest relative to total cross-border flows”. But if stressed oil producers are forced to sell assets to fund gaps in their domestic budgets, that “could in theory be a good deal messier”, he said.

Although some countries with huge foreign-exchange reserves such as Saudi Arabia are better able to withstand the pain from lower oil prices, others such as Venezuela will only suffer more if crude prices fall. Pierre Andurand, a prominent oil hedge fund manager, said that oil prices could drop to $60 a barrel next year.

GEO-ECONOMICS - Petro$$ Crisis and Energy Price (Demand) Collpase

GLOBAL RISK - Increasing Instability

CHINA - Shift in Monetary Policy

China's recently reduced lending & borrowing rates signals another monetary reversal.

They have caught the "western addiction"

Three Reasons China May Cut the Reserve Requirement Ratio 10-04-14 Bloomberg Brief

PATTERNS - Longest Streak In Stock Market History

The Longest Streak In Stock Market History... Is Over 12-01-14 ZH

For 29 days - off the Bullard lows - the S&P 500 closed above its 5-day moving average. As MKM's Jonathan Krinskynoted last week, this is the longest streak of sustained equity momentum higher in the history of US markets (surpassing the previous record 27 days from 1928). Today (well techncially Friday's early close) saw that streak come to an abrupt end...

The outcome post a reversal is mixed:

h/t @ReformedBroker and @JKrinskyMKM

PATTERNS - US versus World Markets

PATTERNS -NYSE Flashing Red

The World's Largest Stock Market Index Is Flashing Red 12-01-14 ZH

With a market capitalization of around $16 trillion, the NYSE Composite Index is a massively broad equity indicator less affected by the day to day gyrations of AAPL, TSLA, BABA, or NFLX. As NewEdge's Brad Wishak remarks, theworld's largest market cap equity index is painting a very different picture than that of the Dow or S&P 500...

Not only is there no breakout to new highs, you have a potential failure developing, not only at old swing resistance but more importantly at the old uptrend line.

As Wishak concludes - one for the radar.

RISK - Concerns

Five reasons why markets are heading for a crash 12-02-14 Telegraph, Jeremy Warner

1. DISCONNECT: Rising Equities While Bond Yields & Commodities Fall
2. EU: Falling oil prices may give Germany an excuse to delay ECB's QE,
3. POLITICAL UNCERTAINTY: Rise of populist, anti government parties in the EU,
4. INTERNATIONAL TURBULENCE: Oil has the potential to further destabilize,
5. NON-FINANCAL SECTOR DEBT: Up by more than 20% and likely has brought forward demand.

This bearish indicator just neared its precrash high 12-01-14 CNBC

Jubilant equity investors have been piling into U.S. exchange traded funds (ETFs) in the last few months, triggering a number of cautionary signals for stocks, according to U.S.-based tracker firm TrimTabs. An ETF is a security that tracks an index, like the S&P 500, and flows into these funds have been positive for four of the past five weeks, according to the research. A time of continued positive sentiment might be a good thing for some investors, but contrarians, who like to go against the grain, see it as a bearish signal that markets might have become too exuberant and are due to pull back.

TrimTabs also highlighted that inflows into these ETFs over the month ending Nov. 26 was $42.9 billion, near a level not seen since December 2007, shortly after the last bull market ended. This inflow figure is also five-times the year-to-date average.

Margin Debt Declines For The 4th Time This Year 11-25-14 GavKal

US$ NEARS CONSOLIDATION LEVEL

SPX UP AGAINST OVERHEAD RESISTANCE

"There is no FREEDOM without NOISE -

and no STABILITY without VOLATILITY."

German pastor Martin Niemöller initially supported Hitler. But he later opposed him, and was imprisoned in the Dachau concentration camp for years.

Niemöller learned the hard way that keep your head down doesn’t keep one out of trouble … in the long run, it increases the danger to all of us.

Niemöller wrote a brilliant poem – First They Came – about the manner in which Germans allowed Nazi abuses by failing to protest the abuse of “others” … first gypsies, gays, communists, and Jews, then Catholics … and eventually everyone.

“When the Nazis arrested the Communists, I said nothing; after all, I was not a Communist.

When they locked up the Social Democrats, I said nothing; after all, I was not a Social Democrat.

When they arrested the trade unionists, I said nothing; after all, I was not a trade unionist.

