Brent price in euro per barrel at an all-time high

Have you recently visited a petrol station somewhere in a Euro country? Shocked by the price level? Well, unnoticed by the press, the cost of oil has risen to its highest nominal level ever. The Brent price ended the day at 120,11 dollar per barrel on Thursday the 16^th. This is well below the Brent-in-dollar peak of 146,08 on the 3^rd of July 2008. However, the euro was then trading at almost 1,6 dollar, whereas now the euro trades below 1,3. The consequence is an all-time high Brent-in euro price of 92,52 euro per barrel. That is the reason why filling your car these days is a costly affair on Europe’s roads.

Fortunately, Europe has managed to significantly reduce its dependence on oil products. Due to fuel efficiency standards, cars guzzle less fuel. Residential heating has been switched away from oil products thanks to environmental policy and the expansion of the gas grids. And environmental policy again, has reduced the usage of oil for industrial and power producing purposes. The consumption of oil in Europe is displaying a steadily declining trend ever since 2005.

High oil prices would have been bad news for almost every continental European consumer of natural gas three years ago, as they all had contracts with the price of natural gas pegged to oil prices. Fortunately, the end market in North-Western Europe is now massively switching to the gas-to-gas pricing of Hub markets (NBP, Zeebrugge, TTF, NCG, Gaspool, PEG). True, these gas prices have also risen in the past year, but not as much as oil prices. With the oil-indexed gas contracts of the past, natural gas would have cost more than 40 euro per MWh by now, just as it did in 2008. At the forward Hub markets, gas consumers can now fix prices below 30 euro per MWh and spot prices haven’t risen much above 25. However, natural gas consumers in countries where access to Hub markets is difficult (Spain, Portugal, Italy, Eastern Europe), have every reason to look worryingly at oil market developments.

High energy prices are particularly bad news for Europe at this moment. Financial markets continue to worry about the potential cataclysm that Greek bankruptcy could cause in Europe’s banking sector. Partly due to this fear, economic growth has stalled. This week Germany published a -0,2% figure for the last quarter. Policymakers across Europe are hesitating between austerity programs to reduce budget deficits (right wing) and policies to support economic recovery (left wing). High energy costs might push struggling businesses over the bankruptcy line. Other companies might have possibilities to pass through higher energy costs in the prices of their products. But is this increasing inflationary pressure a good idea at a moment that consumer confidence drops due to the fear of a Greek tragedy? We should all hope that the combination of a recovering US economy and a weak euro supports export-oriented businesses. But it is clear that the record high Brent-price is bad, bad news for Europe.

The reason for increasing oil prices is simple. OK, here in Europe we reduce the consumption of oil. And yes, the US is reducing as they have also embraced the reduction of fuel consumption by cars. However, such declines are completely undone by developments in emerging economies where the consumption of oil doesn’t stop from growing. On a worldwide scale, we consume more oil year after year. There is enough of if left for the time being. But producing it comes at ever higher costs, which explains the increasing oil price. Squeezing petrol out of the oil sands of Alberta simply is a much more expensive affair than drilling holes in the Arabian dessert. Of course, there is some risk premium added to the price, as the markets ponder the consequences of an oil embargo on Iran and the increasing risk of military conflict in the Persian Gulf. Of course, the forces of speculation are also back. But beware of under-estimating the underlying problem. The increasing demand in oil cannot be met with cheaply produced stuff. The marginal cost economics of oil markets explain the high prices and volatility.

Even if the world’s economy is growing at a slow pace at this moment, it is still growing in the emerging economies, and faster than anywhere else in the world. And countries like China, India, Brazil or Russia, haven’t managed yet to decouple economic growth from oil consumption increases. So, unless we get a repetition of the financial-economic catastrophe of 2008, there isn’t much chance that filling your car will get much cheaper in the near future.

Filed under: Market analysis, Natural gas, Oil, The economy, The market today

Heading for the second leg of the double dip?

