Oil bounces back, IEA gives supply warning. Is it set to soar again?
It’s up again. At the time of writing, oil stands at $70.49 a barrel, meaning it has risen by around 10 per cent in just two days. Is this a new trend?
According to the International Energy Agency, oil production is going to lag behind demand for decades, or so says the FT, which claims to have seen an early copy of the IEA report due out in a few weeks.
So is that it? Is the decline in the price of oil over?
Have you noticed the similarities between the arguments over the price of oil and house prices? On the one hand, you have got those who argue prices will always go up, because demand growth is outstripping supply. On the other hand, you have those who say it just doesn’t work like that. Real demand is based on what people can afford, and in the longer-term there is a limit to just how much prices can go up. Who is right?
The Centre for Economics and Business Research has been predicting a rapid bounce in house prices in a couple of years time, as demographic factors take their toll. And now you have the IEA saying oil output can not keep up with demand, and presumably, argues prices will rise as a result.
According to the FT, the IEA reckons the big problem is lack of investment. In order to make up for declining output from existing oil fields, the world needs to see a massive surge in oil investment of around $360 billion a year, and says even then oil output will decline by 6.4 per cent a year.
But the truth is, oil at the kind of prices it stood at a couple of months ago is just unaffordable. Surely, oil at around £150 probably had as much to do with the current economic crisis, than silly bankers and their reckless lending. And we now know that the world can not afford oil significantly north of current prices. Under current economic conditions, demand will inevitably be less than potential supply.
Oil may have risen by $8 over the last couple of days, but expect it to fall back. This week has seen a return of optimism. But it is patent nonsense to think global demand is set to start rising again. Yesterday’s decision by the Fed to cut rates will not show up in the real economy for months, maybe longer.
In fact, if anything, such is the state of the global economy, demand for oil is likely to mean prices will fall back a good deal further over the next year or so.
But the curiosity is this. In the last oil cycle, the black stuff fell to $10. If the global economy really is in the kind of state people are saying, then it is possible we could see a repeat of that. Imagine oil falling back to those levels; you can see where the impetus will come from for the economic recovery.
But, actually, if oil did fall much further than the current price, it really would be disastrous. And it would be disastrous for a reason that just doesn’t apply to house prices, either.
In the longer-term, we need to find alternatives to oil. Renewable energy has the potential to solve the world’s energy needs in perpetuity, as well as providing the fix to the terror of climate change. But this will only happen if investment in renewable energy soars, and then soars some more.
See it terms of a Sony PlayStation 3. You may recall, when Sony first announced their product, reports out there said the components alone would cost over $500. But when the product was released, and more and more units were sold, economies of scale were exploited, costs fell and, with that, demand rose. Component costs then fell all the more. That is why games consoles can fall by as much as 400 per cent in prices within around four years of launch.
It is like that with energy, too, but the time-scales involved are just more protracted.
But renewable energy needs to gain traction first. Should the price of oil collapse, then the day when global energy needs can be met by the limitless, and effectively free, source of the sun, will be put back. And that is something we can not afford to let happen.
Inflation hits 16-year high
And as eyes turn to the real economy, inflation rears its ugly head. During the pandemonium of the last few weeks, inflation had been all but forgotten. But many fear the cost of the banking bails out will mean a return of inflation. So, keeping an eye on that particular beast remains important, and here is the worry. Inflation hit a 16-year high in September. It is now so much higher than the Bank of England’s official target that it is just plain embarrassing.
In fact, the CPI rate of inflation rose to 5.2 per cent last month, from 4.7 per cent in August. Remember, the Bank of England’s official target is just 2 per cent.
And here is an intriguing aspect of the data. You may recall that when the government told the Bank of England to monitor the consumer price index (CPI), instead of the retail price index (RPI), many warned this would be a mistake. After all, the CPI index tends to be lower, since it excludes council tax and mortgage payments. Well, in September, for the first time since the change in inflation targets, the CPI rate was lower than the retail price index. (Actually, it is a little more complex than that; the Bank of England used to monitor a variation of the RPI, the RPIX index, which still stands at 5.5 per cent, and it is clear that the gap between the two indices is falling rapidly – but the point is, the RPI is the index the press used to focus on.)
And so, it seems, inflation is back.