When they arrested the Jews, I said nothing; after all, I was not a Jew.”

Click To Enlarge

This is my modern interpretation of Niemöller’s poem …

First they tortured a U.S. citizen and gang member …
I remained silent;
I wasn’t a criminal

Then they tortured a U.S. citizen, whistleblower and navy veteran …
I remained silent;
I wasn’t a whistleblower

Then they locked up an attorney for representing accused criminals …
I remained silent;
I wasn’t a defense attorney

Then they arrested a young father walking with his son simply because he told Dick Cheney that he disagreed with his policies …
I remained silent;
I’ve never talked to an important politician

Then they said an entertainer should be killed because she questioned the government’s version of an important historical event …
I remained silent;
I wasn’t an entertainer

Then they arrested people for demanding that Congress hold the President to the Constitution …
I did not speak out;
I’ve never protested in Washington

Then they arrested a man for holding a sign …
I held my tongue;
I’ve never held that kind of sign

Then they broke a minister’s leg because he wanted to speak at a public event …
I said nothing;
I wasn’t a religious leader

Then they shot a student with a taser gun and arrested him for asking a question of a politician at a public event …
I remained silent;
I wasn’t a student

Then they started labeling virtually every innocent and normal behavior as marking Americans as “potential terrorists” …
I remained silent;
I didn’t want to be called a terrorist

Then they threw political dissenters in psychiatric wards …
I remained silent;
I didn’t want to be seen as crazy

Then they declared that they could label U.S. citizens living on U.S. soil as “unlawful enemy combatants” and imprison them indefinitely without access to any attorney …
I remained silent;
I didn’t want to be labeled an enemy

Then they assassinated an American citizen without any court trial
And they killed his son because he should have had a “far more responsible father” …
I remained silent;
I live on American soil

Then they declared that they could assassinate U.S. citizens living on U.S. soil without any due process of law (update) …
I remained silent;
I didn’t want to be on the list

Then they forced down the airplane carrying the president of a sovereign nation, because they were looking for a whistleblower
I remained silent;
I’m not a foreign leader

Then they called for the founder of an independent publisher to be killed by drone
I remained silent;
I don’t want to worry about drone strikes against me

Then they started spying on all Americans, even though top experts say that doesn’t protect us from terrorism
I remained silent;
I didn’t want to call even more attention to myself from the spies

Then they charged the partner of an investigative journalist with terrorism for transporting whistleblowing documents to the journalist regarding illegal NSA spying
I remained silent;
My wife isn’t a journalist

Then they targeted prominent, peaceful American Muslim lawyers for total  surveillance by the NSA and FBI 
I remained silent;
I’m not a Muslim

Then they used military weapons used in the Iraq war on peaceful African-American protestors
I remained silent
I’m not black

When they came for me,
Everyone was silent;
there was no one left to speak out.

FLOWS - Drying Up Quickly On Multiple Front

SUMMARY

• FLOWS REDUCTION: $316bn hit to the cartel’s revenues which previously:
  • Boosted liquidity,
  • Spurred asset prices and helped to
  • Kept borrowing costs down,
  • The $316bn figure would be much higher if other big oil exporters including Russia, Norway, Mexico, Kazakhstan and Oman are taken into account.
• 40% fall in Brent crude since mid-June will reverse trend and for the first time in 20 years Opec nations will be sucking liquidity out,
• ASSET BUYING REDUCTION: In 2012 Opec petrodollar flows into liquid investments such as US Treasuries, high-grade corporate bonds and equities stood at $500bn. Next year, they could drop below $100bn if prices average $78 a barrel,
• US$ LIQUIDITY SQUEEZE : The US is importing less oil than it used to, meaning fewer dollars are being sent abroad: some analysts have said this could lead to a shortfall in dollar liquidity,
• SHIFT IN INVESTMENT PATTERNS: The main impact of the reduction of petrodollar flows will be less on liquidity than on investment patterns. What a sovereign wealth fund might put their money into will be different to what an asset manager might favour.
• FORCED ASSET SELLING: If stressed oil producers are forced to sell assets to fund gaps in their domestic budgets, that “could in theory be a good deal messier”

FLOWS - Drying Up Quickly On Multiple Front

A Dramatic Change in the Liquidity Environment

GavKal 12-02-14