The IMF has lowered its forecast for global economic growth in 2012 to 4%, down from 5% growth in 2010. Even if this seems limited, it would mean standstill and even recession in many economies of the Western world. The IMF cites two main worries:

 

1. The EU debt crisis seems to be running out of control. The policy of helping the Greeks only if they adopt ever more severe savings programs is clearly counter-productive. It pushes the Greek economy into a deeper and deeper crisis. With an imploding economy, it will become impossible for the Greeks to pay back their debts.
2. The US economy is growing, but at a very slow rate. It proves very hard for the US to find new sources of economic growth. The old recipe of stimulating consumption in the US doesn’t work, as the American citizens are still trying to reduce the high debt levels they built up by over-consumption in the two previous decades.

 

The IMF points out that there is a broader issue at hand, a reshaping of globalization. In the period 1990 – 2008, globalization was based on the following trade pattern. US policymakers stimulated their economy by lowering interest rates. American citizens borrowed increasing amounts of money to be able to spend much more than they could afford. A lot of that money was spent on consumer goods produced in emerging economies such as China, causing double digit growth in these countries. This strong economic growth caused commodity prices in general and energy prices in particular to spike sharply. Debt accumulated in the US, capital accumulated in emerging economies and commodity producers such as Saudi-Arabia. This balance got a perverse streak when the accumulated capital in emerging and commodity countries became the source of borrowing to the US. This mechanism resembles a drug dealer that borrows drug money to his junkie clients so that they can buy more drugs. Ever more sophisticated leverage instruments, like Credit Default Swaps (CDS) stimulated the excessive borrowing.

 

The spike in commodity prices was one of the main causes for the balance to derail. By 2008, Americans had to pay 4 times more for heating their homes and – most importantly – driving their gas-guzzling cars. Due to this increasing cost of life, more and more Americans could no longer pay back their mortgages on their houses. Due to the extreme level of leverage, this caused a broad systemic crisis of the financial sector and a subsequent deep economic recession as consumers worldwide stopped consuming.

 

To rebalance the world’s economy, the IMF points out that we need to make a double movement. The established economies of the US and to a lesser degree Western-Europe need to become less dependent on imports, the emerging economies need to become less dependent on exports. In the West-, we need to focus on the development of innovative, high-value industries that we can export to countries like China. The emerging economies have to bolster the development of a middle class that engages in the mass consumption necessary to stimulate home-grown demand. The economic developments of the past two years have shown that we are engaging in this rebalancing act. The Chinese economy returned to double-digit growth remarkably rapidly after the catastrophe of 2008. This was due to stimulus programs that lured the growing Chinese middle class into consuming more. Brazil is another good example of a growing emerging economy thanks to growing middle class consumption. Germany, and in its slipstream Belgium, have been good examples of how Western economies focused on export of high value goods and services can benefit from the economic growth in the emerging economies.

 

The rebalancing act is being played out, but it remains a very delicate one. Two events seem to be undermining it at this moment. The first one is the continuing systemic weakness of the banking sector. It is unbelievable that a middle-sized bank such as Belgian-French Dexia, has built up a position in Greek debt paper that becomes unsustainable. Where are the risk management practices of these institutions? The events with Dexia show that it is not unthinkable that we might see a bank toppling like Lehman Brothers did in 2008, causing a chain reaction that brings the financial functioning of this world to a standstill. The second event that is troublesome is the slow pace of growth in the US, which is having a very hard time to re-invent itself as an export-oriented economy.

 

The solutions will have to come from politicians. European politicians will need to find a workable solution for Greece. US politicians need to find solutions so that they become exporters to emerging economies. Politicians worldwide have to take measures to curb the risk-taking, downward-spiral causing behavior of the financial sector. There is an urgent need for bold economic policies. The good news is that economists seem to agree more and more on what policies are needed. The bad news is that politicians seem to lack the guts to enforce those policies. A world leader like Angela Merkel, seems to be so scared of the public opinion in her country, that her treatment of the Greek debt crisis becomes self-destructive. Barak Obama, is blocked by the extreme bi-partizanship of American politics, with a republican majority in Congress which is increasingly inspired by 18^th century economics (Tea Party) and that blocks every attempt to deal with the economic situation with ideological arguments.

