You know who doesn’t like a falling oil price? Sovereign wealth funds for countries dependent on high oil prices and in love with their (endangered) petrodollars.
And a risk based on that dislike is a presumption of forced selling and equity market weakness becoming self-fulfilling as/ if oil prices slide. Stable oil prices means SWFs don’t have to suddenly liquidate but the opposite would also seem to be true…
The last time JPM’s Flows & Liquidity team looked at this risk they based it on a fall in Brent to an average price of $45 per barrel.
They now assume an average oil price of $40 for 2016 and also note that the “YTD average has already fallen to $42.” Read more
It’s a theory at least, courtesy of a new Bernstein long read on the reported listing of 5 per cent of the state owned oil and gas giant by 2018.
The final highlighted bit being the point, with the question being “why now?”:
Often the simplest explanation is the most likely to be correct. With Saudi running a significant budget deficit, the listing of Aramco is one way to plug a gap in government finances. More broadly the listing of Aramco could be an example to other state owned firms, as Saudi reaches its ‘Thatcher’ moment in seeking to privatize state owned companies to increase efficiency as part of their plan to move beyond oil. The problem for oil markets is that privatized state companies tend to grow more quickly following privatization. Perhaps Aramco’s growth will be focused on refining and natural gas, but it is possible that Saudi have also realized that demand is likely to run out before supply and it makes more sense to deplete their own reserves ahead of others. While this is pure conjecture at this point, it could have bearish implications for oil markets. In the near term however, Saudi will not want to list Aramco at a low oil price. In the run up to 2018, we expect that Saudi will do everything in its power to ensure oil markets remain balanced and prices stable. This could be positive near term for oil equities.
If that last theory is correct, it’s a solid end of the oil age gambit that is based in part on an eventual race to produce kicking in. Read more
Something of significant note just occurred in the global oil hierarchy.
According to a Bloomberg report filed on Wednesday afternoon (UK time), Saudi Arabia may be considering paying some outstanding bills to contractors using government-issued bonds.
Contractors, they added, would be able to hold bond-like instruments until maturity.
This is quite something, not least because paying your contractors with short-term bonds is not entirely dissimilar to paying them with IOUs. Read more
Because if his Royal Highness the prince wants the world’s largest sovereign wealth fund — then who’s to say no?
As for the Arab and Islamic depth, we have the Qiblah of Muslims. We have Medina. We have a very rich Islamic heritage.
We have great Arab depth. The Arabian Peninsula forms the basis of Arabism. The kingdom constitutes a large part of it. That issue has not been exploited in full.
We have a pioneer investment power at the level of the world. Today, you see that many statements are being made, including statements indicating that the Saudi Sovereign Fund will be the largest fund in the world by far, compared to the other funds.
That will be the main engine for the whole world and not only the region. There will be no investment, movement or development in any region of the world without the vote of the Saudi Sovereign Fund.
Commodity curve purists insist that long-term futures prices must not be confused with market forecasts.
People who do that are deemed commodity dummies because long-term futures are said to reflect the price at which market participants are prepared to buy or sell commodities in the future today. That generally means prices that make sense for them right now, but not necessarily those they expect in the future.
As a result, certain assumptions can be made about curve structures.
If long-dated futures are very much higher than spot prices, the market is offering premiums to those who have the capacity to take delivery today and store the oil until the future. It’s a dynamic that indicates an abundance of oil in the spot market today, rather than an expectation that prices will be higher tomorrow. It’s known as a contango market and is generally a bearish signal. Read more
We recently had a chance to chat with a senior Canadian economic policymaker. Among other topics — he estimated fiscal stimulus would boost growth by around half a percentage point in 2016 and by a full percentage point in 2017 — we discussed his belief the depreciation of Canada’s currency could help export growth offset some of the weakness in the oil economy. What follows is an attempt to assess Canada’s progress so far.
For context, the Canadian dollar has lost about 21.5 per cent of its value against the currencies of its trading partners since the most recent peak in mid-2011, although the loonie had dropped as much as 31 per cent before the recent rally in risky assets:
Take the end to the protest by oil workers in Kuwait:
The extraordinary story concerning Monegasque ‘energy services’ group Unaoil, broken jointly by the Fairfax media titles in Australia and Huffington Post in the US 24 hours ago, looks about to erupt fully.
