EDITOR: | January 15th, 2015 | 23 Comments

The Oil Price Plunge – Economic Redistribution on an Epic Scale

| January 15, 2015 | 23 Comments
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The question that exercises minds these days is if the oil price fall is a tailwind or a headwind.

The microcosm of what is currently going on and shifting the balance in the economic equation is best summed up in London’s main shopping drag, Oxford Street. On one side of the street is Selfridge’s with its so-called Wonder Room, where nijab-clad ladies glide between the display cases showing the world’s most expensive watches, while the “bargain category” consists of diamond-encrusted mobile phones (a snip at $216,000 for one model) by Vertu. On the other side of the street is Primark, the pile-em-high sell-em-cheap mass market retailer of “fast fashion” where the English middle class, and below, clientele (and European tourists) stock up on bargain clothing.

luxury-vertu-phones

But a subtle shift has occurred in buying power between the mega-wealthy trawling London for baubles and apartments and the mere mortals sifting through Primark’s racks. Those upscale shoppers have a direct nexus back to the oil export income of their Gulf nations. The mass consumers come from societies that have been paying 100% more for their petroleum purchases in the last five years over what they paid in the preceding five years. The falls in recent days have taken Brent crude back to the levels of six years ago. That level is still more than four times the late 1990’s nadir, when oil traded at $13 per bbl, albeit briefly. With prices at the petrol pumps finally started to follow the freefall of oil price in markets, the benefits are spreading through to “mere drivers” in addition to truckers, shipping companies and the eternally hard-pressed airlines.

Deflation Fears

There is no ray of sunshine that does not also come accompanied these days by doomsters and they have seized upon the price fall of one commodity to justify their fears of a new deflationary crisis. There was precious little talk of inflationary crisis as the price of oil went from the aforementioned $13 to well over $100, but that’s just us being picky.

The average householder was more than aware that they were being massively gouged (and both their spending habits and savings took severe hits as a result). And yet the powers that be were content to spend the last 15 years saying the inflation was minimal as healthcare, fuel costs, rents and food expenses all soared. The “average” shopping basket used for calculating household inflation was jam-packed with exotica and underweighted with the things that people really purchased. Fuel was a component but “not enormously relevant” on the way up but now it’s on the way down it’s a potential deflationary catastrophe? We are almost waiting for a politician to come out and say that high oil prices were “actually good for consumers” to top off the idiocy.

This is one set of beads and mirrors the natives are not buying.. They love lower oil prices. And the biggest of the flow-through effects are yet to come. There will now be a scramble for the gains. The taxman in many countries is a loser as administrations have been siphoning (pardon the pun) off large amounts of the higher pump prices for their own use. Taxes on other categories (income?) will have to go up to make up for the shortfalls. Then again as lower oil prices work their magic on margins, bottom lines of many companies will improve and with that the corporate taxes they pay.

Airlines might reduce their fuel surcharges or may not… Initially they will want to patch broken balance sheets and bottom lines by raking off as much of the fuel price falls before consumer start getting savvy. In many ways one could argue that airlines deserve to keep the bonanza as fares have fallen from where they were decades ago with the result being the perennially bust majors and the diabolical level of service now offered.

Shippers that move an enormous amount of the world’s goods (and thus make up a component of all pricing) and the truckers will also get a windfall. Oil shippers perversely are getting a double windfall as bargain hunters are bidding up day rates for oil tankers so they can store the cheap oil for a rainy day.

A Grand Plan

In a previous commentary we referred to the feeling in intelligence circles that the fall in the oil price might very well be part of a concerted plan by the US (in league with Saudi Arabia) to beggar some of the agents of disorder with the prime targets being Russia, ISIL, Syria and Iran. As it has turned out the collateral damage includes Venezuela, Iraq, Libya and Turkey. In the case of the first of these we wouldn’t be surprised if plunging oil prices morph into being a regime-changer for an already battered and topsy-turvy economy. Consumers are now queuing overnight to buy scarce necessities in Caracas. This is a situation that cannot last long. In the case of Turkey, this country has had its massive current account deficits plugged for a decade by Gulf States’ excess cash on hand. This has only produced one of the most pharaonic building sprees in the history of mankind with all sorts of inane and decadent infrastructure being the result. In essence the excess cash slushing around in the Gulf has just gone to prove that the “devil makes work for idle hands” from sponsoring ISIL through to the excesses and corruption of the Qatar World Cup bid.