 

Sometimes, the economy doesn’t need political intervention to find a new balance. However, if we look at the current figures, it doesn’t seem to be doing that. The chances that we are heading for the second leg of the double dip, increase with every day that the world’s political leaders wait to attack issues like the Greek debt crisis head-on. So far, the energy prices remain at a relatively high level. We are not in the phase of economic decline yet. However, we do see energy demand levels that start to drop, although some of that might be explained by higher than average temperatures in September. Anyway, we recommend everyone to keep in mind the possibility of an economic recession leading to a downtrend of energy prices in the next months. And we hope that this will not happen.

 

Filed under: Market analysis, The economy

Earthquake shakes energy markets

German Cal 12 power ended above 58 euro per MWh today. The disastrous events in Japan have sent ripples across the worldwide energy markets. A brief résumé of the consequences of the earthquake that we currently observe:

1. Oil prices have declined. The Brent traded below 110 dollar per barrel today. Oil traders fear that the economic disruptions due to the earthquake will reduce oil demand in Japan, the world’s third largest consumer of oil. For the moment, it looks like the earthquake has (temporarily?) stopped the bull run in the oil markets.
2. Gas prices increased rapidly. TTF Cal 12 traded above 27 euro per MWh today. Nuclear power production in Japan is out due to the earthquake. It is assumed that the MWh’s not produced by the nuclear facilities will be produced in gas-fired power plants. The extra MWh’s of gas will probably come with LNG shipments from (mostly) Qatar. This sparks fears that the LNG supply to Europe, so important in keeping European gas prices at a reasonable price level, will be reduced.
3. Power prices rallied. This was not only due to the rising gas price. The problems with Japan’s nuclear facility could mean the end of plans to keep nuclear power plants in Europe open for longer than originally planned. Today, German Chancellor Merkel even announced that seven nuclear power plants in Germany would be shut down immediately for safety controls. If other countries would adopt similar measures, we would see a severe shortage of electricity in Europe.

The energy markets have changed completely in less than two months time. Revolution and war in the Middle east and an earthquake in Japan have severely shaken the supply / demand balance. The short term price movements might just be speculation or panic reactions. They could also be the start of a further bull trend. But then the question is: can the recovering economy stand this combination of: 1. Commodity price inflation, 2. Severe disruption of one of the world’s most important economies, 3. A massive switch of insurance money towards the Japanese reconstruction? Is the current crash of stock exchanges the precursor of a new economic crisis looming? Or is it just a panic reaction?

No better illustration of the unpredictable character of energy markets than the past two months. Keep counting on that lack of predictability and spread your buying decisions is the best that we can advise in such circumstances. We have to watch carefully in the next days whether the spot gas prices continue to rise. Because that would clearly indicate that increased Japanese LNG buying is affecting supply to Europe.

For the longer term, it is clear that the Japanese disaster will affect the nuclear power sector. It was the Tsjernobyl disaster in 1986 that inspired European governments to decide to phase out nuclear power production. The 25 years that followed without nuclear incidents inspired those governments to turn back those plans of shutting down nuclear power plants. But what politician will dare to defend expanded lifetimes for nuclear power plants after what has happened in Japan? Let alone decide whether to build a new nuclear power plant. If the nuclear phase-out plans would be resumed, this would inevitably have consequences for power pricing in Europe. But that’s the longer term. No idea what it will bring, as every morning we get up in surprise over a new explosion or fire in the Japanese nuclear power plant.

Filed under: Energy history, Energy policy, Energy technology, Germany, Market analysis, The economy, The market today

Lybia and the day that oil prices were almost 120 dollar

It is with increased horror that I look at the images of Lybia. This shows the true face of dictators, they shun no crime in their lust for power. However, living in the West, I also feel shame. We live in our shelter of a free and democratic society. And we don’t protest when our politicians befriend these dictators. We don’t mind the foreign policy of “rather a dictator that is our friend than a democratic government that is hostile” . The hypocrisy of Western policy in the Middle East and Northern Africa was clearly illustrated by British PM David Cameron’s latest trip. He visited the Tahrir square in Cairo to express his sympathy with the pro-democracy protesters in the region. He was joined by British defense industry people that where on their way to a Defense expo in Abu Dhabi where they will try to sell their weapons to the Middle East’s autocratic regimes. What is the message here? We support your protest for democracy, but we also sell the weapons to shoot at you? (For more on this controversial trip, read the Huffington Post.)

