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Monday, March 15, 2010

Oil And Debt, Baby

Yeah, that's what most of the economic news really adds up as right now. Oil and debt, debt and oil.

But first, in keeping with my mission to insert random Latin hymns into your innocent young minds:

Now, back to oil and debt...
Moody's fires a shot in the debt wars:
The U.S. and the U.K. have moved “substantially” closer to losing their AAA credit ratings as the cost of servicing their debt rose, according to Moody’s Investors Service.
The U.S. government will spend about 7 percent of its revenue servicing debt in 2010 and almost 11 percent in 2013, according to the baseline scenario of moderate economic recovery, fiscal adjustments in line with government plans and a gradual increase in interest rates, Moody’s said.
It's going to be interesting. Moody's says that it will downgrade the US credit rating when debt servicing costs exceed 14%.

This blast from the past regarding the Euro and Italy gives some perspective:
Ministers of the Northern League, which forms part of the governing coalition, recently called for abandoning the euro and reintroducing the lira. That was a surprise, because in the 1990s the Northern League welcomed the impact of the monetary union on Italian borrowing costs ­ the interest rate on Italian government bonds fell from double-digit levels to 3.5 percent and Italy’s government debt servicing costs fell from 12.6 percent of GDP to 4.7 percent.
As you can see, it wasn't only Greece which was paying lower interest rates due to monetary union. Of course, debt servicing costs are quite variable, and perhaps not the best way to measure repayment ability in the future. Debt as a percent of GDP is a better measure, and the ability of the domestic economy to take up public debt is another.

On to oil (which has a great deal to do with future GDP expectations).

The oil drama has been building. Production in Iraq is coming back online (Feb +7%). March 10th OPEC released a report saying that its current production substantially exceeded second quarter projected demand. The IAE then fired back with a release stating that China's oil demand was escalating hugely. This may be so, but China uses less than 9% of the world's oil.

See this Bloomberg article for Baker Hughes and more OPEC info. New projects in Canada's oil sands are also picking up. Chinese and European companies are trying to buy into the oil sands there, and will certainly provide funds. PetroChina did get Canadian approval for its participation in two Alberta oil sands projects. China's oil expansion points up the oddity of US oil policy. We just don't, but in not doing so, we ignore the reality that everyone else just will.

Note the range of pricing forecasts in the Bloomberg article. $60? $50 by 2015? Nobody knows - but the peak oil story is not what it seems to be; economics trumps belief systems as always. IMO the world is figuring out the price of oil. Too high, and the global economy collapses. Too low, and the global economy expands but supply constraints emerge, which corrects the price. Eventually, we will converge on price ranges that allow investment for new development but allow expansion of demand (i.e. a growing world economy).

Not to worry; If the US has a debt problem Germany/France will bail us out.

Econbrower presents an interesting take on oil, the comment section is worth reading also.
One of my favorite scenes from one of my favorite movies. That shot runs not quite four minutes, covers quite a distance in linear terms, and features hundreds of individual actors. That, and they did it with smoke billowing through and a light rain falling. And the director is in the whole shot, so the cinematographer is really directing.

Brilliant the first time I saw it, still brilliant today.
A devalued dollar raises oil prices here making exports
less competitive. The best solution is to raise tariffs
on manufactured goods. We need to supply ourselves
first and keep a stable dollar.
OT: MoM, I just sent you an email..not sure if right address since I couldn't find it on the blog and used an old one I had for you.
Note the range of pricing forecasts in the Bloomberg article. $60? $50 by 2015? Nobody knows - but the peak oil story is not what it seems to be; economics trumps belief systems as always.

And yet those of us "cooler heads" continue to endure the basest most foul insult for being so stupid.
Veeerry funny, CF. I can hear Sarkozy laughing now.

Sonoma Potter - thanks for that link. I found it interesting, but it seemed to me that the adjustment took about as long as it usually did. Obviously the last part of the run-up and the crash occurred very rapidly.

