Almost a year ago in this column, the question was raised as to why the media was not reporting who all had lost billions on their oil contracts. After all, once oil prices started collapsing in June of 2014, when West Texas Intermediate was selling for $105.24 per barrel, every six-week-forward contract for pricing was losing money — unless one was betting on that fall-off in pricing. Mostly, though, oil traders were losing billions on their bets. Yet, while the media went into 24/7 speculation on why the price of oil was falling — mostly premised on the Saudis’ opening the oil taps, hoping to flood the market with crude and destroy our shale industry — that was really much ado about nothing. Yet that same level of specific speculation was trotted out over and over again as if it were gospel handed down from on high on stone tablets.
Just last week we heard that Saudi Arabia will go broke in five years or so at oil’s current prices; the week before that it was that the Saudis were on the verge of destroying our shale industry for years to come. One should wonder how, in the mid-Eighties and late Nineties, when oil was selling for spot prices around $10, Saudi society didn’t collapse then. But it didn’t.
Economic Law Repealed
The theory of trading oil on open markets is that between the seller, the net buyer and the speculator they will somehow determine a fair market price based on supply and demand realities. Of course, it hasn’t been that way in a very, very long time.
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Consider this: Just over a week ago we had 479.9 million barrels of oil on hand, not including our Strategic Petroleum Reserve, with WTI oil selling in the mid-$40 range. Yet in February of 1999 we had only 333.4 million barrels on hand, and again oil was selling on the spot market for less than $10 and gasoline was 99 cents per gallon. Those hard facts on what used to be called “The Law of Supply and Demand” show that oil has long been disconnected from reality.
So we have all this speculation on why oil has fallen, whether it will continue to fall or reverse course, who will fail first — the Saudis or our shale drillers —and so on. Yet none of this speculation is being put to the most obvious use of asking why other major commodities and indices are in a situation similar to oil’s.
Since June of last year, oil prices have fallen by 56.7 percent. But during that same period the Baltic Dry Index, which is the economic indicator of the price of moving major raw materials by sea, fell at its peak by 65.4 percent, and even after a correction it’s still down 51.4 percent. OK, so we’ve had a collapse in the price of shipping raw materials on the open seas that almost mirrors what has happened in the price of oil. Where’s the media speculation on why that happened? (Hint: It had nothing to do with the Saudis or shale drilling in North Dakota.)
Come to think of it, over the past year iron ore has fallen by 29.5 percent, copper by 22.5 percent, and aluminum by 22.8 percent. And last week a news story reported that China is dropping its steel prices because demand has plummeted.
So you see, it wasn’t just oil and its pricing that fell dramatically on trading desks worldwide, although that what’s taken up the most media space — and without anyone’s actually finding the reasons why this has happened. But it didn’t happen in a vacuum: The prices of many critical manufacturing commodities have also fallen; but the one thing that most closely mirrors oil is that Baltic Dry Index, or moving raw materials from regions where they are mined to the industrialized nations that use them. In fact, if one looks at the long-term graph for the BDI, one finds that it almost tripled in price from 2001 to 2005, then skyrocketed in price from late 2006 to the summer of 2008. Just like oil did both times. (It’s not because oil tankers fall into this category; their pricing is found in the Baltic Dirty Tanker Index.)
Last December a friend, who’s been a major oil and fuels trader for decades, told me that what we were really seeing worldwide was probably an unwinding of dollar carry trades. That made sense, since this was one of the issues that triggered the Asian Financial Crisis of late 1998, which in turn gave us $10/bbl oil and 99-cent gas the following spring. One indication this might be happening now is that our own dollar was strengthening against a basket of currencies.
That may be a key reason the Fed steadfastly refuses to raise interest rates, which in the real world could aggravate the influx of other currencies and dollars back to America. Not to mention adding to the national deficit.
Some backing to what was put forward in this column a year ago has been given since then by both Clinton’s former Secretary of the Treasury Larry Summers and Deutsche Bank. Summers, making a presentation to the HSBC’s Global Investment Seminar in New York in late October, observed what was happening worldwide by saying, “It is the substantial reduction in capital inflows to developing countries, and the substantial increase in capital outflows from developing countries.” He summed that up by saying, “It means more and more funds seeking to purchase U.S. assets, safe assets in the industrial world.”
Business Insider also reported that Deutsche Bank put out a note to its investors that included this line: “It’s been a turbulent year for emerging market economies, from Brazil’s fiscal crisis to China’s slowing economy. And this year, emerging markets had the biggest capital outflows since the financial crisis.”
Oh and then CNN/Money carried an article under the headline, “Record Levels of Cash Flocking to the U.S.”
And so there was no mention of Saudis, West Texas Wildcatters or the battle for control of the oil market. It’s just how the big-boy investors are reacting to the world’s economic situation today.
Arabic for Thanks: شكر
Aren’t we lucky to be in Texas? For the past 42 years that I know of, we’ve done exceptionally well during periods of national downturns. And, while this oil situation is going to cause some pain in many regions of our fair state, this too shall pass. If history is any indicator, once emerging markets restructure and start growing again, that’s when the price of oil goes crazy. So, enjoy the cheap gasoline prices while you can, but remember that they won’t stay down forever.
And finally, the one thing in many countries worldwide that’s keeping things looking relatively good, considering the aforementioned issues, is the fact that oil is so cheap that industrialized nations’ economies are doing reasonably well. Including near record volumes for new cars sales here in October. In that case, maybe the Saudis knew when they opened up the crude oil taps last year that this would be a moderating force economically. Because they did the same thing in the early Eighties when the world was stuck in a global recession caused by the Second Energy Crisis. That’s also what they did in the late Nineties during the Asian Financial Crisis, too.
Oh, and with cheap gas we set the all-time sales record for new car sales in 1986, broke that in 2000, and may break it again next year with close to 18 million sales. But I doubt any new car dealers will send thank-you cards to Riyad.
© Ed Wallace 2015
Ed Wallace is a recipient of the Gerald R. Loeb Award for business journalism, given by the Anderson School of Business at UCLA, and is a member of the American Historical Association. He hosts the top-rated talk show, Wheels, 8:00 to 1:00 Saturdays on 570 KLIF AM. E-mail: firstname.lastname@example.org, and read all of Ed’s work at www.insideautomotive.com