It is hypocrisy, but it is also understandable. The Middle East and Northern Africa have an immense economical importance for the West. They produce the bulk of the oil and the natural gas that fire our economies. The recent unrest has pushed these prices through the roof. The gas price for 2012 is already trading around 25 euro per MWh and Brent oil prices traded near 120 dollar per barrel on the 24^th of February. Everyone of us will feel the consequences of the rush for democracy in the Arab world the next time that we fill our car. Is it therefore surprising that we sometimes prefer the stability of a dictatorship? As Berthold Brecht told us ‘Erst das Fressen, dann die Moral”, it is human to put economic interests before ethics. The current situation in Lybia should inspire modesty in the West. We are not the super-ethical beings that can impose our moral superiority upon the rest of the World. We were shaking Colonel Kadhafi’s hand in exchange for his oil. We even got fascinated by his extravagancy, the tents and camels and female bodyguard that he brought in his many recent visits to our capitals. I am not judging anyone. I am only observing that we are only humans. And that we sometimes confuse madness with bling.

The 2008 financial crisis confronted us with the madness of financial markets. Politicians claimed that they would curb the extravagancies of speculative behavior on the markets. And what did we see yesterday morning? A seven dollar price increase in 20 minutes. This reminded us of 2007 – 2008 when similar crazy price moves were observed in the oil markets. What have we learned from the financial crisis? The manic-depression-like movement of energy markets continues. Buyers of energy continue to be confronted with volatility and unpredictability. Until one month ago, we warned energy buyers that rising gas prices should not be taken for granted. There are sufficient gas reserves on this planet for gas to be cheap for some decades to come. But we also warned that supply interruptions from the Middle East could push up prices. Of course, nobody could say then that a few weeks later the whole region would be on fire.

It is not madness that energy prices rise when revolutions brake out in the region that has the largest energy reserves of the world. We are particularly worried about gas prices. We are now in the last weeks of the coldest winter in decades in North-West-Europe. However, our gas prices didn’t rally to previous heights. This was due to LNG ships unloading gas nearly every day in our import terminals. Eight in ten of those ships came from Qatar. These were the marginal MWh’s that kept the system sufficiently supplied. So far, no trouble has been reported in the gas-soaked emirate of Qatar. But trouble in the Suez Canal or in the Strait of Hormuz, the sea passage between Iran and the Arabian peninsula could mean that the LNG ships fail to reach Europe.

However much we sympathize with the protesters in the Arabian countries and in Iran, from an economic point of view this is bad news. Continuing instability will affect the output of the oil and gas industry, as is now already seen in Lybia. This will cause rising energy prices. Moreover, the economy of the region is coming to a standstill. This is bad news for the recovering world economy. These countries are huge importers of consumer goods (the lack of jobs in domestic industries is one of the main reasons for the fiery protests). If people in that region buy less, this will affect the economy. China, whose growth has powered the recent economic recovery, exports ¼ of its goods to the Middle East and Northern Africa. We are starting to fear the disaster scenario of stagflation. Energy prices that continue to grow due to supply cuts while the economy is going into recession. If supply drops faster than demand drops due to economic recession, we will enter this scenario. Both from an ethical and from an economic point of view, we sincerely wish that all these countries make a rapid shift towards a peaceful democratic government. But how likely is that? Therefore, as an energy buyer, you better prepare for a continuation and worsening of the current market situation. We obviously cannot predict the outcome of the current political crisis. But we fear that a swift return to normality is idle hope.

In the longer term, the current situation should be another motivation for Western governments to promote energy independence. Promote the widespread usage of the energy sources that we have in our own region, such as renewable energy and shale gas. In that perspective, the peoples of the Middle East might be shooting in their own foot. But would you care about the longer term economic consequences when you are fighting for your life in the streets of Tripoli?

Filed under: Energy policy, Market analysis, Natural gas, Oil, The economy, The market today

Deutsche Börse – NYSE merger and the German energy market

“Erfolgsgeschichte”, that’s the beautiful German word for success story. And that is clearly what the recent German economic history reads like. The German economy has recovered more rapidly from the 2008 crisis than any other traditional economy. The whole country seems to be vibrating with a newly found self-confident entrepreneurial spirit. This economic success is not without political consequences. At the latest EU Summit, statesmen from other European countries saw an unprecedented German assertiveness. Miss Merkel’s argument seemed to be: “since Germany is the best-performing economy of Europe, all other countries should adopt our economic policy”.

