The linkages, the secondary effects are what you always have to worry about, not the obvious first static impact.
Last week, OPEC decided to keep production quotas at current levels (30 million barrels per day). The market price of oil reacted by falling almost 5%, to below $70/barrel. Lower oil prices tend to be good news for some economies; a few analysts compare the benefit to a “tax-cut”. This time I think we should at least keep our eyes open for a few potential issues.
Missed oil revenues, while good for some, may be bad for others. In fact, the aggregate consumers’ spending power doesn’t probably change by much: it’s the potential reallocation of that spending that we often judge as positive. But reallocations can be troublesome.
Take Russia for example. Besieged by economic sanctions (which are also hampering European exporters), intent on pushing a territorial expansionist agenda and with a falling currency, they are now facing reduced revenues. They also have a considerable amount of debt repayments to foreign holders coming due soon ($150 billion in principal over the next 12 months, says Jawad Mian in the November issue of Stray Reflections), and we know most holders of debt have their own debts to repay.
Other intriguing hints come from elsewhere. Jawad Mian further highlights Daniel Altman’s recent article in Foreign Policy magazine where the following graph appears:
Source: Foreign Policy
In thirty years most of these producing countries have not decreased their dependence on oil revenues. It’s an amazing fact when you think about the money that has flown into their coffers. And they are not well situated in terms of budget deficits either. More debt repayment issues?
Most producing countries, Russia included, have accumulated substantial assets, but their accessibility may not be as straightforward as writing a check (see a recent FT article by Gillian Tett here for an idea). It would involve wholesale liquidation of positions across markets in the world; at the very least this would raise eyebrows and create further uncertainty.
Finally, we can’t forget the booming US shale-oil industry, which was financed also through debt and which the FT again reported has median break-even prices ranging from $115/barrel (high cost developments) to $60/barrel (median cost development).
Now here’s a picture from the demand side of the story:
This is a graph of a “leading indicator” I constructed some time ago. It’s well correlated with the OECD Composite Leading Indicator, but since it’s based on market prices of various securities/commodities, it is evaluated in real-time. It shows the world is slowing down and it has not reached a bottom yet.
In summary, the current episode of decline in oil prices may be cause for some concern ahead. The level of uncertainty does not conform to the euphoric state of the financial markets. I frankly don’t know what it all adds up to but I would think twice before rushing out to spend that “tax-cut” for the Christmas season.
Photo Source: The New York Times, April 20 2008