Low oil prices not just caused by a supply glut
Lower oil prices are not just the result of a supply glut. The fact is that both before and since the global financial crisis, the pace of world economic productivity growth has been lessening. It may well be that the world simply cannot find a productive use for the oil even though the price has dropped.
“A striking feature of the [post-crisis] period has been a continuation of a long-term slowdown in productivity growth that has gone hand-in-hand with weak levels of investment,” the Organisation for Economic Cooperation and Development (OECD) wrote in May.
And productivity matters. As economist Paul Krugman famously wrote in 1994, “productivity isn’t everything but in the long run it is almost everything”.
There is clearly no lack of money floating around the global economy. “After the [global financial crisis], central bankers have collectively spent the past decade stepping up the pace of money printing to new extremes in an attempt to drown the global economy in liquidity,” Societe Generale’s Albert Edwards wrote on Thursday last week.
Indeed, there is no shortage of individual examples of conspicuous expenditure. Hong Kong itself can provide two recent instances. A single parking space can now command a price of HK$5.18 million while a world-record price of HK$2.94 million for a single handbag was set on May 31.
There is plenty of liquidity in the global monetary system but it is seemingly not flowing into investments that enhance improvements in productivity.
As regards oil, when Opec, the oil producers’ cartel, combined with other nations such as Russia to recently agree to extend output curbs, their collective hope was to shore up the oil price. Yet the price has slid.
Of course, opportunist and increasingly efficient US shale oil producers have raised their own production, and countries such as Libya and Nigeria have boosted output, but the reality is that even though the price of a barrel of oil has fallen, new buyers are not rushing to take it up.
In fact, even with the Opec agreement in place, freight rates for very large crude carriers are moving higher as more ships are being chartered to provide floating storage facilities for pumped oil that currently has nowhere to go. That will provide an income stream for ship lessors but it is not enhancing global productivity.
In China, refiners have recognised the problem and are reining in their activities over what would normally be their peak summer season. The third quarter of 2017 will additionally see almost 10 per cent of the country’s refining capacity go offstream. That has to be unnerving for oil markets, given the size of China’s global economic footprint, but from the Chinese perspective, it is perfectly rational.
In the United States, petrol demand, which accounts for 10 per cent of world consumption, fell year on year in each of the first three months of 2017, and pump prices have dropped almost five per cent since the end of April, according to the US Energy Information Administration.
Oil companies will be hoping that the lower pump price will tempt American drivers into their vehicles as the US driving season begins.
In the meantime, it is perhaps no surprise to see that analysts have been downgrading oil stocks. Australia’s Macquarie Capital last week cut the ratings of companies such as BP, Chevron and Royal Dutch Shell.
And all this is occurring against a backdrop of still broadly benign monetary policy settings from the world’s central banks. Japan’s ultra-accommodative monetary policy continues at full throttle and while the US Federal Reserve has made four 25-basis-point rises since December 2015, its approach has been characterised by great caution.
Yet even with all this monetary policy accommodation, all this cheap money, the pace of global productivity growth has remained subdued and investment remains weak. That surely goes some way to explaining the inability of the oil price to gain traction. It is not just an oil supply glut.
But that begs the question of what is going to happen when monetary policy across the world normalises, when the price of borrowing money rises.
Japan is a separate case but the Fed has taken some steps and is indicating it will do more, China has been tightening policy and the European Central Bank may also be considering taking back some monetary accommodation.
If the world cannot find a productive use for oil when the cost of money has been so low, how will it do so when central banks tighten monetary policy? Oil producers may discover their problems have only just begun.