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Rune Likvern

Rune Likvern

Holds an MSc from Norwegian University of Science and Technology (NTNU), 1980, Marine Technology. 20 years of experiences from several international oil companies, primarily Statoil…

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Oil Prices To Stay Low If Global Credit Impulse Turns Negative

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For some time I have explored the relations in developments for total debt [private and public], interest rates, Gross Domestic Product (GDP) energy consumption and thus also the oil price.

My theory has been that there are relations between changes to total debt and energy consumption and thus energy prices. Changes to total credit/debt should thus be reflected in energy consumption. Price formation is also influenced by several other factors and most prominently supply and demand balances.

To me, demand appears to be the one that is poorly understood and demand has been, is and will continue to be what one can pay for.

All transactions involving products and services require some amount of energy thus currency/money becomes a claim on energy.

During the last decades the world was in a gigantic experiment with debt expansion, most recently fueled by low interest policies which allowed to pull demand forward and for some time negate higher prices when demand ran ahead of supplies.

Debt expansions can go on until they cannot, as some economies already have experienced. In the recent decades, growth in total debt was higher than the growth in GDP (ref figure 1) and there is a strong relation between changes to total debt and GDP.

(Click to enlarge)

Figure 1: The chart above shows [stacked areas] developments in total private and public debt in Japan (black/grey), Euro area (yellow), US (blue) and China (red).

In the chart is also shown [stacked lines] developments on the Gross Domestic Product (GDP) for the same 4 economies.

NOTE: All data are market value, US$.

The GDP (lines) have been stacked. The bottom line shows Japan, next is (Euro area + Japan) and the top line [China] also shows the total for the 4 presented economies.

Data on private and public debt from Bank for International Settlements (BIS).

Data on GDP from the World Bank [WB]. WB GDP data for 2016 were not publicly available as this was posted.

Note that total GDP for these 4 economies declined from 2014 to 2015.

In this post I also present a closer look at developments in energy consumption and total debts [private and public] for China, Italy, Japan, Spain, United Kingdom and USA.

As of 2016 these 6 countries had about 47% of the total global energy consumption and 42% of the total global petroleum consumption.

As the private sector debt growth slowed/reversed the public sector took over and it appears that public debt growth is not as potent to stimulate growth in energy consumption [and possibly GDP], but sustains or slows the decline in total energy consumption.

Part of the explanation for this may be that much of the increased public deficit spending is directed towards social programs (more unemployment benefits etc.) which at best may sustain demand.

The 6 countries are presented in the sequence of how I perceive how far they are into the debt deleveraging cycle.

There are other forces at play here as well, as oil companies entered into a bet that high oil prices would be sustained by consumers continuing to have access to credit/debt, which would allow the oil companies in an orderly manner to retire their steep growth in debts required to develop the costlier oil. The debt fuelled growth in investments gradually created a situation where supplies ran ahead of demand, thus collapsing the oil price in 2014.

To me the sequence of events is:

Changes in credit/debt => Changes in energy consumption => Changes in GDP

• The demand and thus the price of oil finds itself now in fierce competition with the growing need to service the growth in total global debts.

• China has for some time had better tolerance for higher oil/energy prices due to its more aggressive growth in debt since 2009. (Ref figure 2 comparing YoY total debt growth for US versus China and their totals since 2000)

• World consumption of crude oil and condensates (C+C) is now about 29 Gb/a [80 Mb/d].

A price increase of $10/b increases the global bill for C+C with about $290 Billion/a.

• According to the International Monetary Fund (IMF) total private and public debt as of 2015 was at $152 Trillion. A 1% increase in the interest rate amounts to $1 520 Billion/a.

A $10/b increase to the oil price has a similar effect as an increase of the interest rate of 0,2%.

• The above illustrates that the global economy now is far more sensitive to increases in the interest rate than to increases in the oil price.

The higher the total global debt gets, the more sensitive the economies become to increases in the interest rate.

• The growing need for debt services may explain why a lower oil price so far has given many economies negligible tailwinds.

• The costs to service these debts are passed on to the consumers, thus also affecting their affordability for higher priced oil/energy.

• Recently all eyes have been on OPEC (and those cooperating) to do something to reign in supplies to improve the support for the oil price.

The thing is OPEC can primarily affect the supply side, but they have NO influence over the actor increasingly playing the major role in the price formation for oil.

This actor is named DEMAND.

Figure 2: The columns show Year over Year (YoY) growth in total private and public debt for the years 2000 – 2016 for USA (blue), China (red) and their total (black).

The strong debt growth in the Euro area and the US (ref figure 1) drove much of the global economy until the Global Financial Crisis (GFC) in 2008.

Post 2008 global debt growth slowed and it was the concerted efforts by primarily China and the US that brought the global debt growth (and GDP) back on its trajectory. This also helped support a higher oil price while demand was stronger than supplies.