An important thing to note is that if the US is the hidden hand using financial markets and the Strategic Petroleum Reserve as collateral for oil price weakening then the price plunge has coincided with the end of a fantastic ten-year period which has taken the US from being dependent upon foreign oil to one in which it is energy independent. Is it then mere coincidence that the US feels it can let oil go for a slide? Truly we might say of the oil independence push “Mission Accomplished” and what next? Clearly it is now using this energy advantage to satisfy many long frustrated global geopolitical goals.

Winner & Losers

The losers are at first glance easy to spot. They are the oil producers. In many cases these nations have become almost exclusively dependent upon oil and gas. The main country that is diversified is Russia but even there most of its other exports are resource-related while its manufacturing has never become globally competitive or innovative (except for the arms trade). All the Middle Eastern economies (except Turkey) are one-trick ponies wedded to the oil and natgas prices. Even those that have tried to diversify into financial services like Dubai are essentially just shuffling around the oil money, which there will be a lot less of to shuffle.

40_oil

While we have mentioned Turkey as prominent amongst the second line losers are Turkey, as a haven for Gulf investment, we should not forget some of the lesser oil producers who had been hoping for future bonanzas and in this group falls Ghana and Ecuador. The oil price decline might save them from becoming too mono-focused before it’s too late. Countries like Angola and Mexico are countries that also have been very oil dependent.

Then one might ask what happens to Brazil’s massively expensive pre-Salt deposit plans with a much lower oil price. Perversely Argentina was an oil producer in decline that has been staggering under massive subsidies to oil users which will get some budget relief from the oil price fall.

We could go on…. But one of the biggest sea changes is in the balance of power between China and Russia. The oil price fall makes the Chinese balance of payments one of the biggest winners and thus it is no surprise that they are out there in recent weeks aggressively buying gold as the Chinese trade surplus should widen even more with one of its largest import items in decline in absolute terms. They do not want more surplus translating into a higher Yuan. That was be just a self-delusion though and the Yuan is destined to continue rising. Russia which uses oil to plug its enormous budget gaps is going to be both a financial loser and a geopolitical loser. The longer Russia is beggared by a low oil price the more power will flow to China relatively speaking.

Conclusion

“It’s the economy, stupid” was James Carville’s rallying cry in the 1992 US presidential campaign. In the case of the oil price fall “Its real incomes, stupid”. There is a massive transfer of wealth going on from the oil producers to the Japanese, to China, to Brazil, to Europe and to India (to mention only a few). In the US it’s a wash (the price of energy independence) with the transfer being from the energy producers to the energy consumers and between certain parts of the country to other parts. The scale of this redistribution is massive.

The International Energy Agency’s prediction for 2014 consumption was 92.7mn bbls per day… let’s say the price had been $100 per bbl. So the daily oil trade was worth a bit over $9.2bn per day. We multiply that by 365… so around $3.38 trillion in a full year. So at current prices over $1.7 trillion that was going to one group is now staying with the end consumer. They do not have to fork that money over to fill their tanks or heat their houses. If ever the Marxist tenet of “From those according to their ability, to those according to their need” could ever be applied then this is such a moment. And yet pundits would have us believe that this redistribution is deflationary. Sure the CPI and PPI will go down but everyone knows they have long been bogus redistributive vehicles to con the economic agents lower down the totem pole that they weren’t being done over by the 1%. The worm has turned, the boot is on the other foot and the change is seismic. It is actually hard to think of a moment in history when one group has been empowered so fast at the expense of another. Kick back… enjoy…

Appendix I: Annual growth in the crude oil tanker
fleet and crude oil seaborne trade (forecast
included): IHS Global Insight and SAI
data as of February 2012.