The subsidies in the developing countries are insulating domestic demand in those countries, but most of those countries have economies dependent upon exports. Thus demand in their economies is hit when world trade is hit. Also at high levels, those subsidies can themselves cause problems for those economies, because they are borrowing or pulling from growth to cover it.

There is a reason why the debt and the oil came up in this post together; in large part, the world sustained the run up for a few years because of greatly increased debt levels. Over time, we cannot do that. Even China cannot continue to throw as much money at their economy as they have done over the last year. Fortunately they don't have to; they have real growth left. But probably not at the pace they have sustained for a few decades. The margins are narrowing.

I do not agree at all with the idea that there can be a long-term decoupling of those economies from energy prices. There's a table at Wikipedia giving some measures of debt/GDP ratios. Of course they are out of date. The important figure is debt held by the public (the stuff the government is paying interest on).

The US ratio (using nominal GDP from Q4 and the current figure of about 8.1 trillion) is currently almost 56%. Obviously we are in trouble territory.

But what isn't so clear is that a country like India is very close to us, and if you added in some other debt (such as the oil bonds) might be a bit ahead. Our current plans seem to guarantee that we sill stay ahead of them, but still....

Another important factor about debt servicing and its effect on GDP is where that debt is held. If most of the debt is held internally, debt payments cycle back into the domestic economy. One of the worrisome things about the US is that so much of its debt is held externally, so that we are sending debt payments outside our economy. That is much more of a drain on future growth.

You might want to see this article about Chinese local government debt. The estimate that local governments will nearly double their borrowing through their own version of SIVs by 2011 is pretty startling. If that is true, China's real debt is far higher than usually estimated.

Thus, when considering oil prices, one must also look at debt levels before projecting the recent past into the future.
Jim Jubak had some really interesting things to say a few days ago.

Is China actually bankrupt?

Is China broke?

It seems like a silly question, right?

That's about as far away from conventional wisdom as wisdom can get.

If the thing were there -- and if I were not dreaming -- the implications would be quite beyond the power of the human spirit to bear. What tormented me most was my momentary inability to feel that my surroundings were a dream. - H.P. Lovecraft

There seems to be a problem with your "links to this post". It shows my last post on my blog linking to this post. I have linked to your posts in the past but I didn't this time.

Your last article also shows me linking to it when I didn't.

Just thought you might want to know. Looks like a bug somewhere.
Mark - it is some sort of blogger function that's picking it up in error.

Regarding China, the issue is how much of that debt is bad. It is not that they couldn't perhaps continue in growth, but their growth would have to be at a much slower overall pace. You can't keep doing this.

A rather sick (but weirdly fascinating) game one can play is to figure out how certain quarters are going to lay the Chinese debt problem at the Jews' door. One knows that they will be blamed by certain parties, but how? What will the explanation be? We wait with bated breath....
You also might want to see yesterday's article about local Chinese financing Rich Chinese Communists channel US Tea Party In Tax Debate.

Communism in China looks a lot like hypercapitalism and the age of the robber barons in the US. Which is okay, but you still can't keep borrowing forever. China now has significant overcapacity in many industries. I think the property bubble is more a symptom of this than a cause.

One thing is certain - money is being siphoned out of other industry and into property, and that is always a sign of a dangerous bubble. When the investment in a non-productive asset bubble starts sucking capital away from investment in productive assets, it is very hard to stop the bubble without inflicting a major economic shock.
On China demand growth, there is now talk that it is not all domestic demand but a reflection of increased refining capacity in China which then gets translated into higher refined products export figures.

On the subsidies front both China and India are moving on the subsidy removal route despite the threat of rising inflation since the subsidy bill can only go higher if Oil spikes. Removal of subsidies will result in some slack in demand in both countries given the experience of other developing nations that have walked on that path before.

Then you factor in 6 million barrels of excess supply in OPEC, add the 10 million barrel that Iraq will add in another 10 years and the impact of new fields in Brazil and the OPEC production compliance issues and you question the rate at which demand needs to grow to overtake production capacity in the next 24 months.
Oil Trader - thanks for the info.

China is also filling up its strategic reserves (they maxed out last year, but they are building new capacity).
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