Here’s the statement released by the Principality on Thursday evening. It seems Britain’s SFO has been first off the mark acting on the findings of a six month long journalistic investigation. The findings will be of interest to certain US regulatory bodies as well, no doubt. Click to read… Read more
Back in October, 2015, Bloomberg’s Tracy Alloway and I struck an OTC futures deal over a teeny, tiny vial of crude oil, which Tracy for some reason felt compelled to nickname “Williston”.
Read about it here.
I now plan to default on this contract (a ladies’ agreement, witnessed by “the world” due its publication on Bloomberg) and this is a public notice explaining my reasons for doing so. Read more
A quick reminder that we’ll be hosting a special edition of Macro Live today at 1:55pm to cover the release of the FOMC statement and subsequent presser.
There’s only a 3.4 per cent chance the Federal Reserve will raise rates today, according to Bloomberg’s WIRP function and the prices of overnight index swaps.
As recently as the end of December 2015, market prices implied odds of at least one rate hike by tomorrow at more than 40 per cent:
It was not too long ago that analysts and economists were arguing that core petrodollar states, such as Saudi Arabia, would be able to withstand a longstanding reversal in the oil price even as weaker petrodollar states such as Venezuela and even Russia took notable hits. Not so much any more.
From Moody’s on Wednesday (our emphasis):
We have changed our outlook for the Saudi Arabian banking system to negative, from stable. The change reflects the credit implications of our revised global oil price forecasts, which we expect to be lower for longer. It also captures new fiscal measures initiated in December by the Saudi government to tackle its rising budget deficit.
FT Alphaville readers will not be strangers to the argument a ballooning petrodollar float over the last decade set alight an emerging market export feedback loop, one of dot comedy vendor-financing proportions. Or how encumbered petrodollars have played an important role in the counterintuitive side-effects of a drop in the price of oil.
The analysts at Citi are on the case as well, calling it “Oilmageddon — death by circular reference”.
Here’s the thrust of their argument set out in a note published Friday (our emphasis):
It appears that four inter-linked phenomena are driving a negative feedback loop in the global economy and across financial markets: 1) stronger USD, 2) weaker oil/commodity prices, 3) weaker world trade/capital flows, eg petrodollars, and 4) weaker EM growth. This cycle then repeats.
The world is a confusing and tangled web of interconnections. One such set of interconnections relates to the cost and storage of commodities and how it feeds into the wider economy.
For years we’ve made a simple point: the return on commodities is pretty indicative of the natural rate of return. When the return on money beats the return on holding commodity inventories, commodity companies are encouraged to drawdown on inventories in a bid to turn them into higher yielding monetary holdings. All of which has two effects.
In the first instance this encourages a liquidation effect. Commodity prices fall as the market scrambles to swap oil for cash reserves. In the second instance it reduces the amount of buffer commodity stocks in the economy, because holding anything other than emergency reserves is considered a capital cost. Read more
Stocks and corporate bonds haven’t been doing so well lately, while the market-implied probability of four Fed rate hikes by the end of this year — the median expectation of policymakers as of December — has plunged below 1 per cent (according to Bloomberg’s WIRP function, anyway). Reasonable people are now starting to wonder whether another downturn is imminent.
Changes in prices could be signalling weakness yet to be captured by the official statistics on employment, output, and incomes. Even if you don’t believe asset prices contain useful information, it’s possible the hit to net wealth could encourage households and businesses to cut spending, thereby leading to recession and job losses.
We can’t answer whether a recession is around the corner, although the probability of another downturn necessarily rises with time since the last one. Instead, we want to lay out some of the main arguments and think through what various downside scenarios might look like. Read more
The intuitive impact of falling oil prices is that it’s a hammer blow for producers and a gift for countries that are net importers. There is obviously some truth in this. Saudi Arabia, for example, is having to take drastic action to cut its fiscal deficit, while Venezuela is in crisis, with chronic shortages of basic everyday goods.
But as we have written before, falling oil prices also impose discipline on sovereigns who were previously able to use a torrent of petrodollars to cover up economic, political and social fractures. And conversely for emerging market importers, the benefit of lower oil costs is likely far outweighed by the broader carnage created by a collapsing energy industry, reversing petrodollar flows and the decreasing appetite for risky EM assets. Read more
Consider this chart from Charles Robertson at Renaissance Capital. Click to enlarge…
Some bullet points from JP Morgan’s Flows & Liquidity team to start the week.
Signs of capitulation, as they put it, in the face of a slowing China, the CNY and its “depaluation”, the Fed, a liquidity vacuum etc:
Retail investors were heavy sellers of equity funds for two consecutive weeks on extreme pessimism.
