Tag Archives: oil prices

Global Impact of Cheap Oil

The crude oil market has declined by approximately 45% since this summer. The massive decline has surpassed most analysts’ expectations including those who advise sovereign nations on international foreign trade issues. The biggest problem most of us face is determining the difference between falling oil prices and gasoline being a good thing at the personal, micro level compared to the damage that falling oil prices have had on equity and currency markets at a macro level. Unfortunately, the answer lies on a continuum rather than an easy black and white answer or a single numerical value. This week, we’ll look at differences in the economic makeup of the major players and determine where they stand in terms of currency and budgetary risks due to oil’s precipitous decline.

Continue reading Global Impact of Cheap Oil

Setting of the Rising Sun

Japan’s economic crisis has been slowly trudging down a dead end road since their economy collapsed in the early 90’s. Their insistence on maintaining public programs as status quo has been financed by selling government debt to domestic corporations and private citizens. This has cannibalized both private citizen and corporate savings. This tacit deal has allowed Japan to artificially keep interest rates low based on their captive pool of treasury purchasers. This process of spending more than the government is collecting on an annual basis, combined with sales of treasuries to finance the difference has left them ill prepared to handle this disaster at a time of global economic uncertainty.

While some economists are taking the stance that Japan’s rebuilding is just what they need to get their economy back on the right track, I think it’s quite possible that their economy may be too far gone to save. Furthermore, the scale of their disaster will place a huge burden on developed nations who will be called upon to assist them in the process. Many of these nations, including the United States, have no room for error in their own economic policies. The end result could be a localized natural disaster that triggers a global recession.

Professor Ken Rogoff of Harvard School of Public Policy Research wrote a book in 2009 describing the historical relationship between banking crises and sovereign default. His research states that the average historical tipping point is approximately 4.2 times debt to revenue. Once a country is spending 4.2 times more than it is collecting, default is on its way. John Hayman and Lawrence McDonald, cite individually, that Japan’s expenses outpace revenues by more than 20 times annually. Their debt to GDP ratio, their total assets and earnings minus total debts and liabilities, is around 200%. The third largest economy in the world spends 20 times more per year than it earns and owes twice as much as it’s worth. One note of caution, the United States ranks third in the debt to revenue ratio, behind Japan and Ireland and we owe as much as we’re worth. We will be double negative in 2011 if we don’t change substantially.

Debt will surely rise even further as Japan borrows to rebuild. Standard and Poor’s downgraded Japan’s credit rating to AA in January, prior to the disaster. Japan will have to move to the open market to finance their reconstruction. Their domestic lenders will be busy financing their own rebuilding processes. This will force Japan to pay open market rates for most of their new debt. Open market rates will be AT LEAST 100 basis points and most likely, closer to 200 basis points higher.  The interest payments would total more than 25% of the country’s revenue. Japanese credit default swaps will sky rocket.

The strain of rebuilding Japan will affect us whether we lend financial assistance or not (which we will). The demand of replacing 30% of Japan’s energy source will show up in the price of fossil fuels. Japan currently consumes 5.2% of the world’s oil supply. Replacement of lost energy will add another 1.3 million barrels per day plus the added oil necessary for the reconstruction. Their added demands equal Italy’s total consumption. Add this to the global uncertainty of North African fuel supplies and the added fuel that goes into fighting a third global conflict and we have questionable supplies coupled with increasing demand.

Rising oil prices couldn’t come at a worse time for our economy, which had been gaining some traction. GaveKal research published a chart in which rapidly rising oil prices are overlaid with economies growing more than 2% above their leading indicators, which we are. This has happened 5 times in the last 70 years. Four of the five led directly to recession. The fifth was in 2005 and was ameliorated by the credit and housing booms, which may have delayed the recession until 2007. Rising fuel costs act as a tax on the economy.  The latest housing numbers, the worst ever, blame much of it on high gas prices. Furthermore, while the unemployment rate is stabilizing, the length of time people are unemployed is at an all time high of 37 weeks. Finally, the stock market has returned to its upper 10%, in normalized valuations. Japan’s natural disaster could very well mean this is the zenith of our economic recovery.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

Govt. Legislation in Free Markets

By David Goldman, CNNMoney.com
staff writer

NEW YORK (CNNMoney.com) — Some of the Democratic lawmakers leading the campaign to crack down on oil traders appeared Wednesday
before the House Committee on Agriculture to explain their proposals.

