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Crude Oil Producers Commit Mass Suicide

Companies / Oil Companies Dec 14, 2014 - 02:10 PM GMT

By: Andrew_McKillop


Everyone's A Loser, Baby
David Nelson, former Lehman Bros chief analys speaking on's 'Inside Story', December 11 said that at least in the short term, and possibly for the long term, OPEC has decided to commit collective suicide by setting a strategy of "keep pumping and hope". The programme quoted a Saudi oil spokesman as saying the oil market "will sort itself out".

Inchallah, to be sure, but the high gain positive feedback of savage write downs on inflated oil-linked assets, and oil sector de-leveraging to cut debt as loan costs soar on risky assets could upstage that cozy philosophical approach. World Bank oil specialist  Mamdouh Salameh, also interviewed on 'Inside Story' said that Saudi Arabia's national budget needs high priced oil to support government spending, exactly like Russia, Canada, Iran Nigeria, Iraq, Venezuela and a list of other export producers getting anywhere from 35% to 85% of their total government revenues from oil. In the US its shale oil producers, according to Salameh, could perhaps live with $65 or $70 a barrel, but not much less, although in fact that also concerns the cost of loans to shale producers, which will certainly get more expensive.

Saudi Arabia, Salameh said, needs around $90 a barrel, like Russia, but other producers like Iran, Iraq, Nigeria and Venezuela need as much as $125 a barrel to keep their governments alive and kicking.  Both in Iraq and Nigeria, battling Islamic insurgents, this has a clear national security handle. For David Nelson, these are the Loser Countries and a minority. Major importers including China, Japan and India, and major European importers will get a boost for consumer spending in particular and their economies in general, if oil prices stay below $60 per barrel for the next 12 – 18 months. He called this is a major transfer of wealth at the global level, and the net upside of cheaper oil will be bigger than the downside. Other speakers on 'Inside Story- - and a host of similar programs and features in world media at this time - however argue that this oil price crash is not just a story of overproduction or sluggish demand, or geopolitical action notably aimed at weakening Russia and Iran (if not ISIS!), but a long-maturing global shift away from oil and fossil energy. Long is the keyword.

E Sometimes Equals MC Squared
 In theory and (repeat) only in theory the oil price crash should trigger a swath of falling dominos across the so-called "tradable asset space". Overpriced oil was as critical to the financial industry bubble economy as overpriced housing and real estate still are. Taking the example of oil and gas sector financing, overall capital expenditure or "capex" in the sector, which sources such as 'Oil and Gas Journal', Barclays and Citigroup placed at around $725 billion in 2013-2014, but only $200 billion in 2005-2006, (about 60% of it in the USA and 40% in the rest of the world), could easily shrink back to 2006 levels. With leverage, more precisely with de-leverage, the crash of nominal asset values in the sector could be, as they say, "awesome" for the bank-broker-insurance companies feeding off the splurge. Not only oil producers and the finance "industry" fear the petrodollar glut morphing to famine - central bankers fear the deflation that will be caused by cheaper energy.

High-priced oil at least bolstered global demand, fed whatever inflation still existed, and gave the financial "industry" easy pickings like making "no brainer" bets on rising oil prices – that always rose. Until very recently, overpriced oil was "forever". Financial spillover and knock-on from a rapid crash in oil prices could also be awesome for national debt funding, for example rising bond rates on OPEC and nonOPEC country loans, with the pain intensified by currency devaluation of the "petromoneys". But sectors favored by cheaper oil – like airlines and shipping – could lever up in an impressive way, measured as increased equity prices for airline companies and a slowing of the rout in world shipping. Food producers and retailers of low-grade "meals for the masses"  like McDonalds or Burger King, who convert oil to pseudo-food, could get a fillip for their bottom lines, like the equity prices for any other "high BTU" economic sector such as carmaking.

Claims by some analysts like Salameh in the Aljazeera programme, are an article of faith for the International Energy Agency (IEA) and for OPEC's Secretariat. They say that cheaper oil will rapidly pull global oil demand upwards, despite a host of reasons to doubt that. The simplistic argument is that falling capex in oil and gas, plus rising demand on the back of cheaper oil firing economic growth will soon cause another oil price explosion.

As it did (not do) following the 1986 oil price crash? Looking for models and precedents, the 1986 oil price crash and its sequels including about 15 years of cheap oil could be tried - and found wanting. In theory an awesome event, the 1986 price crash had dramatically little impact on the world economy – or on geepolitics. Cheap oil for example and notably did nothing to slow the deindustrialization of the"mature western economies" and the rise to industrial supergiant status of China – which in any case was fueled by coal, not oil. 

The financialization of the economy proceeded and today's financial leverage built from overpriced oil is vastly bigger than in the cheap oil era of about 1986-2002.  Another major and "perverse impact" of cheaper oil was in economic policy. Following the 1986 oil price crash (a 67% decline in 6 months), sweet-and-low oil prices merely served to bolster a decade of slow economic growth in the "mature economies" at growth rates which themselves slowly declined. But this process was called "the Clinton boom years" for equities due to equities de-linking themselves from the real economy and floating high and free.The crisis years of 1998-2001 period, starting with the Asian and Russian meltdowns were a partial correction.

Keep Equities Growing
Today, the financialized meta-economy or degutted husk economy is vast, and so detached from the real economy that a 1986-style oil price crash, on "prima facie grounds" should have absolutely no impact, except to stimulate equity growth! In particularly financialized "empty husk economies" like the UK, the heroic struggle will continue to keep house prices rising despite the minor price-shaving impact of cheaper energy on construction industries, and crony governments will siphon the benefit of cheaper oil by holding back on any tax and duty cuts on energy, or raising tax and duties on energy until the bitter political end.

The real and major impact of the current oil price crash is likely to be financial and  geopolitical, not economic. Falling dominos in the finance "industry", triggered by oil price falls could be impressive in their impact, even impaxting broad-brush indexes like the FTSE and S&P 500. The OPEC states and Russia are in the firing line for being forced to install their own austerity programs, which for Saudi Arabia and other Gulf producers could mean less generous funding for the gory civil war they finance in Syria.

One unsurprising impact of the 1986 price crash was a massive retreat from oil sector development – from exploration and development through downstream petrochemicals, surely fitting the IEA and OPEC Secretariat narrative of cheap oil setting the scene for another oil price explosion. However, geopolitcal claims for the benefits of an oil price crash include the sequels following the 1986 price slump. The 1980-1988 Iran-Iraq war was shortened due to both sides losing oil revenues, and the crash accelerated the collapse of the USSR in 1989. Concerning the Iran-Iraq war (Iran is now aiding the Baghdad government in its life and death struggle with ISIS) , both protagonists were starved of petrodollars, but Iraq was bailed out by the Gulf states, including Kuwait. Everybody knows the sequels of Kuwait demanding full repayment of its war loans to Saddam Hussein's Iraq! The demise of the Soviet Union is difficult to attribute mainly to falling oil and gas revenues but the experience on Russian society of a long, lost decade of economic hardship through the Yeltsin years likely included the later "price hawk" attitude to oil by Putin's administrations.

What we might conclude at this time is that a series of financial, economic and geopolitical events and processes driven by the oil price rout will unfold. Overall, deflation and a further slowing of economic growth may take the driver's seat, as well as a major shake-up in the financial sector. However, the geopolitical impacts may be large and long-term, this time around, but will need time to exert themselves.

By Andrew McKillop


Former chief policy analyst, Division A Policy, DG XVII Energy, European Commission. Andrew McKillop Biographic Highlights

Co-author 'The Doomsday Machine', Palgrave Macmillan USA, 2012

Andrew McKillop has more than 30 years experience in the energy, economic and finance domains. Trained at London UK’s University College, he has had specially long experience of energy policy, project administration and the development and financing of alternate energy. This included his role of in-house Expert on Policy and Programming at the DG XVII-Energy of the European Commission, Director of Information of the OAPEC technology transfer subsidiary, AREC and researcher for UN agencies including the ILO.

© 2014 Copyright Andrew McKillop - All Rights Reserved Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisor.

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