While the world contends with the consequences of shrinking petrodollar flows, Emad Mostaque at consultancy Ecstrat provides an interesting take on the potential benefits of such reversals for petro sovereign Saudi Arabia.
Tl;dr: It’s a blessing in disguise because it forces the kingdom to restructure its economy and reduce its dependency on foreign labour and hydrocarbon receipts.
As Mostaque explains, to-date Saudi Arabia’s rulers have supported a social contract with the populace wherein the state offers a level of employment surety through the public sector and benefits, while almost all of the private sector workers are foreigners without settlement rights: Read more
History never repeats and most analogies are wrong, but there are some intriguing parallels between the global macro environment in 1997-8 and today.
Back then, the Federal Reserve controversially chose to ease policy, first by refraining from rate hikes anticipated by the markets and then by cutting its target for Fed funds by 75 basis points. Many believe this choice inflated equity prices and encouraged excessive business investment at a time when America’s economy was already running hot. Despite the subsequent fillips of tax cuts, a boom in defence spending, and a housing bubble, the aftermath was a massive decline in employment and painfully slow recovery.
A simple comparison between conditions then and now suggests the Fed’s explicit desire to “normalise” financial conditions may come from a desire to avoid repeating the experiences of the late 1990s. Whether policymakers are right to prioritise the real economic data, which tells us what’s already happened, over the action in the financial markets, which tends to affect what will happen, is anyone’s guess. Read more
One to watch in the next few weeks — Kinder Morgan, as the energy company approaches junk status:
A few quick things to note. Read more
With Goldman raising the spectre of a $20 crude price, here’s an alternative scenario from Ecstrat strategist Emad Mostaque…
After years of being too high, oil forecasts now appear too low. As supply rolls over we could see prices back at $100, with decade-high geopolitical risks shocking it higher. Read more
Money printing was supposed to cause an inflationary collapse, right?
Except, points out Seth Kleinman at Citi on Wednesday, by encouraging investment in risky commodity ventures like shale, easy money has in reality ended up causing a deflationary feedback loop of hell.
The access to cheap financing that low rates and QE generated has been deflationary in two key ways: 1) the growth of shale and the sanctioning of very high breakeven projects that cheap financing made possible has glutted the markets with oil; and 2) the rampant growth of shale, which is located in the middle of the cost curve and has significantly shorter lead times for first oil versus conventional production, acts as a buffer against price rises. Furthermore, given how much of the EM growth story of the previous decade has been driven by the rise of commodity exporters, the negative growth shock from lower commodity prices is compounding the first order deflationary impact in the US and Europe.
Despite some ups and downs, bonds issued by dodgy borrowers are essentially flat since the start of 2014 — and that’s only after accounting for hefty interest payments:
Ever since oil prices started plunging last summer, people have been wondering whether the producers responsible for the supply added since 2010 — mostly in the US and Canada — would want to keep pumping. How many US shale wells, for example, would be economically viable in a world where the West Texas Intermediate price was about $45 per barrel instead of $100?
It’s now been long enough to get a sense of the answer. Compared to the peak almost exactly one year ago, the number of US rigs drilling has collapsed by 62 per cent, according to Baker Hughes: Read more
About a year ago — a few days before Opec spooked the world with its decision to wage war on shale producers with an oil production race to the bottom, but following a few months of steady oil declines post the Fed’s decision to start signalling an upcoming tightening path — we speculated regarding a what if scenario based on the hypothetical eventuality of no petrodollars :
The monthly IEA oil market report puts things about as simply as they can be put:
In our Christmas podcast and this post, we warned of the eery similarities between the oil market of today and the oil market of JR Ewing and Blake Carrington in the 1980s.
We even predicted that if history tells us anything we might soon be blessed with a modern equivalent of a Dynasty and Dallas TV series, something along the lines of “North Dakota Millionaires”. Read more
Many shale producers outspend cash flow and thus depend on capital market injections to fund ongoing activity.
That’s from Citi’s Richard Morse and Edward Morse (related?), plus team, on the way capital markets rather than cartels are driving commodity prices these days. The note is titled: “From Cartel to Capital Markets: Investors Join OPEC Shaping Oil Market Dynamics.”
This of course relates to our point on Monday that even the big commodity traders have been forced to turn to market-based funding in lieu of a dearth of bank finance in the sector. Read more
From the IEA’s Oil Market Report released on Wednesday: