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Ambrose Evans-Pritchard sums up the state of the oil market

8/8/2015

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The Telegraph
If the oil futures market is correct, Saudi Arabia will start running into trouble within two years. It will be in existential crisis by the end of the decade.


The contract price of US crude oil for delivery in December 2020 is currently $62.05, implying a drastic change in the economic landscape for the Middle East and the petro-rentier states.


The Saudis took a huge gamble last November when they stopped supporting prices and opted instead to flood the market and drive out rivals, boosting their own output to 10.6m barrels a day (b/d) into the teeth of the downturn.


Bank of America says OPEC is now "effectively dissolved". The cartel might as well shut down its offices in Vienna to save money.
The problem for the Saudis is that US shale frackers are not high-cost. They are mostly mid-cost, and as I reported from the CERAWeek energy forum in Houston, experts at IHS think shale companies may be able to shave those costs by 45pc this year - and not only by switching tactically to high-yielding wells.

Advanced pad drilling techniques allow frackers to launch five or ten wells in different directions from the same site. Smart drill-bits with computer chips can seek out cracks in the rock. New dissolvable plugs promise to save $300,000 a well. "We've driven down drilling costs by 50pc, and we can see another 30pc ahead," said John Hess, head of the Hess Corporation.

It was the same story from Scott Sheffield, head of Pioneer Natural Resources. "We have just drilled an 18,000 ft well in 16 days in the Permian Basin. Last year it took 30 days," he said.

He said the resilience of the sister industry of shale gas should be a cautionary warning to those reading too much into the rig-count. Gas prices have collapsed from $8 to $2.78 since 2009, and the number of gas rigs has dropped 1,200 to 209. Yet output has risen by 30pc over that period.

Until now, shale drillers have been cushioned by hedging contracts. The stress test will come over coming months as these expire. But even if scores of over-leveraged wild-catters go bankrupt as funding dries up, it will not do OPEC any good.

The wells will still be there. The technology and infrastructure will still there. Stronger companies will mop up on the cheap, taking over the operations. Once oil climbs back to $60 or even $55 - since the threshold keeps falling - they will crank up production almost instantly.

Mr Sheffield said the Permian Basin in Texas could alone produce 5-6m b/d in the long-term, more than Saudi Arabia's giant Ghawar field, the biggest in the world.

Saudi Arabia is effectively beached. It relies on oil for 90pc of its budget revenues. There is no other industry to speak of, a full fifty years after the oil bonanza began.


In hindsight, it was a strategic error to hold prices so high, for so long, allowing shale frackers - and the solar industry - to come of age. The genie cannot be put back in the bottle.
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Leading indicators suggest we may have avoided a global recession

8/6/2015

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Once again 
The Telegraph AEP
With hindsight it is clear that the world economy came within a whisker of recession earlier this year.


Global shipping volumes contracted by 3.4pc between January and May, according to Holland’s CPB world trade index.


This episode is now behind us. Leading indicators and monetary data in the US, Europe and China point to an accelerating rebound over coming months.

Gabriel Stein, from Oxford Economics, says the growth rate of the world's real M3 money supply – based on the US, China, EMU, the UK, Japan and Canada – rose to a six-year high of 6.2pc in June.


The M3 gauge tends to lead economic growth by 12 months or so, suggesting that the worst may soon be over.

In Europe, the monetary kindling wood of recovery is clearly catching fire.Spain is growing at its fastest pace since the post-Lehman crisis. So is Ireland.

The triple effects of quantitative easing by the European Central Bank, a 12pc fall in the trade-weighted index of the euro in 15 months and the fall in Brent crude prices from $110 to $50, have together lifted Euroland out of its six-year depression.

The property slump is over. Standard & Poor’s expects house prices to rise 3pc in Holland, 4pc in Portugal, 5pc in Germany and 9pc in Ireland this year.

keep going with QE until the end of next year,” he said.

America is slowly weathering the effects of the strong dollar. The economy grew at a 2.3pc rate in the second quarter. Capital Economics expects it to accelerate to 3pc in the second half. Loans are growing at an 8pc rate. It is not a glorious boom, but nor is it the stuff of global meltdowns.