China took over where the US left off in 2009 and has until recently had a stronger debt growth than the US. China’s debt growth had a high in 2013 and has since slowed considerably while the US picked up some of China’s decline.

In 2014 China and the US added a total of $4,82 Trillion in (private and public) debt, which grew their GDP by $1,58 Trillion. In other words, it took about $3.06 of debt to grow GDP by $1.00.

In 2015 China and the US added a total of $4,64 Trillion in (private and public) debt, which grew their GDP by $1,23 Trillion. In other words, it took about $3.79 of debt to grow GDP by $1.00.

Note that the total debt growth for these two economies has noticeably declined since 2014.

A slowdown or a reversal in credit expansion will likely affect energy consumption and thus energy prices. This may create a temporary situation whereby demand declines faster than supplies which erodes price support until demand again catches up with supplies.

This article (from ZeroHedge) presents some of the recent developments in the credit impulse.

For what it is worth, private debt to GDP ratio in the US reached about 170% by the time of the GFC in 2008. China’s debt to GDP ratio stood at about 193% at end 2015.

There are structural differences amongst the 6 presented economies and the degree of energy self-sufficiency. Therefore, some arbitration should be applied when evaluating/comparing the countries.

Over time, energy efficiencies have improved and some substitution has taken place which may explain some of the developments in total energy consumption.

The charts do not adjust for fluctuations in exchange rates.

In the charts that follows, which hopefully are self-explanatory, changes in total private debt is shown as dark blue lines and changes to total private and public debt as black dashed lines [both left hand scales] versus the developments in total energy consumption split on energy sources. Currencies are local with the exception of China.

Generally, as debt growth slows and/or debt deleveraging sets in, energy consumption starts to decline.

(Click to enlarge)

Figure 3: Japan, developments in total energy consumption split on sources [rh scale]. Private and total [private and public] changes to debt shown as lines [lh scale].

What drove the Japanese economy and its energy consumption was growth in debt. In recent years, Japan’s economy has been facing some headwinds.

The combination of lower oil prices, stronger Yen, some growth in debt has so far not translated into increased petroleum consumption.

The documentary “Princes of the Yen: Central Banks and the Transformation of the Economy” [1 hr 32 min] gives some good insights about the Japanese economic miracle.

(Click to enlarge)


Figure 4: Spain, developments in total energy consumption split on sources [rh scale]. Private and total [private and public] changes to debt shown as lines [lh scale].

Spain’s energy consumption reached a high as its private debt reached a high. The following private debt deleveraging [defaults is one way to deleverage] resulted in lower energy consumption and the growth in public spending may have slowed the decline.

The recent increase in primarily petroleum consumption is believed to be primarily driven by lower oil prices.

(Click to enlarge)

Figure 5: Italy, developments in total energy consumption split on sources [rh scale]. Private and total [private and public] changes to debt shown as lines [lh scale].

Italy shows very much the same pattern as Spain.

(Click to enlarge)

Figure 6: U.K., developments in total energy consumption split on sources [rh scale]. Private and total [private and public] changes to debt shown as lines [lh scale].

U.K., stagnant and slow growth in private debt and decline in energy consumption. Recent growth in petroleum consumption believed to be primarily driven by lower oil price and growth in natural gas from a combination of lower prices and carbon emissions policies switching from coal to natural gas.

(Click to enlarge)

Figure 7: USA, developments in total energy consumption split on sources [rh scale]. Private and total [private and public] changes to debt shown as lines [lh scale].

With reference to the 80’s and adjusting for recessions US energy consumption grew with the growth in total debt until the Global Financial Crisis of 2008/2009.

US total energy consumption more or less flattened between 2010 and 2016 while total debt grew by almost $10 Trillion, while oil and natural gas prices came considerable down. The debates to understand this are ongoing.

(Click to enlarge)

Figure 8: China, developments in total energy consumption split on sources [rh scale]. Private and total [private and public] changes to debt shown as lines [lh scale].

China arrived late to the party with debt fuelled economic growth, but they have played catch up with a higher rate of debt growth. A slower or reversal [deleveraging] of the Chinese credit/debt will likely affect the energy markets.

China became the world’s biggest energy consumer as from 2009.

It is things like I presented here that makes me expect that the oil price will continue to remain low and chances are it could go lower if the global credit impulse turns negative for whatever combinations of reasons.

As of now I am not in the camp that expect a sharp increase in the oil price [absent a major geopolitical event] as demand and supplies are brought back into balance. This is because a growing number of consumers struggle with restrained balance sheets.

What will now allow for a much higher oil price is that consumers maintain access to more credit.

Changes in primarily private credit/debt need also to be seen in conjunction with the interest policies and changes to the balance sheets of the big central banks. Other things to watch are the supply/demand balance, stock movements and policy changes.

By Rune Likvern via Fractionalflow.com

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