Nov 292014
 November 29, 2014  Posted by at 7:21 pm Finance Tagged with: , , , , , , , ,  16 Responses »

‘Daly’ Somewhere in the South, possibly Miami 1941

I thought it might be a nice idea to question a certain someone’s theories using their own words, while at the same time showing everybody what the dangers are from falling oil prices. There are many ‘experts and ‘analysts’ out there claiming that economies will experience a stimulus from the low prices, something I’ve already talked about over the past few days in The Price Of Oil Exposes The True State Of The Economy and OPEC Presents: QE4 and Deflation. And I’ve also already said that I don’t think that is true, and I don’t see this ending well.

Today, our old friend Ambrose Evans-Pritchard starts out euphoric, only to cast doubt on his self-chosen headline. He’d have done better to focus on that doubt, in my opinion. And I have his own words from earlier in the year to support that opinion. Ambrose is bad at opinions, but great at collecting data; his personal views are his achilles heel as a journalist. That’s maybe why he fell into the propaganda trap of picking this headline; after all, if you write for the Daily Telegraph you’re supposed to write positive things about the economy.

Oil Drop Is Big Boon For Global Stock Markets, If It Lasts

Tumbling oil prices are a bonanza for global stock markets, provided the chief cause is a surge in crude supply rather than a collapse in economic demand

Roughly one third of the current oil slump is a shortfall in expected demand, caused by China’s industrial slowdown and Europe’s austerity trap. The other two thirds are the result of a sudden supply glut, which Saudi Arabia and the Gulf states have so far chosen not to offset by cutting output. This episode looks relatively benign. Nick Kounis from ABN Amro says it will add $550 billion of stimulus to world markets. “That is fantastic news for the global economy,” he said. But it comes at a time when stocks are already high if measured by indicators of underlying value. The Schiller 10-year price earnings ratio is at nose-bleed levels above 27.

Tobin’s Q, a gauge based on replacement costs, is stretched to near historic highs. Andrew Lapthorne from SocGen says the MSCI world index of stocks has risen 38% over the last three years but reported profits have risen just 3%. “Valuations, as measured by median price to cash flow ratios, are near historical highs. As US QE has come to an end, depriving the world of $1 trillion printed dollars a year, there are plenty of reasons to be nervous,” he said.

Ambrose’s gauge of share values is dead on, and far more important than he seems to realize. He knows full well there are tons of reasons to doubt his own headline. But he still leaves out many of those reasons in that article today. So let’s move back in time to look at what he wrote this summer, before the drop in oil prices.

Here are a few lines from Ambrose on July 9 2014:

Fossil Industry Is The Subprime Danger Of This Cycle

The epicentre of irrational behaviour across global markets has moved to the fossil fuel complex of oil, gas and coal. This is where investors have been throwing the most good money after bad. [..] oil and gas investment in the US has soared to $200 billion a year. It has reached 20% of total US private fixed investment, the same share as home building.

This has never happened before in US history, even during the Second World War when oil production was a strategic imperative. The International Energy Agency (IEA) says global investment in fossil fuel supply doubled in real terms to $900 billion from 2000 to 2008 as the boom gathered pace. It has since stabilised at a very high plateau, near $950 billion last year. The cumulative blitz on exploration and production over the past six years has been $5.4 trillion [..]

upstream costs in the oil industry have risen 300% since 2000 but output is up just 14% [..] The damage has been masked so far as big oil companies draw down on their cheap legacy reserves.

companies are committing $1.1 trillion over the next decade to projects that require prices above $95 to break even. The Canadian tar sands mostly break even at $80-$100. Some of the Arctic and deepwater projects need $120. Several need $150. Petrobras, Statoil, Total, BP, BG, Exxon, Shell, Chevron and Repsol are together gambling $340 billion in these hostile seas.

… the biggest European oil groups (BP, Shell, Total, Statoil and Eni) spent $161 billion on operations and dividends last year, but generated $121 billion in cash flow. They face a $40 billion deficit even though Brent crude prices were buoyant near $100 ..