The commodity crash may feel as if Armageddon has arrived but it is, in reality, the tail-end of China’s hard landing, compounded by Saudi Arabia’s political decision to flood the global crude market and strike a blow against Russia, Iran and the US shale industry.

“There has been a sharp drop in the ‘commodity-intensity’ of China’s economic growth,” said George Magnus, a trade expert and a senior adviser to UBS.

“This has sent very chilly winds through parts of the world. Vast swathes of the emerging market universe have lost their export prop."

The synchronized rout that we have seen across the gamut of commodities – from copper, to thermal coal, soya and milk - is certainly hair-raising. The Reuters-Jeffrey CRB index of raw materials has collapsed by almost 60pc from its peak in 2008 and is back to levels first reached in 1971.

There is a risk that this could go too far and metastasize, leading to a second leg of global deflation. This would play havoc with debt dynamics in a world where debt ratios have risen by 30 percentage points of GDP since 2008, reaching unprecedented levels.

Yet commodity crashes are double-edged. They act as a stimulus for the world economy. The consuming nations are enjoying a $500bn "tax cut" from the OPEC cartel.


The slide may soon touch bottom in any case, if it has not already done so. The Baltic Dry Index measuring freight rates for dry commodities has almost doubled since the start of June. The shipping firm Clarksons said it is being driven by a revival of Chinese steel demand.

The chances are that the growth scare of 2015 will prove to be a false alarm, much like the nasty episodes of 1987 and 1998 when market tantrums – frightening at the time – turned out to be innocuous. The cycle had another two years’ life both times.

Markets over-reacted violently this week to a fall in China’s PMI manufacturing gauge to 47.8 in July, fearing that the economy is now in the grip of such powerful debt-deleveraging that stimulus no longer works. But the survey was distorted by the immediate fallout from the stock market debacle in Shanghai.

Nomura says its "growth surprise index" is signalling a “strong rebound” after touching the bottom in May.




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Karl Marx was right - Global Imbalances

8/10/2014

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Via Reuters.

Now for the bad news. While the steady or slightly accelerating global growth rates predicted by the IMF is the most likely outcome, it may not be achievable because of three imbalances: social, geographical and demographic. These seem deeply embedded in the structure of global capitalism today. They are weakening demand, creating excess savings and driving the buildup of borrowing and lending that has been both a cause and consequence of the global financial crisis.

The most dangerous imbalance is in the distribution of wealth and income. Income disparities have become a source of political and moral controversy, but their macroeconomic effects have attracted less attention. The mechanism whereby income inequality causes economic stagnation was recognized by Karl Marx and other 19th-century writers.

If too much of the income created by capitalism’s capacity to increase production flows to people who are already rich and likely to save rather than spend, then crises of under-consumption become almost inevitable, as described by Marx in Das Kapital and analyzed more rigorously by John Maynard Keynes in the 1930s. The only way to avert such crises is to create financial systems that recycle excess incomes from rich savers to poorer consumers via a buildup of debt.

Geographical imbalances are a second major cause of weak demand. The global imbalance that generated controversy before the crisis was between the United States and Asia. This has largely disappeared as U.S. consumption and borrowing have subsided, while China and Japan have shifted away from export-driven growth models.

In the meantime, however, an equally troublesome imbalance has emerged between Germany and the rest of the Europe. Germany’s current account surplus of 7 percent of GDP is now larger and more persistent than the Japanese or Chinese surpluses before the crisis. Yet on the global stage, Germany is not subjected to the same sort of pressures. Germany’s political dominance in Europe also makes it immune to the kind of demands for policy changes that Washington applied to Japan and China, while the existence of the euro rules out the currency adjustments that ultimately removed the imbalances between Asia and the United States.

The third imbalance is demographic. Believers in secular stagnation have drawn attention to the downward pressure on labor supply as baby boomers retire. But this is unimportant in a period of high unemployment, when there is no shortage of workers to limit economic output. The bigger impact of demographic aging is on macroeconomic demand. Particularly when this problem is aggravated by Social Security and labor policies that shift incomes and economic opportunities in favor of retirees and older workers at the expense of younger generations.




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Why macroeconomics doesn't work that well

5/3/2013

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From Noahpinion
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The FED has got its finger in the dyke - Can it prevent the flood?