The Institute of Fiscal Studies is worried. “Older and poorer households are currently facing the highest average inflation rates because they spend much more of their budget on food and fuel than other households and these are precisely the items rising most rapidly in price. In September 2008, food inflation as measured by the RPI was 11.2 per cent while household fuel inflation was 39.6 per cent. Fuel inflation is now higher than any time since at least 1975,” it said. It explained: “Households in the poorest 10 per cent of the population had an average inflation rate of 7. 9 per cent in September compared to rate of 5.1 per cent for those in the richest 10 per cent.”
But, actually, the point is this: it is all changing. The ONS said: “Food inflation slowed for the first time since March, from 14.5 in August to 12.7 in the year to September.” This is a trend that the British Retail Consortium is celebrating. Stephen Robertson, Director General of the British Retail Consortium, said: “The good news is these figures show we have passed the peak of food inflation.” He went on: “With competition fierce and customers highly value-conscious, retailers are rushing to pass on the benefits of slowing inflation for produce at the farmgate and falls in world costs, such as oil and wheat.”
Then, tellingly, he added: “Shop prices of non-food goods are barely increasing at all.”
So food inflation maybe going into reverse, non-food inflation is fine, why is the CPI index so high?
Well, first of all, remember this: 12 months worth of data makes up the inflation stats. Month on month food inflation may be negative, but it will take almost a year before that shows up in annual falls.
But the killer is, of course, energy.
“Electricity prices rose to 30.3 per cent year on year, up from 18.0 per cent in August. Gas inflation rose to 49.9 per cent, up from 27.7 per cent in August,” said the ONS.
The snag is, the big energy suppliers buy their fuel in advance, and they will often use the futures market to guarantee the prices they pay down the line. But oil is falling rapidly, and when this starts to show up in the data, the monthly falls will become very dramatic.
Capital Economics reckons inflation will be down to 4 per cent by the year’s end, 1 per cent by this time next year, and could then go negative.
For some time, it has been warned here that deflation is a bigger long-term danger than inflation. We are sticking to that warning.
Savings ratio falls to 49 year low.
Look, the author of this article does not want to burden you with his problems, but consider this.
“I recently discovered I had an old account in a building society that had not been touched in over 24 years. Expecting a healthy windfall, I looked forward to getting the money deposited back, complete with the compound interest that would have accrued. To my surprise, the initial sum had not even doubled during that time, meaning the rate of interest was less than 2.5 per cent a year. But, here is an even more extreme example. £20 was deposited into a Post Office savings account when my son was born 14 years ago. Interest accrued over that 14 years was just three pounds.”
Yesterday, the latest set of accounts relating to UK plc were released by the Office of National Statistics. The headline figure says GDP growth was flat in the second quarter of this year. But that is not news, the ONS had already estimated this zero growth, yesterday’s data was merely a confirmation of an earlier estimate.
But the real interest should relate to this figure; The UK savings ratio for the first quarter was revised from plus 1.1 to minus 1.1. That is the lowest level recorded in the 49 year history of this data.
The trouble perhaps is this. The rate of interest should be determined by the demand and supply of money among the public. If there are lots of savers out there, and not many borrowers, interest rates should be low. If it is the other way round, rates should be high.
Instead, we operate under a fractional reserve banking system, in which banks lend out more money than they have on deposit, and interest rates are set by central banks, based on some view of future inflation, which may, or may not, be right. And for ten years, central bankers got it wrong. Commercial banks relied on a flow of money from the money markets - money often originated abroad, and therefore the flow was unreliable, as it was subject to the vagaries of currency markets, because domestic savings were too low.
Interest rates were too low, this led to a plummeting savings ratio. Today banks are under capitalised. This could have been avoided if they had been able to attract more savings from domestic customers. But, with the lousy returns on offer, you really can’t blame consumers for spending, instead of saving.
And maybe, that is why we have a debt crisis, and that is why we have banks on the brink.
Recession strikes in Ireland, Japan sees trade collapse
Okay, so the US is in a mess. But what about the rest of the world?
Yesterday and this morning news was out to show the UK’s fourth-largest export market is in recession, while the world’s second-largest economy is on the rack.
First it’s Ireland. It’s official, Ireland is in recession. We already knew the first quarter saw contraction, well now it appears the Irish economy contracted by 0.5 per cent in the second quarter too.