… the sheer scale of “stranded assets” and potential write-offs in the fossil industry raises eyebrows. IHS Global Insight said the average return on oil and gas exploration in North America has fallen to 8.6%, lower than in 2001 when oil was trading at $27 a barrel.

What happens if oil falls back towards $80 as Libya ends force majeure at its oil hubs and Iran rejoins the world economy?

A large chunk of US investment is going into shale gas ventures that are either underwater or barely breaking even, victims of their own success in creating a supply glut. One chief executive acidly told the TPH Global Shale conference that the only time his shale company ever had cash-flow above zero was the day he sold it – to a gullible foreigner.

… the low-hanging fruit has been picked and the costs are ratcheting up. Three Forks McKenzie in Montana has a break-even price of $91. [..]

“Under a global climate deal consistent with a two degrees centigrade world, we estimate that the fossil fuel industry would stand to lose $28 trillion of gross revenues over the next two decades , compared with business as usual,” said Mr Lewis. The oil industry alone would face stranded assets of $19 trillion, concentrated on deepwater fields, tar sands and shale.

By their actions, the oil companies implicitly dismiss the solemn climate pledges of world leaders as posturing, though shareholders are starting to ask why management is sinking so much their money into projects with such political risk.

Those numbers alone, combined with the knowledge that prices are off close to 40% by now, should be enough to give anyone the jitters, about the oil industry, and therefore about the global economy. Any industry that’s so deeply in debt cannot afford a 40% dip in revenue, not even for a short while. Dominoes must start tumbling in short order.

And of course saying ‘any industry so deeply in debt’ is already a bit misleading, because there is no industry like oil in the world (except maybe steel, and look how that’s doing), and it’s highly doubtful there’s another one with such debt levels. Oil stocks are down somewhat, but it’s hard to see how they could not fall a lot further. And as for the huge amounts invested in energy junk bonds, one can but shudder.

On August 11 2014, Ambrose had some more:

Oil And Gas Company Debt Soars To Danger Levels To Cover Cash Shortfall

The world’s leading oil and gas companies are taking on debt and selling assets on an unprecedented scale to cover a shortfall in cash, calling into question the long-term viability of large parts of the industry. The US Energy Information Administration (EIA) said a review of 127 companies across the globe found that they had increased net debt by $106 billion in the year to March, in order to cover the surging costs of machinery and exploration, while still paying generous dividends at the same time.

They also sold off a net $73 billion of assets. [..] The EIA said revenues from oil and gas sales have reached a plateau since 2011, stagnating at $568 billion over the last year as oil hovers near $100 a barrel. Yet costs have continued to rise relentlessly.

… the shortfall between cash earnings from operations and expenditure – mostly CAPEX and dividends – has widened from $18 billion in 2010 to $110 billion during the past three years. Companies appear to have been borrowing heavily both to keep dividends steady and to buy back their own shares, spending an average of $39 billion on repurchases since 2011.

… “continued declines in cash flow, particularly in the face of rising debt levels, could challenge future exploration and development”. [..] upstream costs of exploring and drilling have been surging, causing companies to raise long-term debt by 9% in 2012, and 11% last year. Upstream costs rose by 12% a year from 2000 to 2012 due to rising rig rates, deeper water depths, and the costs of seismic technology. This was disguised as China burst onto the world scene and powered crude prices to record highs.

Global output of conventional oil peaked in 2005 despite huge investment. [..] the productivity of new capital spending has fallen by a factor of five since 2000. “The vast majority of public oil and gas companies require oil prices of over $100 to achieve positive free cash flow under current capex and dividend programmes. Nearly half of the industry needs more than $120,” ..

Analysts are split over the giant Petrobras project off the coast of Brazil, described by Citigroup as the “single-most important source of new low-cost world oil supply.” The ultra-deepwater fields lie below layers of salt, making seismic imaging very hard. They will operate at extreme pressure at up to three thousand meters, 50% deeper than BP’s disaster in the Gulf of Mexico.

