Monthly Archives: December 2015

Oil Export Ban Lifted Amid Price Collapse – 12/18/15

The US has lifted its long-standing oil export ban at a time when commodity prices are at decade lows.

Although allowing the export of US oil for the first time in decades is historic, it is unlikely to have much immediate impact. The move comes during an oversupply in oil globally when companies are already struggling with debt taken on when major projects still seemed profitable. It may be because large effects seem unlikely that the legislation was able to pass, since it is only human nature to avoid rocking the boat when people are already uneasy with establishment figures. Naturally, even with both political sides claiming victory, there are some who will not benefit from the deal. Since the ban on exporting raw oil made domestic refineries the only option for many US firms, some higher cost refiners will go out of business if cheaper foreign refiners can be found. Though those firms will close and jobs will be lost, the oil producers will see the benefits of a global market both in buyers and refining services while U.S. oil prices will move to be more in line with global benchmarks.

Low oil prices don’t seem to dissuade banks from reining in high cost producers in the US oil market. Optimistic projections and hesitation to set off a chain of failures that would leave the banks holding oil assets may result in the US producers that OPEC members had hoped would collapse under low prices being much more robust. Since banks prefer to avoid holding foreclosed upon assets such as houses and oil assets, it is not unexpected that they would hope for a rebound in prices. Unfortunately, all the rose colored glass in the world can’t stop heavy losses in the energy industry, and banks holding loans from small, private oil producers may be facing a harsh reality if prices remain low well into 2016 as overproduction, bulging stockpiles, and moderate temperatures suggest. The lifting of the oil export ban was largely accounted for in prices minimizing the effect of the news on stocks.

Brazil continues to experience political and economic issues as major credit-rating firms downgrade the sovereign bonds to junk ratings, the president attempts to stave off impeachment, and the economy continues to struggle with basement-level commodity prices. Between the increased difficulty of servicing government debts and the graft scandal hitting the upper echelons of Brazilian society, policy is unlikely to help Brazil pull itself out of recession anytime soon. On the other side of the globe, the Bank of Japan is taking steps to reassure the nation that it can bolster an economy that has seen almost no growth in the last decade. An aging population combined with a reluctance to accept foreign labor is just one of the major issues facing the nation.

Rate Hike and Junk Bond Worries – 12/15/15

As the Federal Reserve prepares to rise the benchmark short-term interest rate from zero in its first rate hike since the financial crisis, analysts are closely watching for signs of weakness that could cause a reversal.

The Summer slowdown in the Chinese economy combined with below target inflation had made the Fed reluctant to make the rate hike earlier in the year but the robustness of American growth in the face of such issues abroad has inspired some degree of confidence. At this point, businesses have long been prepared for the increases so another delay would only bring doubt to a market better served by predictable regulation. Even so, the US economy has been growing for over half a decade and, as in every business cycle, the further away from the last crash we go, the closer we get to the next. Asset bubbles are taking shape constantly and any one of them could force reversals over fear of fizzling growth. On the other hand, if the Fed does nothing, then the interest rate will no longer be a tool it can use to boost growth unless it runs rates negative.

The threat of a destabilizing run on debt markets is looming. As oil-prices continue to disappoint companies and investors, junk bonds drag down performance of the funds holding them. Many seeking an out sell what they can to meet the earliest out calls leaving those who remain with less liquidity and greater to desire to exit. As a result, demand for riskier assets has dropped dramatically and many fear that the market will begin to freeze up and the economy as a whole will start a new decline. The state of global junk-bond markets and commodity prices have driven down stock markets across most nations as investor confidence has dipped. Oil-and-gas and mining sectors are posting the losses causing markets to stumble and risk premiums to rise. And pessimism due to oversupply and warm weather has led many fund managers to bet against a near-term revival in oil and gas prices.

Oil Glut Squeezes Small Suppliers – 12/09/15

As the oil glut continues, many investors are betting against the small, high-cost producers that have managed to survive the extended period of low prices.

Many small producers with heavy debt loads find themselves with little hope of relief as overflowing inventories dim the already faint hope for a quick rebound in prices. Since the low prices are outlasting even long term hedging positions, many producers are unable to pay down debt built up for now unprofitable projects as losses in the energy sector junk-bond market pile up and investor sentiment continues to sour. Defaults, driven by the weak bond market, are expected to accelerate.  Even support industries in storage and transport are suffering as the market responds to unrestricted production and weak Winter demand.

