Looming oil price shock that could trigger the next global recession

By Paul Homewood

 

 

An insightful analysis by Jeremy Warner, which has more relevance than he might imagine:

 

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Revenge, it is said, is a dish best served cold. When Mohammed bin Salman (MBS) rounded up more than a hundred of Saudi Arabia’s richest businessmen, investors and members of the royal family and imprisoned them in the comparative luxury of Riyadh’s Ritz-Carlton, cheering the crown prince on from the sidelines was one Donald Trump.

“Some of those they are harshly treating have been ‘milking’ their country for years!”, he tweeted. He didn’t say exactly who he meant, but he must surely have had primarily in mind Prince Alwaleed bin Talal, a Saudi royal who likes to think of himself as the Warren Buffett of Arabia, with a string of apparently successful western investments to his name, including substantial stakes in Citigroup and, until very recently, Rupert Murdoch’s 21st Century Fox.

When Trump essentially went bust in the recession of the early Nineties, Alwaleed helped bail him out by buying his yacht and, just when a crucial debt payment was due to be made, taking a stake in New York’s Plaza Hotel. Strangely, Alwaleed later seemed to take the view that he’d had his pocket felt, and started slagging the then presidential hopeful off on Twitter and on the New York social circuit. Trump’s eventual victory might have seemed unlikely at the time, but it rarely pays to make an enemy of someone who might actually one day become the world’s most powerful man.

Since his elevation to the presidency, Mr Trump has become cheerleader in chief for MBS, with a seeming willingness to back virtually everything he does, including the imprisonment of Alwaleed.

For Trump, there’s an element of payback time. The price of freedom is that Alwaleed surrenders more than half of his wealth and agrees for evermore to worship at the feet of MBS. The two things may be disconnected, but Alwaleed now seems to be dumping assets right left and centre. It all sounds like a sub-plot from Game of Thrones, which is sort of what it is. Only with real life implications; these positively medieval goings on have potentially dramatic geopolitical and economic repercussions.

Trump’s unconditional backing for MBS has emboldened the new Crown Prince’s regional ambitions. Always fractious relations with Iran grow worse by the day, with a vicious proxy war already being fought in Yemen.

Despite the present glut in supply, the oil price has again been creeping up. Long in abeyance, we are seeing the re-emergence of a geopolitical risk premium. Generally, this is taken for granted in the oil price, but in recent years it all but disappeared, apparently made redundant by the advent of US shale.

Now it is coming back. Like a siren going off, traders are suddenly waking up to an old bogey – the possibility that rising tensions could close the Strait of Hormuz, through which approximately a fifth of world oil supplies pass. Any such disruption, even for a few weeks, would cause the oil price to skyrocket anew, notwithstanding the newly emerged pressure valve of US shale.

It was faintly amusing in this context to see Norway’s sovereign wealth fund last week signal that it would be selling down all its investments in oil and gas, including large stakes in BP and Shell. There is a rich irony, even if the logic is also irrefutable, since Norway’s sovereign wealth fund is entirely founded on the windfall of North Sea oil and gas.

For what it is worth, Norway’s central bank, which runs the fund, insists that its strategy is not driven either by environmental concerns or worries that green technologies will end up rendering hydrocarbons obsolete, and therefore reserves stranded. It’s simply that if already deriving much of your income from such reserves, does it really make any sense to double up and invest the proceeds in even more? Even so, the move seems to mark another milestone on the road to Big Oil’s eventual demise.

That said, the journey’s end is still plainly a long way off. Despite the now almost exponential growth in renewable energy, oil still has the power to shock. Closure of the Gulf strait would cause the price to at least double, delivering a heavy blow to the world economy similar to a substantial rise in interest rates.

A rising oil price is both inflationary and deflationary at the same time; it adds to prices, but by doing so, it takes money out of other forms of consumption and thereby depresses overall demand. If there is one thing pretty much guaranteed to bring the economic expansion of recent years to an end and tip the world back into recession, it would be an oil price shock. Don’t believe that renewables in combination with American shale have entirely insulated us against this hardy perennial of a threat to global growth. They haven’t.

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We can ignore the Saudi power politics for a moment, but the key here is the risk of an oil price shock, which in turn could bring a new global recession.

Certainly closing the Straits of Hormuz would be up there as one of the top risks. But it actually needs much less then that to bring about the next oil price spike.

It was rapidly increasing Chinese demand for oil which put up prices at the start of the 21stC, and arguably triggered the 2008 financial crisis.

But you only have to go back to 2013 to find prices of $113/bbl, showing that prices can be high even when global economic growth is slowing down.