Petrobras is committed to spending $102 billion on development by 2018. It already has $112 billion of debt. The company said its break-even cost on pre-salt drilling so far is $41 to $57 a barrel. Critics say some of the fields may in reality prove to be nearer $130. Petrobras’s share price has fallen by two-thirds since 2010.

… global investment in fossil fuel supply rose from $400 billion to $900 billion during the boom from 2000 and 2008, doubling in real terms. It has since levelled off, reaching $950 billion last year. [..] Not a single large oil project has come on stream at a break-even cost below $80 a barrel for almost three years.

companies are committing $1.1 trillion over the next decade to projects requiring prices above $95 to make money. Some of the Arctic and deepwater projects have a break-even cost near $120 . The IEA says companies have booked assets that can never be burned if there is a deal limit to C02 levels to 450 (PPM), a serious political risk for the industry. Estimates vary but Mr Lewis said this could reach $19 trillion for the oil nexus, and $28 trillion for all forms of fossil fuel.

For now the major oil companies are mostly pressing ahead with their plans. ExxonMobil began drilling in Russia’s Arctic ‘High North’ last week with its partner Rosneft, even though Rosneft is on the US sanctions list. “Exxon must be doing a lot of soul-searching as they get drawn deeper into this,” said one oil veteran with intimate experience of Russia. “We don’t think they ever make any money in the Arctic. It is just too expensive and too difficult.”

Plummeting oil prices not only mirror the state of the – real – economy, they will also drag the state of that economy down further. Much further. If only for no other reason than that today’s oil industry swims in debt, not reserves. Investment policies, both within the industry and on the outside where people buy oil company stocks and – junk – bonds, have been based on lies, false presumptions, hubris and oil prices over $100.

The oil industry is no longer what it once was, it’s not even a normal industry anymore. Oil companies sell assets and borrow heavily, then buy back their own stock and pay out big dividends. What kind of business model is that? Well, not the kind that can survive a 40% cut in revenue for long. The industry’s debt levels were, in Ambrose’s words, at a ‘danger level’ when oil was still at $110.

Is Big Oil still a going concern? You tell me. I don’t want to tell the whole story bite-sized on a platter, there’s more value in providing the numbers, this time from Ambrose but there are many other sources, and have you make up your own mind, do the math etc.

Ambrose’s exact numbers can and will be contested three ways to Sunday, but his numbers are not that far off, and if anything, he may still be sugarcoating. WTI closed at $66.15 on Friday, Brent is at $70.15. Given the above data, where would you think the industry is headed? What will happen to the trillions in debt the industry was already drowning in when oil was still above $100?

And how will this be a boon to the economy even if, as Ambrose puts it, the ”oil drop lasts”? Do you have any idea how much your pension fund is invested in oil? Your money market fund? Your government? I would almost say you don’t want to know.

There can be very little doubt that oil prices will at some point rise again from whatever bottom they will reach. Even if nobody knows what that bottom will be. At the same time, there can also be very little doubt that when that happens, the energy industry’s ‘financial landscape’ will look very different from today. And so will the – real – economy.

Cheap oil a boon for the economy? You might want to give that some thought.

Oct 092014
 October 9, 2014  Posted by at 10:18 pm Finance Tagged with: , , , ,  19 Responses »

Unknown Marble contest on Boston Common 1920

The world stock markets big see saw zig zags over the last few days seems to be a harbinger of more to come. Christine Lagarde has warned of a fresh pan-European recession and just this once she may actually have a point.

Not that the old continent ever left the ‘old’ crisis, but since so much time and money was inserted into the recovery hologram, and we’re in a generous mood, let’s pretend and play along: it’s a new recession! That or a triple dip. The terminology is not the main point here; it’s going to be too nasty to occupy ourselves with semantics.

As I was writing about the shame of putting millions of young Europeans into the dark hole of long-term unemployment yesterday in The Disgrace of Sacrificing a Generation, Europe’s leaders met to discuss that very theme. Only, they didn’t.

They went on and on again about wanting the freedom to spend more, either through support from Mario Draghi bond purchases or by simply violating EU budget limits. EU PM Renzi called those limits outdated: it’s new world out there!