Ireland is the first Eurozone economy to hit recession, in this phase of the cycle.
Ireland, of course, witnessed a property and debt bubble quite unprecedented and far more serious than any seen anywhere else in the world – except for Spain, that is, and maybe Denmark, oh and maybe Australia. But, apart from Spain, Denmark and Australia, the Irish debt/property bubble was completely unique.
Apart from Britain, that is.
Meanwhile, something happened in the economy of the Rising Sun in August that isn’t supposed to happen. The Japanese economy saw a trade deficit. With the exception of January, which usually sees a trade deficit – and that’s largely down to structural reasons – it was the first trade deficit in Japan in 25 years.
Exports to the US saw the biggest fall ever recorded.
But not all of Japan’s problem were caused directly by the US crisis.
Japan is reliant on importing raw material – things such as oil and food, and as their price went up, the cost of the country’s imports soared.
So what conclusions can we draw?
First off, just in case you haven’t guessed it yet, the US economy really is in a mess. If exports from Japan have fallen so drastically, it must surely mean the US economy itself is now contracting.
Secondly, it goes to show how un-de-coupled the world is. (that’s a fine word isn’t it – un-de-coupled? – ed) The idea that the rest of the world could carry on growing when the US is struggling has now been shown to be false
Thirdly, though, good news. At least good news if you are Japanese.
If the prices of food and oil fall, which they will surely do if the current financial crisis leads to falling demand the way one would expect, then the Japanese economy will bounce back.
And, by the way, this will be the root for global economic recovery too.
Right now we face two possibilities. One, the economy is in crisis. Two the talk is overblown.
If talk is overblown, then it doesn’t matter.
If the crisis really is as bad as they say, demand for oil and food will fall drastically – and price will crash, and all of a sudden things will seem cheap again. And that is when we can get on with the business of enjoying the next boom, and have fun spotting the next bubble.
The battle for new economy begins
While the world seemingly stares financial ruin in the face – or perhaps more realistically suffers the distinct possibility of recession – something more important has been bubbling beneath surface.
While the media’s attention has been focused on the battle to save banks, another battle is being fought. On the one hand, you have the old guard. The traditional way of doing things. On the other hand, you have the whizz kids with their new foolhardy ideas.
It is just that, on this occasion, the old guard are standing in the way of progress. The bright young things come armed with ideas that could transform the global economy, and generate so much wealth for us all that a few trillion dollars of debt will seem inconsequential.
And to understand why that is, let us first take a look at the old guard’s final throw of the dice. The Apple iPod – it might look cool, it might have its users eulogising over Steve Jobs, a man they think can walk on water – but it’s based on old thinking, old thinking about to go the way of the dinosaurs.
A new rival to the iTunes music store has emerged: My Space. And it has one killer unique selling point, a USP, Apple will struggle to match – the music it supplies is free.
The music industry don’t like the Internet, they have been dragged screaming into the digital era – they much preferred it when we forked out £15 or more on the latest album. When Internet piracy descended on the music business, we were told it would be the end of original music.
The reality is different. If original music nearly came to an end, then that period was surely the late 1980s and 1990s, when the music industry ruled supreme, and music executives made decisions on what type of music we wanted to listen to next.
The Internet has transformed that. New bands with exciting new sounds find they can bypass the men in suits – or even the men and women in designer jeans for that matter, and go straight to us. And still make a tidy fortune.
How can this be? Banks are seeing the Internet as a promotional tool, the money comes from live performance. The result, we are seeing the beginning of a music explosion set to eclipse anything seen in the 1960s.
Any business relying on traditional methods of selling music, is doomed to fail.
But Apple symbolizes the old guard in another way – the way of proprietary technology.
It is surely only a matter of time before Linux-based systems make all other computers superfluous. And who will rake in the bucks? Companies like IBM who have made it their business to understand Linux, to provide advice on how to interface different Linux modules. And they have done this by throwing out old conventional ideas of proprietary technology, instead they have opened up, shared their ideas, and become experts.
Yesterday, the BBC web site reported on the findings of the Canada-based Innovation Partnership which said patents are delaying advances in cancer medicine.
The day in which different companies sit on their own patents, refusing to share their knowledge, will soon come to an end. There is a growing understanding that if companies share their knowledge, tap into public domain research, work with universities, then the pace of innovation will accelerate.
Science is complicated. The research behind new drugs is hard to understand. Until recently, it was thought that companies needed to be afforded protection via patents in order to encourage them to invest further. Now, there is growing realization that only companies that invest in R&D will have the expertise required to exploit new discoveries.
“If we are to turn the atoms of publicly funded discovery into molecules of innovation… we have to make sure research avenues stay open,” said Professor Richard Gold from Innovation Partnership. “That doesn’t mean there will be no patents. It simply means that patents don’t become a barrier to early stage research.
“We do not want to end up in the same situation with nanotechnology that we are in with genetics.”
The old guard are fighting a new seismic change, just like the old guard in the music industry fought the Internet.
It is essential the old guard lose.
US bail out, and UK house prices: will the crash end?
Unless you have been living on Mars you will know the UK housing market is in a bit of a state, no doubt; you will guess the recent shenanigans will just add to the woe. Although, a big question mark lurks over what impact the $0.7 trillion bail out by the US Treasury will have. A view often expressed is that the UK market will not recover until we see the end of the US subprime crisis, so maybe the US Treasury’s massive bail out will do the trick, although don’t expect changes to occur overnight. Markets in stocks, shares, and money may turn on a sixpence, housing markets turn a lot more slowly.
But this morning, property web site Rightmove did have something interesting to say.
Right move reported on a 1 per cent fall in asking prices in September, with its commercial director Miles Shipside saying: “The housing market is in limbo and will remain so until financial institutions address the disastrous state of the mortgage funding markets. We are now seeing the lowest level of new sellers for years. There’s a baseline level of activity from those that have to sell, but beyond that, discretionary sellers are increasingly scarce. While this market provides a good opportunity to trade up, it requires a degree of bravery in the face of the ongoing turmoil in the financial markets.”
The report concluded: “Rightmove’s analysis of its September House Price Index concludes that house prices are continuing on their downward trend and that the housing market has little chance of beginning its recovery until the banking crisis has abated.”
It is true the US banking scene is looking increasingly like an extension of the State. It is true US taxpayers may have to pick up a very nasty bill, but the US based banking crisis must surely be coming to an end now. With all that toxic waste magicked away, banks, and management, must feel a massive sense of relief.
Maybe then we are about to see the end of the great property crash.
The only snag with that is that, in the US, inventory levels of unsold properties are now so high, it will take a year of quite frantic activity to clear them. This will surely mean more price falls to follow.
As for the UK, house prices to income are still way too high. With affordability so stretched at the moment, with job losses mounting, it is difficult to see how even $0.7 trillion of Uncle Sam’s money will help.
Some may blame the crash in house prices on lack of funding, others may blame the lack of funding on a crash in house prices – caused because they were too high in the first place. No amount of taxpayers money can change that reality – or if it does, it will only be in the sense of creating another bubble.
And the Fed comes riding in
Ben and Hank, their swords raised in triumph, galloped into the melee last night, and to resounding cheers, markets soared again.
Well, actually, the two men and their teams have not quite cracked it yet, but they are working all weekend. But it does seem the plan is for US authorities to take on bad debt.
An official statement from the US Treasury said that Mr Paulson et al “began a discussion … on a comprehensive approach to address the illiquid assets on bank balance sheets that are … the underlying source of the current stresses in our financial institutions and financial markets.”
And Manchester United’s main sponsor, Ben Bernanke said: “We look forward to working closely with Congress to resolve this financial crisis and get our economy moving again.” He added: “At issue is a proposal to create a new government entity that could take bad assets off of banks’ and financial firms’ balance sheets and sell them at auction, according to published reports.”
According to the Wall Street Journal the Treasury have been working on plans for some time but were reluctant to put it before Congress. No doubt something to do with fear of derision stayed their hand. But now the crisis has got so manifestly worse, it seems that just about all congressmen and -women can be expected to play ball.
The talk is that the plan being cooked up will resemble the Resolution Trust Corporation, which was set up in 1989 at the time of the US savings and loans crisis. The corporation was charged with the task of liquidating assets, including real estate and mortgages it had acquired from insolvent savings and loans associations.
