Get Ready for $10 Oil Rising oil production and falling demand will combine to drive oil prices lower. By A. Gary Shilling – Feb 16, 2015, 6:00:02 PM

Get Ready for $10 Oil
Rising oil production and falling demand will combine to drive oil prices lower.

By A. Gary Shilling – Feb 16, 2015, 6:00:02 PM

Black, yes. Gold, not so much.
At about $50 a barrel, crude oil prices are down by more than half from their June 2014 peak of $107. They may fall more, perhaps even as low as $10 to $20. Here’s why.

U.S. economic growth has averaged 2.3 percent a year since the recovery started in mid-2009. That’s about half the rate you might expect in a rebound from the deepest recession since the 1930s. Meanwhile, growth in China is slowing, is minimal in the euro zone and is negative in Japan. Throw in the large increase in U.S. vehicle gas mileage and other conservation measures and it’s clear why global oil demand is weak and might even decline.

Oil Prices

At the same time, output is climbing, thanks in large part to increased U.S. production from hydraulic fracking and horizontal drilling. U.S. output rose by 15 percent in the 12 months through November from a year earlier, based on the latest data, while imports declined 4 percent.

Something else figures in the mix: The eroding power of the OPEC cartel. Like all cartels, the Organization of Petroleum Exporting Countries is designed to ensure stable and above-market crude prices. But those high prices encourage cheating, as cartel members exceed their quotas. For the cartel to function, its leader — in this case, Saudi Arabia — must accommodate the cheaters by cutting its own output to keep prices from falling. But the Saudis have seen their past cutbacks result in market-share losses.

So the Saudis, backed by other Persian Gulf oil producers with sizable financial resources — Kuwait, Qatar and the United Arab Emirates — embarked on a game of chicken with the cheaters. On Nov. 27, OPEC said that it wouldn’t cut output, sending oil prices off a cliff. The Saudis figure they can withstand low prices for longer than their financially weaker competitors, who will have to cut production first as pumping becomes uneconomical.

What is the price at which major producers chicken out and slash output? Whatever that price is, it is much lower than the $125 a barrel Venezuela needs to support its mismanaged economy. The same goes for Ecuador, Algeria, Nigeria, Iraq, Iran and Angola.

Saudi Arabia requires a price of more than $90 to fund its budget. But it has $726 billion in foreign currency reserves and is betting it can survive for two years with prices of less than $40 a barrel.

Furthermore, the price when producers chicken out isn’t necessarily the average cost of production, which for 80 percent of new U.S. shale oil production this year will be $50 to $69 a barrel, according to Daniel Yergin of energy consultant IHS Cambridge Energy Research Associates. Instead, the chicken-out point is the marginal cost of production, or the additional costs after the wells are drilled and the pipes are laid. Another way to think of it: It’s the price at which cash flow for an additional barrel falls to zero.

Last month, Wood Mackenzie, an energy research organization, found that of 2,222 oil fields surveyed worldwide, only 1.6 percent would have negative cash flow at $40 a barrel. That suggests there won’t be a lot of chickening out at $40. Keep in mind that the marginal cost for efficient U.S. shale-oil producers is about $10 to $20 a barrel in the Permian Basin in Texas and about the same for oil produced in the Persian Gulf.

Also consider the conundrum financially troubled countries such as Russia and Venezuela find themselves in: They desperately need the revenue from oil exports to service foreign debts and fund imports. Yet, the lower the price, the more oil they need to produce and export to earn the same number of dollars, the currency used to price and trade oil.

With new discoveries, stability in parts of the Middle East and increasing drilling efficiency, global oil output will no doubt rise in the next several years, adding to pressure on prices. U.S. crude oil production is forecast to rise by 300,000 barrels a day during the next year from 9.1 million now. Sure, the drilling rig count is falling, but it’s the inefficient rigs that are being idled, not the horizontal rigs that are the backbone of the fracking industry. Consider also Iraq’s recent deal with the Kurds, meaning that another 550,000 barrels a day will enter the market.

While supply climbs, demand is weakening. OPEC forecasts demand for its oil at a 14-year low of 28.2 million barrels a day in 2017, 600,000 less than its forecast a year ago and down from current output of 30.7 million. It also cut its 2015 demand forecast to a 12-year low of 29.12 million barrels.

Meanwhile, the International Energy Agency reduced its 2015 global demand forecast for the fourth time in 12 months by 230,000 barrels a day to 93.3 million and sees supply exceeding demand this year by 400,000 barrels a day.

Although the 40 percent decline in U.S. gasoline prices since April 2014 has led consumers to buy more gas-guzzling SUVs and pick-up trucks, consumers during the past few years have bought the most efficient blend of cars and trucks ever. At the same time, slowing growth in China and the shift away from energy-intensive manufactured exports and infrastructure to consumer services is depressing oil demand. China accounted for two-thirds of the growth in demand for oil in the past decade.