What they did say about the jobs issue was that more money was not needed, since there’s an existing $82 billion fund for youth jobs, of which only 12% has been used … That crazy detail tells us two things: Brussels and the European capitals don’t care about their children, as the entire situation also makes clear enough.

It also tells us that they have no idea what to do. But that should never be an excuse. Go figure it out. Want to be a leader? That comes with responsibilities. Having 50% youth unemployment in Spain and Greece should have gotten you guys fired. Some things are simply not acceptable.

But of course all those young people can count on from now on is that they will be even more abandoned. Because the crisis is back. And Germany doesn’t think the party with the biggest debt wins the contest. So southern Europe will drop further into the hole. Until someone steps off the train and decides to have a go at it alone.

And if the next move down is not enough to make that happen then maybe they all deserve each other. Still, looking at Europe now, it should be crystal clear to everyone what a failure the EU has become.

Which is one of the reasons our dear Ambrose had me laugh again today. When Evans-Pritchard starts drawing conclusions from what he hears and reads, strange things happen. This time Germany has drawn his ire. Next week it’ll be someone else.

Ambrose thinks it’s a crime not to bury a country in debt, if you have the opportunity. And he thinks the Germans are a bunch of criminals for not allowing the entire continent to bury its head in the quicksand either.

The words he uses are great: ‘household fallacy’, ‘fiscal fetishism’, ‘the false god of fiscal balance’, ‘the corrosive psychology of ageing’, ‘lumpen-proletariat’, ‘contractionary vortex’.

German Model Is Ruinous For Germany, And Deadly For Europe

The Kaiser Wilhelm Canal in Kiel is crumbling. Last year, the authorities had to close the 60-mile shortcut from the Baltic to the North Sea for two weeks, something that had never happened through two world wars. The locks had failed. [..]It has been a running saga of problems, the result of slashing investment to the bone, and cutting maintenance funds in 2012 from €60m (£47m) a year to €11m.

This is an odd way to treat the busiest waterway in the world, letting through 35,000 ships a year, so vital to the Port of Hamburg. It is odder still given that the German state can borrow funds for five years at an interest rate of 0.15%.

There you go. That’s what ultra-low rates to to people. It doesn’t just make them get into debt, it makes them believe it’s crazy not to.

Yet such is the economic policy of Germany, worshipping the false of god of fiscal balance. The Bundestag is waking up to the economic folly of this. It has approved €260m of funding to refurbish the canal over the next five years. Yet experts say it needs €1bn, one of countless projects crying out for money across the derelict infrastructure of a nation that has forgotten how to invest, sleepwalking into decline.

That is, a nation that has forgotten how to invest … with borrowed money.

France may look like the sick of man of Europe, but Germany’s woes run deeper, rooted in mercantilist dogma, the glorification of saving for its own sake, and the corrosive psychology of ageing.

“Germany considers itself the model for the world, but pride comes before the fall,” says Olaf Gersemann, Die Welt’s economics chief, in a new book, The Germany Bubble: the Last Hurrah of a Great Economic Nation. Mr Gersemann says the Second Wirtschaftswunder – or economic miracle – from 2005 onwards has “gone to Germany’s head”.[..]

Marcel Fratzscher, head of the German Institute for Economic Research (DIW), makes a parallel critique (more Keynesian in flavour) in his new book, Die Deutschland Illusion, no translation needed. It is a broadside against the fiscal fetishism of finance minister Wolfgang Schauble, now written into the constitution as a balanced budget law from 2016 onwards…

Balanced budgets are just so 20th century. It’s a new world out there. Ask the Italian PM. Ask Krugman. Ask Ambrose.

It is the self-deception of a country “resting on its laurels”, prisoner of the “household fallacy” that economies are like family budgets, and falsely reassured by the misplaced flattery of foreigners who rarely look under the bonnet at the German engine below.