IHS_tankers

 


Christopher Ecclestone

Editor:

Christopher Ecclestone is the EU Editor for InvestorIntel and is a Principal and mining strategist at Hallgarten & Company in London. Prior to founding Hallgarten ... <Read more about Christopher Ecclestone>


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Comments

  • InvestWatch

    No-one else has mentioned (that I have seen) — this largest transfer of economic power in history in the space of a mere two months…

    until today. Great piece!

    January 15, 2015 - 5:01 PM

  • Adrian Nixon

    Excellent piece Christopher, fascinating insights. I wonder how long this low oil price will last?

    January 16, 2015 - 4:09 AM

  • Christopher Ecclestone

    Interesting question…. IF the plunge has been orchestrated then it clearly has not done it work yet… Ideally to beggar Russia and the rest would need a good year.. Venezuela is teetering.. The Iranians are seemingly holding well… who knows whether ISIL are suffering enough!

    If the dive is really just because of slack demand then it could turn around smartly on global demand… but then again I have long suspected that the prices of over $100 per bbl were rather artificial… the new normal could be back in the $50-70 per bbl level… after all the US has gone from a big deficit to independence without scarcely moving the price (until now)… the non-conspiratorial view might be that the current price plunge is a Wile E. Coyote moment… which unfortunately commodity markets seem more prone to than most..

    January 16, 2015 - 4:52 AM

  • Adrian Nixon

    I wonder if the political orchestration is a by-product of a straightforward supply and demand situation?
    Global supply seems to be capped around 30bbl per year partly due to reservoir constraints and partly to the fact that no-one is building extra refinery capacity. I’d guess the rising price was a function of demand (although accessing reliable demand figures is not easy)
    The falling oil price may simply be a response to global demand falling, everything else being a sideshow.
    Oil and GDP have a circular relationship, the more oil the global economy consumes the more wealth it creates.
    A lower oil price should stimulate economic activity, raising the demand again.
    One further thing, EIA data shows that the US tight oil boom is temporary and will reach a maximum around 2020. This was at $100 prices, so the maximum may well have occurred already. Claims of US oil independence may be exaggerated.

    January 16, 2015 - 6:28 AM

  • Tim Ainsworth

    Excellent summary Chris, another dark theory may be that we are witnessing a blow off bottom from the Masters of the Universe pre trend change.
    Copper action may be supportive.

    January 16, 2015 - 6:31 AM

  • Christopher Ecclestone

    Tim…. well, rumour has it that GS are on the opposite side of the massive Red Kite trade in copper.. and the latest leg down in copper came hot on the heels of GS’s apocalyptic statements on the oil price..

    I had wondered whether the copper dive was an attempt to force massive margin calls upon Red Kite.. stranger things have happened…

    January 16, 2015 - 6:56 AM

  • Christopher Ecclestone

    Adrian, I would concur that US energy independence is a delicate flower indeed… and maybe others in the Powers-that-Be agree as the XL pipeline has seemingly got some tailwind again..

    If oil had not been where it was for the last few years the whole surge in US investment would not have happened.. some will be shut in and product will be bought in international markets until price is up again.

    The interesting stories around are about the aggressive hiring of tankers in Asia to store the cheap oil. This would indicate to me that there is no shortage of demand (or supply) as producers keep churning the product out with even more gusto as they need to make up for lower prices with more volume (if they can).

    The more that is stored in these floating “tank farms” the more that will act as a hangover on price rebound.

    The circular argument on GDP/oil is a valid one.. will be interesting to see how the US driving season gets going.. more people driving about because its cheaper… in Europe the public are not likely to binge on more oil after having spent decades getting consumption down.

    January 16, 2015 - 7:03 AM

  • Adrian Nixon

    Christopher: A really interesting point about tankers being used to store cheap oil. If this is on quite a scale could this create a bottleneck in supply and reverse the price decline?