A dozen or so bills have been introduced on the subject of oil speculators,
and Democratic leaders in the House have promised to address the issue by
tackling what they call “excessive” speculation.

But some Congressmen are skeptical that the legislation will do any good –
and could even cost consumers more by driving up the price of other commodities
such as corn and soybeans.

“Given that charges against speculators have historically been more wrong
than right, it is important that we have the facts, data and analysis that
demonstrate the validity of this contention before we take action,” said
committee chairman Collin Peterson, D-Minn. “Any legislative remedy that seeks
to remove speculative interests from futures markets could result in more
volatile markets, as the role of speculators has always been vital for price
discovery and liquidity.”

The slew of speculation-tackling bills that have not yet faced a vote address
a variety of issues.

Some have bipartisan support, such as one increasing the Commodity Futures
Trading Commission’s (CFTC) budget, and some are more contentious, such as
limiting over-the-counter trades to producers and boosting traders’ margin
requirements.

If applied to all commodity traders, some lawmakers say the propositions may
have unintended consequences on other markets.

“Increasing margin requirements, for example, would be very problematic, as
volatility in the futures prices of the grains … has already made it tough for
elevators in farm country to meet margin calls,” Peterson said. “Such
instability can have serious effects on the prices we pay at the
supermarket.”

Legislation necessary to combat high oil prices

But other lawmakers are convinced that curbing excessive speculation by
expanding the role of CFTC will help reduce oil and fuel prices for
consumers.

“While some have advocated for doing nothing and others believe that we
should simply bar index investors and others from the energy commodity markets
altogether, I believe what we really need is a level playing field that is
transparent and accountable,” said Rep. Jim Matheson, D-Utah. “Our goal should
be to make sure that the regulator – the CFTC – has the ability to ensure undue
manipulation isn’t taking place in the markets.”

Though many lawmakers are still unconvinced that speculation plays a role in
higher gas prices due to a lack of concrete evidence, other Congressmen say the
circumstantial evidence is enough reason to act.

“In light of the dramatically increased speculative inflows into the energy
futures markets … coinciding with a staggering 1,000% jump in the price of a
barrel of oil, I believe the burden is on those who would argue for maintaining
the status quo,” said Rep. Chris Van Hollen, D-Md.

“Proponents of maintaining current law must definitively demonstrate that the
exceptions we have thus far permitted to persist in the Commodities Exchange Act
do in fact support the primary functions of price discovery and offsetting price
risk necessary for a healthy energy futures marketplace,” Van Hollen added.

Speculation debate continues

Since 2003, the volume of investment funds in commodity markets – especially
oil – has risen from about $15 billion to $260 billion, according to the
International Energy Agency (IEA), an influential oil-policy group.

But the IEA released a report last week arguing that the increase in
oil-market speculation is not driving up crude prices.

“There is little evidence that large investment flows into the futures market
are causing an imbalance between supply and demand, and are therefore
contributing to high oil prices,” the report said.

But the study far from ends the debate.

“A growing chorus of congressional testimony and market commentary from a
wide range of credible and authoritative sources has concluded that the run-up
in today’s price of oil cannot be explained by the forces of supply and demand
alone,” said Van Hollen.

Even analysts who concede that the laws of supply and demand are the main
contributors to record oil prices say that speculation can make price swings
more volatile.

The House Agriculture panel has planned hearings Thursday and Friday to
further discuss the issue of amending the Commodity Exchange Act. To top of page