The German economy has already stalled. [..] Prof Fratzscher accuses Germany’s elites of losing the plot in every important respect. Investment has fallen from 23% to 17% of GDP since the early 1990s. Net public investment has been negative for 12 years. Growth has averaged 1.1% since the beginning of the decade, placing Germany 13th out of 18 in the eurozone (or 156th out of 166 countries worldwide over the past 20 years).

I like that last bit, but I don’t believe it for a second. Besides, I don’t get how a 1.1% growth level since the beginning of the decade – which is 4 years – places you anywhere over the past 20 years. Sounds like apples and passion fruit to me.

Data from the OECD show that German productivity growth slumped to 0.3% a year in the period from 2007 to 2012, compared with 0.5% in Denmark, 0.7% in Austria, 0.9% in Japan, 1.3% in Australia, 1.5% in the US and 3.2% in Korea. Britain has been negative, of course, but that is no benchmark.

Prof Fratzscher says the chief effect was to let companies compress wages through labour arbitrage. Real pay has fallen back to the levels of the late 1990s. The legacy of Hartz IV is a lumpen-proletariat of 7.4m people on “mini-jobs”, part-time work that is tax-free up to €450.

That’s not great, but just about all countries hide a lot of unemployment that way. Nothing specifically German about it.

A fifth of German children are raised in poverty.

That’s horrible, but again there’s nothing specifically German about it. France, UK, US, you name them, the numbers will be similar.

Capital flows within EMU have been a form of vendor financing for buyers of German exports, but it should be obvious that such a structure must reach breaking point – for Germany as well as EMU – if France and Italy buckle to demands and follow Greece, Spain, Portugal and Ireland into wage deflation.

There’s no such thing as ‘wage deflation’, but it’s clear that wages in France and Italy will come under increased pressure (in Germany too). And it’s clear that Germany has used the EU as its own backyard market. And the structure will indeed break.

Europe is already sliding slowly into a contractionary vortex, replicating the errors of the Gold Standard in the 1930s. Doubling down would be calamitous. Germany must move with great care. As Mr Gersemann argues in his book, it is enjoying the last days of a particularly powerful demographic dividend, soon to reverse with a vengeance.

The European Commission’s Ageing Report (2012) said Germany’s workforce will shrink by 200,000 a year this decade. The old age dependency ratio will jump from 31% in 2010, to 36% in 2020, 41% in 2025, 48% in 2030 and 57% in 2045, tantamount to national suicide.

Once more, nothing specifically German about it. Try Japan, China, most of northwest Europe, Italy. Whether every ageing society, every country with falling population numbers, is committing suicide, I don’t know. They will change, and hugely, that’s for sure.

This is a grave failure of public policy over decades. Tax policies and social structures have encouraged the collapse of the fertility rate. Lack of investment has compounded the error.

Wow, Ambrose. Really? Decades of tax policies have made people have less children? You just figured out what has puzzled scientists for all these years! You mean that if the Germans and Japanese and Chinese and Italians had only borrowed more money, and invested it in crumbling canals, we could have had 8 billion people on the planet instead of the measly 7 billion we have now? And our workforces wouldn’t have shrunk, and we could have filled all the jobs we don’t have?

Within five years it will surely become obvious to everybody that Germany is in deep trouble, and a balanced budget will not prove any defence.

The whole rich world in is deep trouble, not just Germany. You know why? Because they’re drowning in debt. And you know who seem to be about the only people left who understand that? The Germans. A balanced budget won’t check all problems at the door, but it’s a lot better than having debt of 200% or 400% of your – rapidly shrinking – GDP. Which is what many nations face.

Within 10 years, France will be the dominant power of continental Europe.

And pigs will fly to Mars. And Marine Le Pen will be crowned Empress. And proudly parade all those fair-skinned but not blond babies down the Champs d’Élysées.

What all these countries will need to figure out is what to do when their economies have stopped growing. When they are shrinking instead. What to do with the huge debtloads piled up on top of them when everyone was still trying to borrow their way into growth. And how to divide what remains in such a way that they can keep themselves from blowing up in unrest and fighting and revolutions.

You really think Germany will do all that bad under those conditions? Worse than all the others?