With the International Energy Agency reporting swollen inventories, lackluster demand, and the unlikeliness of a quick rebound, oil prices continue to fall as even oil bulls turn bearish. As we enter 2016, bankruptcies will be common in the shale oil industry but, with the oil pumping assets already in place, it is tough to say if production will drop quickly enough to have a significant effect on prices. And with oil and other commodities experiencing significant, sustained falls in price, Brazil and China are experiencing slowdowns which are only partially offset by growth in India. Meanwhile, Russia’s oil-dependent economy continues to contract due to the low prices.

As the dollar strengthens, US exports will be more expensive for foreign importers. US consumers on the other hand will benefit from cheaper prices at the pumps and relatively cheaper imports though the harm that low commodity prices are doing may outweigh benefits felt domestically as job cuts and investment reductions in affected industries become necessary. Many energy companies are already consolidating and selling off assets, such as pipelines and gas terminals, to stave off creditors. In the mining industry, metal prices have been hit especially hard by the slowdown of China, the primary driver of demand growth, and are not likely to recover anytime soon. Possibly the largest beneficiaries of cheap fuel, airlines are benefiting from low costs but face troubles ahead if slowed global growth eats into revenues. Some airlines are unable to take advantage of low fuel prices due to locked in rates that won’t expire until next year, but overall profits have been at record highs.

Low Demand Forces Cost Cuts – 12/7/15

As we enter an unusually warm December, companies which usually counted on increased fuel use in the winter months face falling stock prices due to low demand. The companies, already facing high debt volumes taken on for projects not profitable under the current low prices, are in need of weather related demand as industrial demand for petroleum products falters. If the warmer than normal weather persists, then the energy sector will continue to drag on overall economic growth.

Companies may be able to salvage their own bottom lines through cost cuts provided that they are willing to reduce investments and, consequently, long term growth prospects. Some companies may benefit from the carnage brought about by plummeting prices provided they can acquire troubled competitors at sufficient discounts. Still, there is the possibility of prices staying depressed as slow downs in major consumer economies like China’s result in low demand growth while oversupplied inventories bulge due to high and robust output.

Even cheap buys could be too costly as margins continue to shrink. OPEC refusing to reduce output, the robustness of high-cost US producers and fracking operations, and the impending re-entry of Iranian suppliers previously sanctioned are all factors investors are weighing as they send benchmarks further and further below $40 a barrel. And as those prices fall further ETF’s investing in green energy will find themselves under greater pressure as renewable sources appear less economically viable and China reins in demand. Managers of such funds are likely to keep a close eye on the Paris climate talks and its after effects.

Demographics Threaten Asian Economies – 12/06/15

Demographic trends – long-term changes in the makeup of a population – drive or are driven by major turning points in human history. Improvements of technology lead to booms in population size, lower maternal mortality rates, and mass migrations. In the 21st century, the trends differ significantly from those of the past. Developed countries in Asia and Europe face especially troubling demographics trends such as graying populations, something that weighs down economies where fewer workers must provide for increasing numbers of elderly non-workers, and disproportionately high male-to-female birthrates in China and India, artifacts of cultural practices encouraging the birth of boys and the selective abortion and abandonment of girls, leaving the countries with skewed sex ratios and significantly weakened growth prospects.

In recent years, Japan has faced significant issues related to the aging of its populace as roughly 25% are 65 or older, a proportion likely to increase given low fertility rates and high life expectancy. A lack of young workers combined with a reluctance to expand immigration programs has encouraged the development of automation techniques and ways to utilize the elderly who still wish to participate in the labor force but leaves Japanese companies short-staffed. Low expectations for long-term growth have also scared off much needed capital investments. Though Japanese policies and technical innovations will  help to cushion the impact of an increasing number of dependents per worker, this greying trend is the new normal for developed countries. The aging of Japan represents a dilemma that many of the most populous and developed countries will face within a few decades.

