Friday, September 10, 2010

Trend Break in Oil Supply

The enthusiastic professionals in Paris report that:
Global oil supply fell 250 kb/d to 86.8 mb/d in August, as non-OPEC output dipped to 52.4 mb/d on seasonal maintenance in Canada, the UK and Russia.
I've added that to the graph above (along with the OPEC data point I discussed yesterday).  As often, the agencies don't completely agree on what's going on, with OPEC now seeing July as only a partial restoration of production cuts in June, but the IEA still seeing it as taking production to a higher level.  But both concur that August is now below the level of February.

So there is certainly the appearance of a trend break here.  To give you some idea, from May 2009 to February 2010, the slope of the three-agency average was 0.25 ± 0.03 mbd/month, while from Feb to August of this year, the slope was -0.02 ± 0.04 mbd/month.  So the slope since February is not significantly different than zero.  However, the slope is significantly different than last year - the difference between the two is 0.27 ± 0.05, which is highly significant*.

To interpret the fact that global oil production has stagnated for most of this year, we obviously have to look at price trends too:

Prices dropped a few months ago from being over $80 into the $70s, and haven't really climbed very much since.  So it still seems to me that the most likely picture here is that a stagnating global economy is not pushing prices high enough to unlock additional supply (which OPEC undoubtedly has).

So what happens now?  Does oil supply resume growing again and surpass the July 2008 peak?  Or does it begin to go down again?

My educated guess would be this: in the short term, I see the global economy stagnant.  European countries are belt-tightening (especially the U.K.).   The US is too paralyzed by political polarization to take much action of any kind, but the growth effects of the stimulus from ARRA are mostly over.  Deleveraging still has a long way to go and will exert a dampening effect over much of the globe.

In the medium term, it seems that the place to watch is Greece.  We know the European stress tests left out sovereign default, which I am cynical enough to think means that European regulators knew important banks couldn't cope with a Greek default.  But it's a little hard to see how Greece doesn't default (did everyone see that amazing Michael Lewis piece in Vanity Fair?).  And if it did, I assume that would trigger Financial Crisis 2.0 (probably less severe than Financial Crisis 1.0 in 2008) which in turn would probably trigger another jog down in global oil consumption/production.

Here are the latest European Bond Spreads (courtesy Atlanta Fed):

Greece is paying absolutely usurious interest rates.

I guess leading reasons to think otherwise: the Fed and the ECB might, at some point, become sufficiently alarmed about deflation to start to take stronger quantitative easing measures and manage to provoke some kind of recovery.  However, I have to think any such recovery could only be very shallow and temporary.  In a world with a major Too Much Debt problem, lowering interest rates to provoke more borrowing cannot be a lasting strategy for fixing the problem.

The other possibility is that emerging economies could continue to grow their oil consumption enough to offset falls in developed countries.  But their oil consumption is still much smaller, and many of the largest emerging economies are still very export dependent.

So on balance, I think it's more likely than not that oil supply will drift sideways for a while, and then fall a mbd or three in a financial shock.  However, the world is a very complex place, and I wouldn't place more than, say, 65% confidence in the bet that it will break downwards rather than upwards.

(*Nerdy footnote: Note that the significance would be reduced somewhat by the fact that we decided where to place the putative trend break after looking at the data, but not likely enough to erase this big of an effect).


Burk Braun said...

Great post, Stuart-

I agree that Greece is likely to default, and they would be better off sooner than later, accompanied by an exit from the Euro.

The moderate oil prices provide the developed world with a valuable window of opportunity to set up carbon tax systems in advance of peak issues, so that we can address climate change, which is coming a lot faster than lack of fossil fuels. Another political pipe dream, perhaps, but future generations will certainly be paying attention.

Lastly, the US government has zero problem with "Too Much Debt", though we certainly do in the private economy. The solution is to directly fund jobs from the federal budget, transforming the massive savings going to Federal bonds into economic activity. You'll recall that the paydown of federal debt after world war II was pretty painless, with economic activity picking up and erasing most of it through increased GDP and positive revenues.

Stuart Staniford said...

Burk: my "Too Much Debt" comment was intended to refer to private debt, and the sense that the utility of QE will be limited by the fact that the private sector is in a position of needing to deleverage, and thus will not do a lot of borrowing and expanding even if interest rates are low.

Irrespective of the merits of the kind of large fiscal expansion you suggest, it seems pretty unlikely in the present political environment.

James said...

Why the fed is not engaging in more QE is a mystery to me, but it is easy to see why this option may soon be off the table for the ECB.

The classic argument against the euro zone has always been that it would be impossible to craft a monetary policy that would be good for both Germany and Club Med (aka the PiGS). It was predicted that at some point Germany would require high interest rates to contain inflation while Club Med would require low interest rates to spur growth. With Club Med in recession if not yet depression and Germany's economy booming, the ECB will soon be on the horns of a dilemma. If they keep interest rates low (and even engage in QE) to help Greece, then inflation in Germany will start to take off - and when inflation starts to rise in a loose monetary policy environment, it doesn't just rise steadily it accelerates upwards. We all know how the Germans feel about Hyperinflation and the Weimar Republic. I can't see how the Euro Zone will hold together - and every analysis I've read about a EuroZone breakup has suggested it will be seriously ugly.

Greg T. Jeffers said...

It might seem trivial... but what I most appreciate about your analysis is that you give a probability of occurance - "65". I was a career trader on Wall Street; I always did a probability call and then a move call... say, I give a 65% chance the trade will go this way with a move of 10, and 35% chance the trade will go south with a move of 20. If probability X move on our bet did not exceed probability X move on the risk, we didn't do the trade.

I am not long or short any oil contracts at the moment. THe political risks are just too difficult to assess... otherwise, I'd be short for the near term.

Alexander Ac said...

Here you can find bond yields online:

there is only Greece but one can find codes for other countries...

regarding Greece, this might be relevant, if alarmistic: