Saudis Are Going for the Kill But the Oil Market Is Turning Anyway.
Date
4/20/2016 5:00:44 AM
(MENAFN- ProactiveInvestors - UK) Fuller Treacy Money 09:04
Saudis Are Going for the Kill But the Oil Market Is Turning Anyway.
Here is the opening of this informative article by Ambrose Evan-Pritchard for The Telegraph:
The collapse of OPEC talks with Russia over the weekend makes absolutely no difference to the balance of supply and demand in the global oil markets. The putative freeze in crude output was political eyewash.
Hardly any country in the OPEC cartel is capable of producing more oil. Several are failed states or sliding into political crises.
Russia is milking a final burst of production before the depleting pre-Soviet wells of Western Siberia go into slow run-off. Sanctions have stymied its efforts to develop new fields or kick-start shale fracking in the Bazhenov basin.
Saudi Arabia's hard-nosed decision to break ranks with its Gulf allies at the meeting in Doha - and with every other OPEC country - punctures any remaining illusion that there is still a regulating structure in global oil industry. It told us that the cartel no longer exists in any meaningful sense. Beyond that it was irrelevant.
Hedge funds were clearly caught off guard by the outcome since net 'long' positions on the futures markets were trading at a record high going into the meeting. Brent crude plunged 7pc to $41 a barrel in early Asian trading but what is more revealing is how quickly prices recovered.
Market dynamics are changing fast. Output is slipping all over the place: in China Latin America Kazakhstan Algeria the North Sea. The US shale industry has rolled over though it has taken far longer than the Saudis expected when they first flooded the market in November 2014. The US Energy Department expects total US output to drop to 8.6m barrels per day (b/d) this year from 9.4m last year.
China is filling up the new sites of its strategic petroleum reserves at a record pace. Its oil imports have jumped to 8m b/d this year from 6.7m in 2015 soaking up a large part of the global glut. Some is rotating back out again as diesel: most is being consumed in China.
Goldman Sachs says the twin effect of rising demand and supply disruptions across the world is bringing the market back into balance leading to a 'sustainable deficit' as soon as the third quarter. The inflexion point could come sooner than almost anybody expects if a strike this week in Kuwait drags on as oil workers fight pay cuts. The outage is already costing 1.6m b/d.
Kuwait's woes are the first taste of how difficult it will be for the petro-sheikhdoms to impose austerity measures or threaten the cradle-to-grave social contracts that keep a lid on dissent across the Gulf.
David Fuller's view
While I had seen this article in The Telegraph and was planning to use it I also received this email from a subscriber today:
I am sure you have read the above. He is saying precisely what you said many moons ago but the conclusion is I think somewhat different.
Thanks and yes he does have a different conclusion which I will comment on below but first here is the article's headline from the printed edition:
Saudi Arabia's strategy has killed Opec the cartel is now irrelevant
OPEC was rapidly losing control thanks to technology. However the Saudis have hastened this process by flooding the market. This was always going to be a Pyrrhic victory at best and it cut every oil producers' revenue much more quickly than was necessary. They could have kept prices at least $30 to $40 higher for the lengthy medium term by making some marginal supply cutbacks rather than flooding the markets with oil.
That opportunity was lost so what happens next?
The Weekly View: Better News Globally: Oil Prices and China Stabilize
My thanks to Rod Smyth for his ever-interesting market letter published by RiverFront. Here is a brief sample from the opening:
Global growth is tepid few would dispute that but markets are typically influenced by changes at the margin. Global stocks and most risk assets including oil bottomed on February 11. Since then the S&P 500 stock index and non-US stocks (as measured by Datastream) are up about 14% as of Friday.
Despite our consistent view that lower oil prices are a net benefit to the world it is undeniable that stocks in the US and especially outside the US have struggled to make any ground since mid-2014 when oil prices peaked.
David Fuller's view
At this stage of the global stock market cycle seven years plus to the upside for Wall Street and a few other developed markets such as New Zealand and Denmark but considerably weaker for most other global indices we can expect more volatile ranging. Most shares are not cheap.
This year's best news has been the weakening of the Dollar Index. Had it broken decisively above 100 as plenty of institutional speculators were betting the USA would have been considerably more susceptible to recession. It would have also caused more problems for countries which had borrowed US Dollars when the currency was considerably weaker. I credit surreptitious intervention by the US Treasury on behalf of the Federal Reserve for weakening the greenback.
