The bears are still firmly in charge in the oil market. September 2015 marked the 11th monthly price decline in the last 15 months. A year ago, oil stood at around $100 a barrel. It is now around $48, having fallen back below $50 last week, and signs of a sustained upturn remain elusive.
Early this week, China reported falling industrial profits and the International Monetary Fund cut its target for global GDP growth for this year and next, due to slowing growth in emerging markets. “None of this is rosy for crude demand,” says Daniel Holder of Schneider Electric. And while production has fallen slightly in America, Russia, Norway and Mexico, this hasn’t been “enough to balance the supply glut”.
Oil cartel Opec’s output continued to rise between April and August, while Brazil has sped up its rate of oil extraction, says Nicole Friedman in The Wall Street Journal. Iran also claims it will be able to increase oil exports by 500,000 barrels a day by late November or early December.
Consulting firm Energy Aspects estimates that global crude stockpiles are at 80% of capacity, meaning that the supply glut could remain for some time to come. A strong dollar has also dented oil prices, as commodities are priced in the American currency. The upshot? Oil is set to trade between $40 and $50 a barrel for the rest of 2015, says Societe Generale.
Saudi Arabia under pressure
This sustained low-oil environment has devastated oil-producing nations such as Venezuela and Nigeria. It has also proved unexpectedly turbulent for Saudi Arabia, Opec’s key producer. Since last November, it has deliberately been keeping production high to lower prices and crush the upstart American shale industry, thus safeguarding the cartel’s market share.
But to the Saudis’ surprise, the shale industry has proved more resilient than expected – many firms have been able to lower costs and maintain output. Plenty of shale drillers are heavily indebted and vulnerable to sustained low prices, but the sector has certainly not suffered as much as the Saudis would like. And the current price is hurting them badly. The Saudis “are bleeding red ink”, says Liam Halligan in The Sunday Telegraph. The break-even price for the Saudis on oil is $90 per barrel; at these prices, they’re running up a deficit of $500m a day.
The country has been withdrawing billions from its foreign-exchange reserves every month to keep itself afloat. Its cash pile has slipped from $774bn last December to $664bn in August.Overall public debt is very low, but set to mount quickly: the budget deficit this year is set to reach 20% of GDP.
The impact on markets
The kingdom has issued bonds for the first time in years – and is now turning to redeeming its own investments. The Saudi Arabian Monetary Agency (SAMA) has “pulled out $50bn-$70bn over the past six months” from various global asset managers, says Nigel Sillitoe, chief executive of market intelligence company Insight Discovery, in the FT. This is unfortunate, says Sillitoe, because these “managers have been really quite reliant on SAMA for business in recent years”.
But the Saudis aren’t the only ones pulling in their horns. Norway’s sovereign wealth fund, worth $870bn, is the biggest in the world and owns the equivalent of more than 1% of every single equity in the world; it accounts for 2.4% of European stocks.The fund has seen a “precipitous drop in cash injections” from the government due to oil’s slide, says Saleha Mohsin on Bloomberg.com. Other oil producers’ sovereign wealth funds may also consider retrenching if prices stay low. This suggests that, for the first time in many years, equity markets can’t count on much of a boost from money from sovereign wealth fund. Another tailwind for stocks is fading.
Nobel Prize-winner Robert Shiller of Yale University has a good track record on bubbles. His book Irrational Exuberance, which followed several warnings about overpriced stocks, appeared just as the dotcom bubble peaked. In 2005, he began to fret about US housing markets. Now, he reckons US stocks are due a fall. The S&P 500 has a cyclically adjusted price/earnings ratio (also known as the Shiller p/e) of 27, a level superseded only in 1929, 2000 and 2007, whereupon markets collapsed, he notes in Wirtschaftswoche. Note too that the last recession was eight years ago.
Usually there is a downturn at least every ten years, another reason to expect the party to end before long. In the 1990s, markets climbed from very expensive to absurdly expensive, so a crash may not be imminent. But Shiller says that this summer he sold some of his stocks, notably those that had risen for the previous six years. He reckons the Dow Jones could fall by 30%, and jitters will spread to other markets.