Today, a next chapter in the success story of the German economy is written. The Belgian business newspaper ran as its headline today “Deutsche Börse takes over the New York Stock Exchange”. The headline is exaggerated as headlines should be. Deutsche Börse is not taking over, it is merging with the world’s most famous trading place on Wall Street. But as 10 of the 17 top jobs in the new company will be held by Germans, it is clear that Frankfurt is the leading dancing partner. So, to continue in hyperbolic language, who would have thought that Germans would once run Wall Street?

I guess that in the next years we will be able to buy many books that explain in detail for what reason the German economy recovered at such a rapid pace. I don’t have the arrogance to share more than an observation with you on this topic. In recent years, I have done a lot of business in Germany. What I have come to appreciate especially in the way Germans do business is their ability to balance discipline and creativity. This can also be observed in the policy adopted by the German government to recover from the crisis, a policy which they would like other European countries to copy. It is a cocktail of budgetary discipline and increased entrepreneurial flexibility, e.g. by relaxing rigid employment conditions.

The question is of course, whether we can see a similar positive, vibrating development in the German energy market. Many would argue that this is not the case. In my opinion, the German energy market is still facing two major issues:

1. The non-commodity part of the energy bill is higher in Germany than in any other country. As I have written earlier in this blog, Germany has developed its green power production remarkably fast. But it comes at a massive cost of now 35 euro per MWh. On top of that, grid fees are the highest of any Western-European country. The reason for that is very simple. There are more than a thousand different grid companies, all of which have fixed costs. Michèle Bellon, the CEO of ERDF, the French electricity distribution grid operator, probably has a decent salary. But the French pay just one CEO salary for having electricity distributed in 95% of their country. The Germans pay a thousand CEO salaries for that same service.
2. To some extent the German energy market remains stuck in archaic structures. There are not only a multitude of local grid companies, the Stadtwerke, most of them also continued to run a supply business after liberalization. What is the future of such companies? If they don’t develop a commercial approach to attract customers outside their traditional supply area, they are sitting ducks, waiting for new suppliers to steal away clients from them. As the Stadtwerke are run by local politicians, they often lack the willingness to expand the business beyond their locality.

In many cases we observe negative consequences of the archaic market structure with buyers of energy. I have already praised the unique German cocktail of discipline and creativity. However, sometimes the discipline takes over and becomes conservatism. This is nurtured by the local supply companies that rely heavily on the decades long relationship that they have with a client to convince him to continue working with him. But when these local companies are small, they often lack the ability or willingness to develop the new energy buying solutions to face today’s energy market challenges and grasp the opportunities. German energy buyers then continue to sign fix price contracts for electricity and oil-indexed gas contracts, out of habit, and not based on a genuine analysis of their risk exposure in the energy markets.

I am not too negative about the German energy market however. We do see the discipline – creativity cocktail manifest itself in many – surprisingly rapid – evolutions:

1. The German gas market is developing at light speed. We now find gas contracts based on Hub prices available for almost every client. Prices can be spot based with good possibilities for forward hedging. We can see most suppliers still struggling to develop the right approach, but such contracts are almost as good as anything you can find in for example the UK or the Netherlands.
2. Especially as I come from Belgium, I’m surprised to find in Germany a country with a government that takes decisions and implements them relatively efficiently. This is probably why German politics succeeded in coming out of the crisis the way they did. We also observe it in the energy markets. One of the main issues with deregulating the German market is having free access to grids arranged in a country with such a massive amount of grid companies. Even the transportation grid is split up in a multitude of different grids. In the past four years, the German authorities have worked very hard on assuring free third party access and with great success. In the electricity market, any supplier can now supply to any client anywhere in the country if he wants. For gas, some restrictions remain, but they are removed at an extremely rapid pace.
3. Thanks to the multitude of energy companies in the country, the supply market is very vivid and competitive. The German power market, for example, is not dominated by a single large supplier such as EdF in France or Electrabel in Belgium, there are four big players in the power market: E-On, RWE, Vattenfall and EnBW. Next to that there are several local suppliers or conglomerates of local suppliers that have developed a nation-wide business, players such as EWE, MVV, Trianel, N-Ergie, etc. And then there are new players, newly created companies such as Natgas or Gasag in the gas market. One of the consequences of this vivid competition is that new products such as a tranche model contract for buying gas on the TTF or NCG have been developed very rapidly.
4. Leipzig-based EEX is the most liquid of all continental European energy exchanges. I remain skeptical whether the energy markets will develop as exchange-traded or as OTC markets. But if the exchange-traded model prevails, the EEX will be the big name in Europe. A little bit like Deutsche Börse in the stock markets?