1/14/2012

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I have had several friends ask me “which way is the market going  in 2012?”My answer has been - it depends on how the debt crisis is handled. Last fall, we had a Greek debt restructuring and the US FED (covertly and perhaps illegally) bailed out European banks.

Much of the Euro zone, the US and Japan have unsustainable debt trajectories, on top of which they have banking systems which themselves are  impaired with bad loans. Kyle Bass, hedge fund manager at Hayman Capital Management LP, calculates that when sovereign debt + size of banking system> 5X government revenues - the government loses the ability to bail out the  banking system.
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There are two primary options that can be used to address a  sovereign debt crisis, one is a default; the other is the central bank can print  money and diminish the real value of the debt. The former option is deflationary, the latter is inflationary.

The question for the individual investor, risk manager and portfolio manager is which market effect is likely to dominate? Deflation is  bad for commodities like gold but good for US treasuries, vice versa for inflation.

Moreover, as was the case last fall, it isunlikely that all countries would have uniform responses. For example, debt restructuring could dominate the Euro zone and the US response could be inflationary. Ray Dalio, of Bridgewater Associates, also sees a non-uniform response.

"Dalio believes that some heavily indebted countries, including the United States, will eventually opt for printing money as a way to deal with their debts, which will lead to a collapse in their currency and in their bond markets. “There hasn’t been a case in history where they haven’t eventually printed money and devalued their currency,” he said. Other developed countries, particularly those tied to the euro and thus to the European Central Bank, don’t have the option of printing money and are destined to undergo “classic depressions,” Dalio said.
 
We are in a new age of volatility. The central banks, particularly the FED, have been managing the market levels, providing accommodation that may have short term benefits but serves to increase systematic risk and volatility in the economy. This means all asset managers are now risk managers.



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I spit on your US numbers - optimists

12/20/2011

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There is an old adage in forecasting that says -give a date or a  number but never both. 

The current market expectations around the US economy are much  too positive. I alluded to this in a post over a month ago.  

I have discussed the dismal state of Wall Street, IMF and FED forecasting on several occasions in these pages. These analysts: act as a herd, over rely on models, do not know how to think about systems, focus on the wrong data, and, as Hussman points out, exhibit binary thinking. 
 
From Hussman:
More broadly, the real question is how much importance should we  put on the fact that economic data has delivered consistent "positive surprises"  in recent weeks? Don't all these surprises significantly short-circuit the risk of probable recession? 

On that question, the evidence is very clear. No, they do not.

 In order to properly understand economic "surprises," it's  important to recognize that unlike actual economic data, where fluctuations have to do with, well, the actual economy, economic surprises are - by definition -  measured relative to the subjective expectations of economists and Wall Street analysts. Unfortunately, analysts tend to be all-or-none. Instead of allowing for a normal ebb-and-flow of data, they form expectations that overshoot both on  the pessimistic side and on the optimistic side. As a result, once the economy experiences an initial softening, expectations turn lower, often very aggressively. Over the following weeks, economic data can continue to be fairly  soft, but because expectations have collapsed, the new data is interpreted as  being "above expectations." After a while, that experience of positive surprises causes analysts to over-correct by forming overly optimistic expectations, which is predictably followed by a period where the data, unless it is spectacular,
almost cannot help but disappoint. 

My observation is that this cycle of optimism and pessimism tends to run just over 20 weeks in each direction, though that is certainly not a magic number of any kind, and is best interpreted as a tendency. To give you an idea of how this regular pendulum of hope and despair affects the data in practice, the chart below presents the Citigroup Economic Surprises Index (a tally of how often recent economic reports have either beat or fallen short of  consensus expectations). The blue line, to the thrill of anyone who enjoys Trigonometry, is a sine wave with a period of 44 weeks. “ (See Chart at end of post) 

So how would I do it better? Start by asking questions if your  data or models or answers actually make sense given the broader context of what is happening. Start by asking yourself how bad things are going to get in Europe. 