Additionally there is a growing belief that China is finally coming to grips with its problems. Let us hope so because the world's second largest economy has considerable influence. However China's conundrum is that no command economy leadership has figured out how to move from a developing to a developed basis in the modern era let alone one largely ruled by one man. The world economy will be better off if China succeeds but watch out for further turmoil if / when the PRC devalues.
This item continues in the Subscriber's Area where The Weekly View is also posted.
My personal portfolio
A slightly in-the-money stop triggered
David Fuller's view
Details and charts are in the Subscriber's Area.
The Markets Now
Monday 25th April at London's East India Club
David Fuller's view
Iain Little guest speaker Charles Elliott and I look forward to discussing these interesting and challenging markets with subscribers and their friends. Both Iain and I will have plenty to say about precious metals. Charles will talking about promising UK technology shares.
If our mainly UK delegates at Markets Now are interested in a general discussion of Brexit we will allow some time for this before heading for additional conversations at East India Club's excellent cash bar. Do stay on and join us if you have the time.
Here is the current brochure.
Helicopters 101: your guide to monetary financing
Thanks to a subscriber for this report from Deutsche Bank explaining just how many tools are available to central bankers that go beyond conventional thinking. Here is a section:
It is the adoption of modern accounting standards for central banks that perhaps best summarizes the tension between a central bank's actual abilities and the institutional limits placed by modern practice. Unlike any corporate government or household a central bank has no reason to be bound by its balance sheet or income statement. It can simply create money out of thin air (a liability) and buy an asset or give the liability (money) out for free. It can run perpetual losses (negative equity) because it can fund these by printing more money.
Taking this fundamental principle on board leaves us with the following menu of policy options in ascending order of unorthodoxy. We accompany each option with a discussion on the implications for the CB balance sheet.
1. Quantitative easing combined with fiscal policy expansion: This is the least 'unconventional' option and is already happening albeit with a lack of explicit co-ordination. Central banks purchase interest-bearing government debt with a temporary increase in the monetary base.
This is accompanied by increased fiscal spending (or tax cuts) enacted by the Treasury in reaction to implicit central bank support for bond markets. The Treasury has more room to increase the deficit and the outstanding term of its maturing government bonds because financing costs are made lower by central banks but this support can be withdrawn at any time. In this case the central bank's assets and liabilities rise in parallel: the rise in central bank government bond holdings shows up as an increase in assets while the increase in private-sector cash holdings shows up as a rise in central bank liabilities.
2. Cash transfers to governments: Same as option (2) except the government debt is non-redeemable and hence the increase in the monetary base is permanent. Money can be credited directly to the Treasury account at the central bank which would keep government debt/GDP ratios stable. The central bank can purchase 0% coupon perpetuities from the Treasury which because they have no value should amount to the same thing.3 The precise impact on the balance sheet here will depend on the nature of the transaction with the government. In the case where cash is swapped for a zero-coupon perpetuity assets and liabilities would rise correspondingly but the central bank would make a loss because it would not receive a coupon on government debt while eventually having to pay interest on bank reserve balances if interest rates rise.
3. Haircuts on existing CB-held debt: The central bank can unilaterally restructure and/or forgive its government debt holdings improving government debt sustainability and allowing the Treasury room for future deficit spending. This can happen in a one-off fashion or according to some graduated rule. For instance the central bank could commit to write off 5% of government debt holdings until some target is achieved. The Greek OSI and PSI experience offers a precedent for distinguishing between privately and publicly held government bond holdings thus potentially avoiding CDS triggers. Note that central bank purchases of negative-yielding instruments are a form of notional haircuts as the government pays back to the central bank less than it issued. The resulting balance sheet change here is also straightforward: the central bank's assets would be reduced by the corresponding size of the haircut and this would be registered as a loss on the central bank's liability ledger.
4. Cash transfers to households: The most radical option has central banks create and transfer money to individuals directly (through cheques bank transfers or state pension contribution credits) cutting out the role of the Treasury entirely. In this case the central bank's liabilities would rise as the public's cash holdings against the central bank would show up as a rising liability. If no asset is purchased by the central bank the rise in the liability would have to be offset by a corresponding loss on the balance sheet in the form of negative equity.
Eoin Treacy's view
A link to the full report is posted in the Subscriber's Area.