What was interesting about this endeavour is that the Resolution Trust Corporation didn’t just sell these assets on, it often retained an equity stake in them. In this way the risk to institutions taking the assets on was reduced, and the Corporation itself was able to benefit from higher returns in the long-term.
By the way, a similar plan (home ownership loan corporation) was also launched in 1933 by the Roosevelt government, as a part of the New Deal.
So the plan being prepared is not completely new, but it is to be welcomed.
But, as Ben Bernanke, chairman of the Fed, which now owns AIG, the sponsor of Manchester United, said: “The root cause of distress in capital markets is the real estate correction and what’s going on in terms of the price declines in real estate…So we’re coming together to work for an expeditious solution aimed right at the heart of this problem, which is illiquid assets on financial institutions’ balance sheets.”
The big problem with all this, however, is that the recent falls in US real estate – or house prices, as we may more colloquially refer to it – are unprecedented. The new plan may have a precedent, but the challenge ahead seems unique. US house prices are not going to rocket back up again, so assets secured against real estate are not going to suddenly become valuable.
It has been suggested here before that, in the UK, we may ultimately need to see some kind of government backed negative equity mortgage relief scheme, in which the government takes on those portions of mortgages that are higher than the properties they are secured against. For the holders of these negative equity mortgages, the repayments could be treated a little like student loans, with repayments a function of income, deducted at source. In this way, individuals would then be able to acquire new mortgage debt – even though they owe more than the assets they own.
But the government would need to exact a heavy price from banks and building societies for introducing this scheme.
Oil drops like stone, then bounces like rubber ball
The story was already half-written, when OPEC put its spokes in.
Oil was down again yesterday, falling to just $102. That was the lowest price since April and $43 dollars down on the year high.
For several months now, it has been predicted here that oil was near peak, and would soon begin a steady decline. But when the fall did occur a few weeks later, we were taken a tad by surprise. It had come so quickly. But then if the credit crunch of 2008 has one overriding characteristic it is that it has all happened quickly. House prices are falling faster than the most bearish commentators would have believed, so why shouldn’t oil fall as fast too?
There is plenty of evidence, discussed here on innumerable occasions, to show how demand for oil in the US, UK and Eurozone is falling.
But then this morning, OPEC reduced oil supply. “All the foregoing indicates a shift in market sentiment causing downside risks to the global oil market outlook,” said an OPEC statement.
“Actions will be taken by members as soon as they can, that means in the next 40 days,” said the Algerian Oil Minister Chakib Khelil, who chaired the OPEC meeting.
The parallels with the housing market are clear. The housing market has been characterized by both suppliers and customers running a mile, and we end up with a kind of race to the bottom, with price determined by which falls the most, demand or supply.
At the moment, of course, there is a limit to how much demand for oil can fall. This black liquid has, after all, been the lifeblood of the global economy for the last one hundred years or so. Even so, it seems unlikely OPEC will cut supply sufficiently to stop further falls in oil in the longer term.
Yesterday, the black stuff fell by over $4; within a few hours of the OPEC announcement it was up a couple of dollars. But, markets do tend to overreact, so the trend for oil is still likely to be down.
OPEC would, in any case, be making a huge mistake if they cut supply so much that the price went shooting up again. There are alternatives to oil out there, it will just take a lot of money to develop them. But once this money has been spent, and more and more of us use these alternatives, the cost will fall. New technology works like that. Once the initial development cost is funded, price falls rapidly.
OPEC’s best interests are not served by trying to prop up the price of oil. Take into account the threat of global warming, however, and it could be argued that the world’s best interests are served by expensive oil forcing the development of renewable alternatives.
PS – on the subject of global warming, it is amazing how many cynics there still are out there on this. Thirty years ago, one scientist said somewhere that an ice age was imminent, and as things like this work, for a few months the press jumped on a scaremongering bandwagon. Today, the vast majority of scientists believe global warming is real, yet cynics point to that one fairly obscure theory, that got taken out of context by the media, as evidence you can’t trust scientists.
Should the price of oil fall back, and spark a new global economy, we suspect these global warming cynics will find their cause gets more popular. No doubt they will still be saying global warming is a myth right up to the moment the last iceberg melts and the water levels turn the sand in which their heads are buried, into swamp.