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As with the mining sector, prices for oil tend to run in cycles. When demand is high, prices surge, which in turn leads to more drilling.

This increases supply, often at the same time as high prices have slowed economic growth, thus stunting demand. Prices consequently fall, which leads to oilfields shutting and a cut in capital expenditure on new fields.

Supply falls, prices go up, etc etc.

What I am saying, in a very convoluted fashion, is that prices of oil can be very volatile.

But where does this all leave us?

There is currently a lot of pressure on oil companies, whether of the Exxon knew variety, divestment campaigns, threats of carbon taxes, electric cars and decarbonisation targets.

With all of this swirling around them, who would blame them if they left the oil in the ground and used spare cash for dividends and share buy backs?

But, as we know from history, the effect on the world’s economy could be absolutely disastrous. It might take a few years, but we would inevitably see a contraction of supply, and a consequent spike in prices.

Significantly China has spent the last decade buying up and financing oil developments around the world, which would allow them to protect themselves against the worst.

One of these days, the world might get by without oil, but it certainly won’t be in any of our lifetimes. Yet there are many who want to make life as difficult as possible for oil industry.

They might be more careful what they wish for.

 

Footnote

Jeremy Warner makes this comment:

Despite the now almost exponential growth in renewable energy

I commented on a similar claim yesterday, with a little anecdote, which is worth relating in full.

This is from The Maths Forum:

 

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Which is more: being given one million dollars, or one penny the first day, double that penny the next day, then double the previous day’s pennies and so on for a month?

It certainly looks as if a million dollars is more than all those pennies added up, because each penny is worth so little. How could even a whole lot of pennies be anywhere near a million dollars?

If we think carefully about this problem, however, we will find a surprising answer.


To begin, let’s look at what happens in the first five days and see if we can find a pattern.

       Day    No.of Pennies Given    Total No.of Pennies

        1                 1                         1
        2        1 x 2 =  2                  1+2 =  3                      
        3        2 x 2 =  4                1+2+4 =  7
        4        4 x 2 =  8              1+2+4+8 = 15
        5        8 x 2 = 16           1+2+4+8+16 = 31

We see that the series whose sum gives the total number of pennies follows a regular pattern: each new term added to it is a power of two. This is an example of a geometric series. A geometric series is defined as having a constant ratio between consecutive terms.

In our case, we are told that the number of pennies given each day is double the number given the day before, which suggests that the ratio of this series is 2. Let’s check:

     no. pennies given on second day      2
     -------------------------------  =  ---  =  2
     no. pennies given on first day       1


     no. pennies given on third day       4
     -------------------------------  =  ---  =  2
     no. pennies given on second day      2


     no. pennies given on fourth day      8
     -------------------------------  =  ---  =  2
     no. pennies given on third day       4

Indeed, the ratio of the geometric series that gives the total number of pennies on a particular day is 2.

Having found this ratio, we can now use the fact that the sum of a geometric series (called S) with n terms whose ratio is r is the following:

    S = (first term)(1-r^n)/(1-r)

This means that for our penny series with a first term of 1 and a ratio of 2, we find the sum after n days

    = 1(1 – 2^n) / (1 – 2)

    = – (1 – 2^n)

    = 2^n – 1


We can also arrive at this formula by looking at the number of pennies we’ll have after a given number of days. The number of pennies we will have is always one less than a power of two. For instance:

       Day           Number of Pennies

        1            2^1-1 =  2-1 =  1
        2            2^2-1 =  4-1 =  3
        3            2^3-1 =  8-1 =  7
        4            2^4-1 = 16-1 = 15

We see that on day n we will have 2^n – 1 pennies – the same formula we arrived at above by using the fact that our series is geometric.


Now for our problem. Using our formula, since a month has about 30 days we will let n equal 30. This means that after a month we will have 2^30 – 1 pennies. Is this more than a million dollars?

Well, 2^30 – 1 = 1,073,741,824 – 1 = 1,073,741,823 pennies. That’s more than a billion pennies!

If we divide this number by 100 (remember, there are 100 pennies in a dollar), we can find how many dollars this is:

    1,073,741,823 divided by 100 = $10,737,418.23. That’s almost eleven million dollars!

If you keep doubling your pennies, you’ll wind up with many more than a million dollars.

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From a statistical point of view, the idea that renewable energy can replace fossil fuels, based on its rapid rate of increase in the last few years, is as fanciful as somebody doubling your pennies everyday.

via NOT A LOT OF PEOPLE KNOW THAT

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November 21, 2017 at 01:42PM

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