The German energy market is full of opportunities. And I am confident that the newly-found economic self-confidence will inspire the creativity in German companies to grasp these opportunities.

Filed under: Energy history, Energy policy, Energy suppliers, Germany, The economy, The market today

100 dollar oil: back where it all started?

Yesterday the Brent has traded above 100 dollar again. This is its highest level in 28 months. The first time that the oil price broke above 100 dollar was on the 28th of February 2008. It was then followed by a speculative craze that pushed the Brent price all the way up to 146,08 dollar per barrel. By that time oil demand in the US, the key oil consuming region, was going down. More and more US citizens defaulted on their mortgages and one of the reasons for this was the derailing fuel budgets. It is clear that rising fuel prices and their consequences for other commodities such as food was one of the reasons for the 2008 financial crisis.

This time, the consequences for European consumers of oil products and oil-indexed natural gas are even more severe than in 2008. Back then, the euro was worth 1,5121 dollars whereas now its value has declined to 1,3692 dollars. This means that in euro, a barrel of crude oil is now more than 10% more expensive than in February 2008.

There are parallels to be found with the situation in 2008:

• The underlying fundamental is similar: the 10% growth rates of emerging economies, foremost China, sucking up commodities faster than production can grow.
• It’s not only oil that is rising, metals, coal and soft commodities are also contributing to general inflationary pressure.
• Analysts’ hysteria is contributing to the bull run. This morning already you can read plenty of articles of enlightened minds that “forecast” even higher levels.
• Opec claims to have spare capacity but refuses to bring it to the market, saying that there is more than enough oil in the market.
• The contango in the market has almost disappeared and turned into backwardation, meaning that the further you go into the future, the cheaper the price at which you can buy oil. To some, this is proof that the bullish sentiment is unsupported.

However, we also see two important differences:

• In February 2008, we crossed the hundred dollar barrier at a moment of solid economic growth in all parts of the world. This time, we cross it at a moment of fragile economic recovery in the Western world. The traditional medicine for curbing inflation is raising interest rates. Governments hope that this will inspire citizens to save more and spend less and companies to invest less. This would obviously reduce demand for commodities and can stop the bull run. But on the other hand, it would also kill off the beginning of a recovery that we have seen in recent months. Moreover, it’s not only governments in the West that fear inflation. Authoritarian regimes across the globe know that many revolutions have started with a middle class that reacts to a rising cost of life. It is therefore not surprising that the Chinese government is taking steps to reduce inflation. But it is clear that these steps will reduce growth in China, the growth that has been the engine of recovery in many other parts of the world, as far as Germany. The Chinese government can see good examples of the danger for the regime of inflation happening before their eyes in the Arab world. The people on the streets of Cairo quote rising food prices as one of the reasons for their anger.
• This brings us to the second danger. Geopolitical tensions have always been cited as a reason for oil price increases. But if you look back in history, you can find only two occasions of serious oil price inflation due to political conflict. The first one was in 1973 with the Yom Kippoer war and the ensuing blockade of the Suez Canal. The second one was in 1979 with the Islamic revolution in Iran. The Gulf Wars for example, had only a limited effect on oil prices as Saudi-Arabia stopped initial price increases by pumping up more oil. Opec is now claiming again that it will open the valves if the Egyptian crisis would cause restraints to the world’s oil supplies. However, the current situation bears some very uncomfortable analogies to the two previous occasions of politics leading to oil supply crunches. There is a danger that if Hosni Mubarak is ousted, he will be replaced with a regime that is much less friendly with Israel. It might even be an Islamic government. War between Egypt and Israel would disrupt supplies through the Suez Canal. Fear of this scenario was the reason most cited for yesterday’s push above 100 dollar.