    January 16, 2015 - 8:11 AM

  • Christopher Ecclestone

    Interesting article from a few days ago in the FT on tankers as storage option::
    http://www.ft.com/cms/s/0/8be5347a-9a32-11e4-9602-00144feabdc0.html#axzz3OzSctrE8

    January 16, 2015 - 8:18 AM

  • Christopher Ecclestone

    and I added an appendix to the article showing the state of the tanker market in terms of supply… would appear to be ongoing growth, albeit 2% per annum in tanker volumes which if oil movements are down means that sidelining tankers for storage duty will not necessarily create a shortage for movements. The supposed US oil independence has meant that there is reduced traffic between Mid-East and Nth America anyway… also freeing up ships.. older, less efficient ships can be turned into these floating tank farms..

    January 16, 2015 - 8:36 AM

  • Adrian Nixon

    …so lots of capacity in the supply chain.

    Clear analysis, thank you.

    January 16, 2015 - 8:53 AM

  • Adam Bold

    Is the impact being overstated? While spot prices have halved, how much of world trade is done on spot vrs long term contracts? Will producers manage their lower income by liquidating sovereign wealth or by increasing debt (which is at record lows) and frustrate the projected GDP impact?
    To the extent that some country’s GDP may rise will the increased activity generate its own price response as demand increases and quickly reverses the present spot?

    January 18, 2015 - 8:53 PM

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    […] given the costs involved; moreover, as Christopher Ecclestone noted in an article outlining the winners and losers of the falling oil prices, there is a massive transfer of wealth going on from the oil producers to the Japanese, to China, […]

    January 19, 2015 - 11:29 AM

  • Daniel

    Alaska revenue down to one third. Ucore???

    January 19, 2015 - 4:25 PM

  • Christopher Ecclestone

    Its a loan guarantee not a grant…. it would only lose its value if the state was not regarded as a good risk by banks any more…. I am doubting that will happen.. If anything it shows the reason why the state’s economy needs to diversify..

    January 19, 2015 - 5:30 PM

  • Daniel

    How much of that loan is cash flow for Ucore. I read most of that goes to infrastructure to build the roads.
    If Alaska is down to a third of its revenue:
    50% state budget 90% discretionary spending from oil revenue.
    Washington 19% total budget.
    78% revenue from oil but 80% down from oil tax.
    14 billion in reserve.
    Alaska is running on 20% of the 78%=15.60% plus the 22%=37.6%
    Another Detroit?

    January 19, 2015 - 5:58 PM

  • Daniel

    WTI Crude 47.52. India wants exemption like FTA countries for oil and LNG as well 150 billion from the US every year to build solar mfg in India under Make in India. Exemption to do business with Iran Oil.
    This the Most interesting story of the decade.

    January 19, 2015 - 6:08 PM

  • Daniel

    WTI crude 46.91. Everything is on the table in Alaska Budget crisis. Doesn’t look well for Ucore Loan guarantee. Its a horse race. The decline in the price of oil and the survival of the State of Alaska.

    January 20, 2015 - 12:26 PM

  • Christopher Ecclestone

    Repeating again.. a loan guarantee is NOT a loan…..

    January 20, 2015 - 12:34 PM

  • Daniel

    Sorry I always jump in logic ahead of others. Revoke Loan guarantee in a credit crisis when the credit rating is revised for the State of Alaska.

    January 20, 2015 - 12:37 PM

  • Christopher Ecclestone

    Would require legislators to revoke it as its a bill passed by both houses…

    January 20, 2015 - 12:53 PM

  • Daniel

    Totally agree it requires legislation. They have hard choices to make. A freeze in either house would mean doom for the State. Its also up to the Lender whether they would review the interest rate on the loan or even call in the loan depending on the contract.
    As you say its Epic and the Bankruptcy of an entire State is open to possibility.

    January 20, 2015 - 1:17 PM

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    October 22, 2015 - 11:43 AM

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