Europe is going to have a strong recession. What’s more they are practicing austerity and have structural issues that prevent their economies from readjusting to sustainable growth path. I have heard remarked on business television that 40% of US corporate earnings are tied to Europe. At home, the states have a budget crisis and, at this writing, congress is struggling to pass  a bill that extends the payroll tax holiday for only 60 days. Not to mention the US has its own structural employment  issues.

IMO, the only way the US can avoid a recession is if a stimulus package is passed. What are the odds of that? How big will it be, when will it get implemented?

The problem in forecasting is not when you expect growth to be 3.7% and it turns out to be 3.3%. The problem occurs when growth is 1.7%. Just look at the embarrassing forecasts put out by the FED this year that typify the stupidity of mainstream analysis.(See second graph at end of post)

As my Econometrics professor was apt to say: “Monkeys can run regressions.” 

Thinking about and understanding the context of data that is another matter entirely. This is a rarity in the professional economist
community.
  
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Long Run thinking and Macroeconomic analysis

9/8/2011

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Macroeconomic analysis is foundedon on systems thinking. One is always looking for fundamental imbalances that cannot be sustained over the long run. These imbalances are often not recognized by many analysts and build up slowly overtime. I have come to think of the global economy in terms of the  human body. If you force your body out of balance by overeating, over drinking or some other form of abuse there are short term effects and long term effects. The short term effects can seem small and inconsequential in the moment, while the long term health debts are growing.  Many analysts seem blissfully unware of the approaching dangers and indeed even argrue that the system is in no danger at all. Relax everything is fine. The market wil solve all problems.

An example of this type of bad analysis can be found on this blog post which is commenting on a report on downward mobility in America. The blogger commenting on the findings of the report states:
 
"But turn that around and what do you get? A fairly simple recipe  for staying in the middle class: Go to college, get married, stay married, steer clear of hard drugs.
 
Do those simple things and the odds are on your side. The keys to a financially successful life seem to be family, education, sobriety. Seems boring and obvious, doesn’t it? But it also suggests that American life isn’t quite as bad as the press wants to paint it."

 
I guess this blogger has a different perception of the definition of “simple” than I do. My assertion is that if 50% of marriages fail- staying married is not simple. Paraphrasing Billy Graham, America’s most revered evangelist, he once asked his wife if she had ever considered divorce to which  she replied “no - but I have considered  murder”.


Is it simple to go to college? The US public primary and secondary education system has been in decline for 30 years. Post-secondary education costs are sky rocketing, while middle class wages are stagnant to declining and health care costs are growing at 2-3 times the rate of GDP.

 What about the broader question of mobility in general. Can someone born in urban America achieve the middle class in the same way that someone who is born in Fairfax,  Virginia?

 What depresses me about society is that we often fail to even achieve the minimal threshold of discourse necessary to move policy forward. We do not reach agreement on the definition of the core of the problem.
 
Of course, the longer we take to address systemic imbalances the bigger the problem gets (see my dragon analogy last post). Have another burger and beer, watch a football game - Rome is slowly burning.

 My feelings and frustrations on this and other public policy points on this can be summed up in this way.        

JERRYPOURNELLE: DESPAIR IS A SIN:
“I do not warn you of a future you cannot avoid. On the other hand I have for forty years warned that we are approaching a precipice, and yet we continue to move toward it. Sometimes I get discouraged.”

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It is going to be a tough decade for the global economy and the BRICS will not save us.

8/29/2011

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Unfortunately, I agree with much of the sentiments of Michael Pettis and have been teaching them in my International Macro classes (in the case of the Euro) for the past decade. For various reasons, I continue to prefer Brazil out of the BRICS and believe things will be substantively better for them than for the others.  Other than that, my views pretty much line up with Pettis.

Those wanting just a summary click here.
Those wanting more in Pettis own words click here. 

As I pointed out in my last blog, there are millions of jobs that have been lost in manufacturing since China joined the WTO. Absent intervention, these jobs are gone forever, and with the loss of millions of construction jobs, unemployment for the low skilled will become chronic.

I have suggested that that this will lead to a level of social unrest not seen in Amercia since the 60s. Pettis believes that both the US and UK  will become trade protectionist. I see this as the easiest and most likely way that policy makers will deal with problems of social inequality. Fundamental reform of education is much tougher, especially in a budget constrained enviroment.
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