So look for more big declines in crude oil and related energy prices. My next column will cover the winners and losers from low oil prices.

To contact the author on this story:
A Gary Shilling at insight@agaryshilling.com

To contact the editor on this story:
James Greiff at jgreiff@bloomberg.net

Commodities Decline to 2009 Low as China Signals Slower Growth (US Interest Rates)

By Chanyaporn Chanjaroen Bloomberg Sep 22, 2014 1:45 AM ET

Commodities fell to a five-year low on speculation that slowing Chinese growth will temper demand in the world’s biggest metals and energy consumer.

The Bloomberg Commodity Index (BCOM) of 22 raw materials dropped as much as 0.7 percent to 118.652, the lowest since July 2009, before reaching 118.6568 by 1:44 p.m Singapore time. Corn and soybeans fell to the lowest since 2010 as nickel touched a five-month low and crude slid for the third time in four days.

Commodities are 12 percent lower this quarter, set for the biggest such loss since the financial crisis in 2008. China’s Finance Minister Lou Jiwei said in a statement yesterday that growth in Asia’s largest economy faces downward pressure. Data tomorrow may show China’s manufacturing slowing for a second straight month, according to a Bloomberg survey.

“We are looking at a downturn right now as China continues to disappoint,” Justin Smirk, a senior economist at Westpac Banking Corp., said today by phone from Sydney. “It’s about the uncertainty that people are worried about.”

A preliminary reading on the HSBC Holdings Plc and Markit Economics China Purchasing Managers’ Index for September will probably show a drop to 50 from 50.2 in August. A reading above 50 shows expansion.

Commodities have also slid this quarter as speculation the U.S. will lift interest rates boosted the dollar, increasing demand for commodities priced in the U.S. currency. The Bloomberg Dollar Spot Index is poised for a 5.1 percent advance, the most since 2011, and touched a four-year high on Sept. 18. U.S. Federal Reserve officials last week raised their median estimate for the federal funds rate at the end of 2015 to 1.375 percent, compared with 1.125 percent in June.

Brent crude for November settlement slid as much as 0.6 percent to $97.85 a barrel on the London-based ICE Futures Europe exchange, set for a third month of losses. Soybeans in Chicago dropped as much as 1.5 percent to the lowest since July 2010 as U.S. farmers started to harvest the biggest crop ever. Nickel futures in London retreated as much as 4.6 percent.

To contact the reporter on this story: Chanyaporn Chanjaroen in Singapore at cchanjaroen@bloomberg.net

A Tremor in the World Economic Force?


An Economic Problem in China Could Affect Everyone.
1) Oil could drop like a rock
2) US Bonds Could Fall Without China Buying Them
3) International Trade Could Slow Down impacting everyone
New York Times
December 27, 2013

Markets on Edge as China Moves to Curb Risky Lending

By NEIL GOUGH and 

HONG KONG — China’s financial system is in danger of becoming too big to bail out.

Official bank lending has more than doubled since the global financial crisis, growing nearly twice as fast as the overall economy. The even bigger problem, however, appears to come from the rise of a shadow banking system that has allowed a number of companies and individuals, often with political connections, to borrow from state-controlled banks at low interest rates and relend the money at much higher rates to private businesses desperate for credit at almost any price.

Now, in an effort to wean the banks and the economy off their addiction to such risky practices, Beijing has pledged to deliver what amounts to the country’s most sweeping financial overhaul in decades. Markets will play the “decisive” role in directing the economy, policy makers promised last month after a key plenum meeting of the Communist Party leadership. Interest rates are to be liberalized, cross-border investment will be welcomed and regional and bureaucratic protectionism will be curtailed, they declared.

But already, even relatively modest government moves are producing turbulence in money markets; just this week China’s central bank was forced to back off, at least temporarily, to avoid putting too much stress on the banking system and potentially drawing an angry reaction from powerful vested interests in China accustomed to paying very little for their loans.

“It’s been pretty clear since June, and especially clear since the plenum, that the new crowd is interested in tightening monetary policy and letting interest rates rise,” said Arthur R. Kroeber, the Beijing-based managing director of GK Dragonomics, an economic research firm. “The purpose is to reduce the rate at which credit is expanding, which has been a bit of a problem over the last couple of years.”

China has experimented twice this year with much higher, market-driven interest rates. As with a similar experiment in June, the central bank allowed rates late last week and early this week to soar to unsustainable levels. Instead of regularly scheduled open-market operations, the bank tried unconventional methods of guiding money markets.

That approach involved the central bank’s turning to posts on China’s Twitter-like social messaging service, Sina Weibo, to chasten banks to “make rational adjustments to the structure of their assets and liabilities, and improve their liquidity management using a scientific and long-term approach.”

But as in June, the experiment did not last long. On Tuesday, China’s central bank, the People’s Bank of China, provided a direct injection of fresh money after the market pushed seven-day interest rates to nearly 10 percent, double their earlier level. The central bank’s action eased pressure on the financial system and quelled fears of an immediate credit crisis. But rates remain elevated, and the bank may have only postponed the moment of reckoning for a few months.

“The key message from the current central bank-induced tightness is deleveraging,” said Stephen Green, the head of research for greater China at Standard Chartered. “We’ll see what happens when we see greater levels of corporate distress in 2014, whether Beijing buckles or not.”

A complex and loosely regulated network of financial go-betweens has sprung up to profit from repackaging and reselling China’s new mountains of debt, turning loans into investment products. Such products have become popular among ordinary investors in China because they pay much higher interest rates than deposits in savings accounts, where rates are capped by the government to protect the state-owned banking system from competition.

But loosely regulated financial businesses can make a dicey business model, as Wall Street learned in 2008. And they pose a particular threat in an economy where growth is slowing, as it has been in China for the last three years.

“The final users of the money will not be able to earn returns high enough to repay the money and promised interest,” said Yu Yongding, a senior fellow at the Institute of World Economics and Politics of the Chinese Academy of Social Sciences and a former member of the monetary policy committee at China’s central bank. “The chains of lending and borrowing can be long, just like the securitized subprime mortgages. The result can be devastating.”

Indeed, the real-life stress tests the central bank has been experimenting with are not without casualties. As markets became jittery in the run-up to the June credit crunch, two branches of the state-owned China Everbright Bank technically defaulted on 6.5 billion renminbi, or $1.1 billion, worth of short-term payments.

In a regulatory disclosure that was part of its $3 billion Hong Kong share offering earlier this month, the Everbright Bank explained that while it had sufficient financing and liquidity at the corporate level, “the branches did not manage to fulfill their obligations to repay short-term interbank loans.” Instead, the payments were settled a day late.

The bank said that in response to the episode and to the greater volatility in China’s bank-to-bank lending market, it had increased reserve levels and “emphasized among our departments the overriding importance of sound liquidity.”

The big risk for China’s cosseted banks is not necessarily bank runs of the sort seen in the early 1930s in the United States, with depositors lining up to withdraw money before a bank can fail. The Chinese authorities have made clear that they will not tolerate disorderly closures of banks, and over the years have reportedly rushed cash to banks that faced sudden withdrawals.

Instead, the greater worry has been what some experts describe as “a walk on the banks” — depositors steadily removing their savings from banks after losing enthusiasm for deposit rates that have long been set by regulation at levels often below the inflation rate and only occasionally slightly above it. That slow drain could imperil the banks’ ability to continue pumping ever-larger loans to state-owned enterprises and politically connected individuals, even when many of those loans appear to be for helping borrowers repay previous loans.

Banks in China have been able to stay profitable while lending at low rates only because the government has required all of them to pay even lower rates for deposits. Savers have had few alternatives to banks until very recently: Real estate prices are already stratospheric relative to incomes, the weakly regulated and highly speculative domestic stock markets are widely distrusted and shadow banking businesses are periodically reined in by the government.

Total credit in China, although growing fast, remains slightly smaller relative to economic output than in the West. The worry is that the eventual proportion of nonperforming loans may prove even higher than other countries have had to manage, while China’s less developed financial system may make it hard to bail out less regulated entities, even as the central bank retains tighter links to the four main state-owned banks.

While policy makers say they are worried about upsetting the delicate mechanisms of the current banking system, public criticism continues to grow, even within China’s elite. That suggests further market-oriented experiments could be coming soon.

“Banking in China has become like a highway toll system,” Yao Jingyuan, the former chief economist at the state statistics agency, said late last week during a speech at Nanjing University, according to numerous Chinese news reports. “Banks charge every time money goes through them.”

“With this kind of operational model,” Mr. Yao added, “banks will continue making money even if all the bank presidents go home to sleep and you replaced them by putting a small dog in their seats.”

The Future Of Shale Development Worldwide, In Three Charts

world shale map

You may have seen the above map showing worldwide shale basins. It seems like a lot of other nations could replicate America’s shale boom if they only put their minds to it.

But while Mother Earth may have generously distributed her deposits of unconventional resources, she and Man have also conspired to make them not all equally accessible.

Scott Gruber at AllianceBernstein has created three annotated charts showing the amount of known shale reserves for all major countries, and the barriers to companies’ ability to drill there.

Check it out:

Europe, who arguably needs it most as it faces an energy cost crisis, has put in place the greatest restrictions to accessing its reserves.

  world shale scene

Latin America, led by Argentina, will likely be runner-up to the North American boom. 

world shale scene

Asia, especially China, has great potential, but, for now at least, the rocks there are a bit more difficult to drill.

world shale scene