China and India may face their own demographics crunches brought on by a lack of women. In China, a combination of One Child policy, Confucius traditions  encouraging a strong bias towards male heirs, and increasing urbanization has left the country with a dangerously skewed sex ratio, following years of anti-female birth practices, and a population with little incentive to the additional girls needed to sustain the society. Though the government scaled back its restrictions on the number of children each family could have, a slowing economy has discouraged families already having fewer children due to less need for large families in the urban area where an educated few tend to be more successful. India faces similar issues due to a patriarchal society and dowry system which have made having a female baby a social and financial liability.

Oil Dependent Countries Suffer as Glut Rages On – 12/04/15

As crude-oil futures fall below $40 a barrel, oil dependent countries relying on sales of the commodity to balance their books are squeezed by prices that have fallen below half of 2014 levels with no sign of a bottoming out. Oil revenue reliant countries, such as Venezuela, Russia, Saudi Arabia, and a multitude of others in South America and the Middle East, are seeing large budget deficits in the wake of weak demand and resiliently high output.

Since the deceleration of China’s economy began this Summer with a plunge in its stock market, the country’s demand for oil has fallen significantly. The Chinese government is attempting to use policy to maintain the 7% growth rate from previous years but will likely fail by even its own metrics as looming demographic and economic issues weigh on the nation. By extension, many commodity driven economies like those of Brazil and Australia also face slowdowns as China cuts orders for raw materials. Coupled with increased fuel efficiency, eased sanctions against Iran, a strong dollar, climate talks calling for decreases in fossil fuel usage, and the increasing cost-efficiency of alternative energy/electric vehicle systems, the slowdowns continue to weaken global demand.

Oil outputs remain high in spite of lower demand and unprofitable oil prices. In an attempt to force out smaller producers in the US, Saudi Arabia drills to maximize output in spite of OPEC discontent with the oil glut. The issue will likely not be resolved by pressure at this year’s meeting. The smaller producers in the US are proving to be more stubborn than anticipated as they continue to keep output high to maximize their cash flows.

Their creditors are also proving unexpectedly robust as the cuts to credit lines are well below expectations of industry executives. Shale oil available via fracking technology has greatly reduced the influence OPEC can assert with output reductions. Russia and Iran competing for market share, especially in Europe, have refused outright to rein in output and pump at record levels while analysis funded by OPEC has indicated that even with reduced output the market faces significant overproduction due to non-OPEC entities and bulging stockpiles. Saudi Arabia and Iran head opposing sides reflecting their competition for influence in the destabilized regions of Syria and Yemen. OPEC has long been plagued by free rider problems as countries within the group pump past output ceilings and major producers outside the group maximize output in order to maximize revenues even as prices collapse.

For many years, the ruling party of Venezuela relied on oil revenues to maintain their legitimacy. Now, with collapsed oil prices, the United Socialist Party is unable to use income from the state-owned oil companies to provide the cheap food, housing, and services that won over voters. Even with the lack of information provided by the government, food shortages and the collapse of many state welfare institutions make it apparent that the country is facing serious economic woes revealing decades of oil reliance has left the populace with few alternatives to government programs. Dominance over the media and the reliance of many on government jobs and welfare are among the many tools the ruling party will use to contain opposition in the upcoming elections.

In Russia, the price collapse has made a recession all but certain as oil and natural gas account for over 2/3’s of export revenues. The combination of low prices, wars abroad, Western sanctions, a shrinking populace, and rampant corruption weigh down the nation’s prospects and the Russian government shows plans to help stabilize prices or pull back from other costly engagements. Conflicts with Ukraine, the West, and now Turkey have put the Russian leader Putin into a position where his government needs the oil revenues to fuel military production and combat a looming budget crisis.

In the US, the Federal Reserve prepares to raise interest rates for the first time since the 2008 crisis. The strong dollar has increased demand for foreign goods as relatively cheaper imports and increased employment have led to increased consumption but do not offset the effects of the output from US shale oil and natural gas deposits as they add to an oversupplied oil market. In recent times, US firms have used to these new sources and other advances in technology and capital streams to maintain a larger production base less susceptible to attempts by OPEC members to price these smaller, higher-cost producers out of the market for significant time frames.

The Paris Climate talks have shown the contention between developed and developing countries over the future costs of fossil fuel usage. Countries such as India question how they could grow without the cheap energy that other nations had access to and ask for financial help be given if they are expected to shift to more costly green energy sources. The effects of climate change are to be most costly for less developed countries that do not have the means to deal with shifts in shorelines and more volatile weather.