The consequences of cheap oil... good and bad

ref:- "What Oil at $50 a Barrel Means for the World Economy", Bloomberg Economics

Catching a falling knife is a particularly unpleasant but descriptive metaphor used about the dangers of attempting to pick market bottoms ..... the essence of it being course that trying to do so and taking a counter-trend market position can prove a very costly business. The crude oil market over recent weeks would be a fine case in point. In early October Brent crude was trading above $85 per barrel and the talk was all about the possibility of $100 oil once more (West Texas Intermediate (WTI), the US benchmark, currently trades a touch over $9 lower). Crude had a better day yesterday but at one stage on Friday Brent was trading at close to $58.

We know the reasons for the decline well enough : worries about demand as expectations for global economic growth in 2019 are reined back ; record production levels in the US and Russia, and of course in Saudi Arabia (who being short of friends on the diplomatic stage in the aftermath of the Kashoggi killing have been happy to follow President Trump's none-too-subtle advice to turn on the taps) ; Mr Trump's own surprise decision to give eight nations a waiver on the embargo of Iranian oil purchases; and the persistently strong US dollar, the currency in which oil is traded.

All pretty fundamental supply/demand stuff, but just as the reassessment of the value of oil was justified in the light of those changing fundamentals, some players (that may or may not have included us) have wondered at certain points whether the correction in prices was close to running its course. If those players had had the courage of their convictions, so to speak, and bought the market ..... well, that's when it gets expensive.

Things can change quickly of course ..... this very weekend the G20 meeting in Argentina and the world will be watching for, amongst other things, signs of 1. a thawing of the US / China relationship that would bode well for trade, economic growth and thus greater demand for oil, and 2. Saudi Arabia and Russia getting together on the sidelines, which might suggest the possibility of production cuts to boost prices -- of course the Saudis would have to brace themselves against a tirade from Mr Trump but they may feel that in their delicate balancing act that the balance has swung too far to the downside for their own comfort.

This morning Bloomberg offer their thoughts on what a hypothetical and prolonged period of WTI at $50 might mean. Obviously, it goes (almost) without saying that energy importers, most happily for those with current account deficits, will benefit and energy producers will feel the pain. But beyond that, the

effects of cheap oil reduces the pressure on central banks to tighten policy. That's not always a good thing .... some of them would feel more comfortable with higher rates as it gives them more ammunition if they have to cut rates in the future, and in the case of the Bank of Japan that has been trying to encourage a bit of healthy inflation for what seems like decades (because it is), $50 oil is definitely a two-edged sword.

Emerging markets have been having a tough time in 2018, and quoting Capital Economics Bloomberg estimates that every $10 fall in the oil price boosts incomes by 0.5 to 0.7% of GDP in EM oil importers. Being the largest importer of all, China stands to benefit most from lower oil -- a most welcome development given the effects that the trade war is having on an already slowing economy. By contrast, the same $10 fall in prices would cut 3 to 5% of the GDP of most Gulf producers, and 1.5 to 2% of GDP in UAE, Russia and Nigeria.

In the US, President Trump will be thrilled at having successfully engineered lower prices and has called the move "like a tax cut for the US". That may be overstating it .... the US is still a net importer and so on balance will benefit, but the rapid growth of shale production that reduces the reliance on imported oil means that any positive effects may be limited. And whilst we're on the subject, it'll be interesting to see how the shale industry performs in those conditions. There's a great irony in that the massive slump in prices engineered by the Saudis to undercut the shale producers actually forced them into radical efficiency programmes. There's talk that many of them could now operate with oil at $30. If that's true, then long term the down move will only have strengthened the hand of shale producers.

Anyway, back to the present and the OPEC meeting starting on Dec 6th is greater and greater importance.

Watch out for Fedspeak!

In the light of falling asset prices and slowing global (but not yet US) growth, do the faintly doveish noises heard from various Fed personnel recently actually signify a change in their oft-repeated plans for monetary policy -- a hike in December, and three more in 2019? The markets seem to think so ..... Eurodollar interest rate futures have put the spread between the Dec 2019 contract and the Dec 2018 contract at just 27 basis points. In other words, it indicates that just one 25 bp hike is most likely in 2019.

We may find out more this week when a stream of Fed names is queuing up to speak. In particular, look out for Vice Chairman Clarida today, Chairman Powell tomorrow, and the release of the minutes of the Fed's November meeting on Thursday.

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