Anyone who believes central banks have come close to the end of what can be achieved by monetary accommodation should read this report. When a central bank has the ability to create money out of the nothing there is absolutely no limit to what they can do in an effort to achieve their goals. The results might not be to everyone's' liking because items 2 3 and 4 above would stoke additional asset price inflation but that does not mean they cannot be implemented.
Australia's Stevens Posits Whether Policy Has Reached Its Limits
This article by Michael Heath for Bloomberg offers a window on the thinking of a major central banker approaching the end of his tenure so with little to lose. Here is a section:
Australian central bank Governor Glenn Stevens speculated that monetary policy may have reached its limits in spurring economic growth and suggested this could explain why markets are being easily rattled.
'Monetary policy alone hasn't been and isn't able to generate sustained growth to the extent people desire' Stevens said in a speech in New York on Tuesday. 'Maybe we need to be clearer about what we can't do. Monetary solutions are for monetary problems. If there are other problems in the underlying working of the economy central banks won't be able to solve those.'
The irony here is that Stevens who has resisted the global movement to further easing and kept his benchmark rate at 2 percent for almost a year is facing a currency that has reversed course in the past three months and threatened his push to broaden Australia's growth drivers. He warned in minutes of this month's policy meeting Tuesday that the Aussie's appreciation could complicate efforts to rebalance the economy away from mining.
Stevens who is in the final months of his 10-year stint at the helm of the Reserve Bank of Australia also questioned in the notes of his speech whether central banks and their unorthodox policies are solely responsible for the decline in long-term interest rates.
'Monetary policy is not supposed to be able to affect real variables -- like real interest rates -- on a sustained basis' he said. 'Presumably changes in risk appetite subdued growth and expectations that growth will continue to be subdued have also played a role in lowering real rates.'
Eoin Treacy's view
The need for Australia to develop additional sources of economic growth outside the resources sector was a major focus of attention while the price of commodities was falling. With the rebound in energy industrial resources and soft commodities now underway the urgency of that drive is less pressing. In fact it is likely to act as headwind because the RBA will be less inclined to ease monetary policy when commodities are doing well.
Eoin's personal portfolio: stock market index shorts opened
Musings From the Oil Patch April 19th 2016
Thanks to a subscriber for this edition of Allen Brooks' ever interesting report for PPHB. Here is a section:
In light of that view a critical question is whether a real economic transformation can be performed. An earlier attempt was made in 2000 following the late 1990s oil price downturn and the expensive Saudi-financed war to oust Saddam Hussein's troops from neighboring Kuwait. The financial pain of that experience was washed away by the rebound in oil prices that ended that transition effort. That experience leads Saudis to expect something to bail them out from having to make hard economic and social decisions.
Critical to this transition effort will be the mindset of the young Saudis who dominate the country's population. By 2030 the youth group will add 4.5 million new Saudis to the labor force nearly doubling its current size to 10 million workers. If the female labor force participation rate increases the number could be larger. This population demographic will force the economy to have to create three times the number of jobs for Saudis than it did during the oil boom of 2003-2013 which seems highly unlikely to occur.
There are a number of social impediments to making this transition occur including Saudi reluctance to take blue-collar jobs that are thought to be menial. Saudi workers enjoy the slow pace and shorter working hours of government jobs. There is also a problem associated with tapping the young females in the country who are constrained by the social stigmas of not being able to drive and not earning enough to employ a car and driver. Here is where modern technology is helping as Uber helps liberate some of these females. More females are taking white-collar jobs in the private sector. Instead of becoming teachers many are become lawyers and professionals. The challenge is that many of them are willing to trade down to government jobs with shorter hours when they have children. There are also social and employment issues involved with marriage when a woman's father prefers that a prospective husband have the security of a government job.
Probably the greatest challenge for Saudi Arabia is that both the rulers and the ruled have been satisfied with the social compact that underlies the nation. The populace trades loyalty and obedience to the government in exchange for prosperity which costs the government substantially. The new social compact will demand greater self-reliance from the people in exchange for their prosperity. Whether the populous understands how precarious their position is in continuing to depend on the government's continuing largess because of the current and future market for oil.
Eoin Treacy's view
A link to the full report is posted in the Subscriber's Area.
Governance is Everything has been a idiom at this Service for decades and Saudi Arabia has a long way to go before it can be considered that governance is improving regardless of how low the base is.
Fuller Treacy Money