Overall, and as always, the picture for the next months is complicated and unpredictable. Mister Mubarak might survive the crisis. He might be replaced by mister El Barradei who seems to be a peaceful figure (he has a Nobel prize on his desk to remind him of that). I have read in many books and articles that the Egyptian Muslim Brotherhood has developed more in the direction of Turkey’s moderate Islamic party than in the direction of radical Islamism. It is clear that no one can predict what will happen in Egypt. And even if Egypt becomes a broader conflict with ramifications for oil supplies, it is not clear whether oil prices can continue to rise. My best guess is that it will cause a new recession as governments raise interest rates and middle classes see higher commodity prices cutting into their buying power.

The economic picture of the past decade looks really bleak. A large part of this planet is growing towards a better future by growing their economies rapidly. This leads to spectacular boom phases. But the planet is unable to support that growth with sufficient commodities. The consequence is high inflation cutting into buying power which leads to spectacular busts. There is a shimmer of hope however and it lies in the third difference with the situation in February 2008. This time, many gas consumers in the West are not affected by the rising oil price. They buy gas in the Hub markets. In Europe, these prices haven’t risen much higher than 20 euro per MWh even in the coldest winter in decades. In the US, prices are half that thanks to the shale gas boom. The developments in the gas market show the way out of the boom and bust cycle. We have to reduce our dependence on scarce commodities such as oil.

Filed under: Energy history, Market analysis, Oil, The economy, The market today

Fuel for the dragon

Last month, figures were published that made clear that China has surpassed the US as the world’s largest consumer of energy.  Economic pessimists will probably interpret this as another sign that the Western economies are being surpassed by the Asian economies. It is true that for many years now, the economies of the east have grown faster than our economies. However, you are only surpassed when your competitor is becoming bigger than yours. And if we are discussing economic performance, you should watch for per capita figures rather than absolute figures. If you only watch absolute figures, the tiny country of Belgium that I live in, would never be good in anything. If you look at the energy consumption figures in that perspective, it still means that US energy consumption per capita is four times bigger than the Chinese. So, once again, we should remark that China is catching up rather than surpassing. In the past decades, this economic miracle has lifted 400 million Chinese out of poverty. Who can be against that?

The dragon economy of China has recovered more swiftly than that of any other country from the perils of the 2008 financial crisis. Moreover, it looks like they are managing to reduce the dependency on export (and American credit-based consumption) by stimulating inland demand. As the Chinese become richer (and wages are rising fastly), they buy more and more consumer goods. They also move into higher added value goods, which is a logic step. Being the world’s cheap labor workshop is not a source of sustainable economic growth. The counterside of that economic growth is of course the rise in energy consumption. And this gives rise to some important reflections:

1. Since hitting their lowest point in the beginning of 2009, oil prices have more than doubled again, fueled by the rapid recovery of Chinese oil demand growth. Coal prices didn’t grow as much, as increasing demand was matched by increasing supplies.  However, the evolution of oil prices shows that increasing Chinese demand has an important impact on commodities that are traded on a worldwide scale. This is also obvious in other commodity markets with tight supply such as copper.  What does this mean for natural gas markets, now that they are becoming more and more worldwide markets due to the LNG boom? Will China dash for gas and tap into the reserves of Russia, Southeast Asia and the worldwide LNG markets? And will the newly tapped reserves of shale gas be able to fuel an increase in worldwide gas demand? Will China itself be able to increase its production of gas due to the shale gas evolution?

2. Chinese energy demand growth has a big impact on the global carbon dioxide balance. China is growing fastly in renewable energy and for wind and solar power, it is a key market. But this renewable energy is unable to compensate for the even larger growth of coal-fired power plants. With its newly won status of being the world’s largest consumer of energy, the pressure on China for taking more responsibility in terms of reducing carbon dioxide emissions will be bigger than ever.

3. Even if China is obviously the most important factor in determining oil prices, the market is still looking mostly at the US for its analysis of prices. See this previous entry for more on that. This is due to the lack of good quality data on Chinese oil consumption. In the past two years we have seen the market surprised again and again by unexpected growth in Chinese oil demand. It is clear that an improvement in Chinese energy statistics would make the markets a lot more transparent.

We will have to see in the next years if the Chinese economy can continue its economic success story. Anyhow, it is clear that we will have to look East for information about the energy markets.

Filed under: Climate change, Energy demand, Energy history, Natural gas, Oil, The economy

The Greek problem

The euro is currently trading at 1,36 dollar. The reason for the recent downtrend in euro value is the troubles with the Greek budget. Greece’s credit ratings have been downgraded as it becomes clear that the country is in much deeper financial trouble than previously presumed. The Greek government has lied about its budget figures to enter into the euro zone. It now becomes clear that the country is facing a budget deficit of 12,2% in 2010. A deficit that it has to finance by taking on ever more expensive debt. Anyone with some basic understanding of economics knows what this is leading to: bankruptcy. The only way for Greece to avoid this is by making drastic cuts in its expenses. Already, the first protesters have taken to the streets of Athens against the budget discipline measures.

The fact that the economic troubles of Greece are dragging down the euro seems to be exaggerated at first sight. Greece is only 2,5% of the EU economy. As a comparison, budgetary trouble in California is even larger than in Greece. And California represents 12,5% of the US economy. Why are markets so much more worried by developments in a dwarf economy like Greece’s, more so than those in California?

The first reason obviously is the fact that Greece belongs to the euro zone. The euro is a unique experiment. Never before had so many different countries with such different economic characteristics been brought together under a common currency. From the outset, some economists were skeptical about the euro’s chances for success. They now see those doubts confirmed in what looks like a self-fulfilling prophecy. The euro-skeptics publish reports about how Greece can drag down Europe, the markets react on that by pushing down the euro, causing the skeptics to produce even more dramatic reports, and so on, and so on.

The movement described above is: a downward spiral. The only way of getting out of that is by taking some drastic measures. And this is not exactly what we expect (and see) from the European Union. I can understand why it is hard for a German or French politician to explain to German or French taxpayers why their money is to be spent to save a country which obviously is spending too much money. And the fact that the Greeks have lied about their situation is obviously not to their advantage. But still, great statesmen are characterized by their capacity of taking decisions that even if not supported by a majority of the voters, are clearly in the general interest. Neither Miss Merkel nor Mr. Sarkozy are currently showing such statesmanship. They prefer to have the new EU President Van Rompuy making some half-baked declarations. It is precisely this lack of political clout that makes the markets fear that the euro policymakers will be unable to stop the spiral that might start when Greece stumbles.

First of all, if Greece goes under, the confidence shake-up that this will cause will increase the cost of borrowing for other European countries. And Greece is not the only country that currently relies heavily on borrowing to prop up a budget slashed by the economic downturn. Larger economies such as Spain and Portugal are also deep in the red figures. If the cost of borrowing increases for them, we might see further mayhem. Secondly, Greece has most of its money borrowed from German banks. If Greece goes broke, German banks might face a situation comparable to what happened with American banks when US homeowners could no longer pay back their debts.

This is what really frightens me. What happens if a large German bank gets into trouble because of unpaid loans to Greece? Could we see a repetition of the disaster that struck the markets in 2008? By massively going short on euro (and euro assets) this seems to be what ‘the market’ is betting at. And this short-selling speculation is increasing the underlying problem.

This last remark shows me how utterly self-destructive the financial markets can be. If we get a second financial crisis, we will also get a second round of lay-offs in the financial sector. So, by short-selling the speculators, the traders in the banks, are creating the fundamentals for a further collapse of their sector and they are undermining their own job security. Still, just imagine you are a trader in one of the banks. You see your neighbor winning a big bonus for this year by short-selling euro. It must be very tempting to go for that same easy win. Even if you realize that by doing so, you become part of a machinery that might ultimately eat you. It’s understandable, which makes it even more sad. The way the banking sector treats the Greece problem clearly shows that they have learned absolutely nothing from the 2008 experience.

Let’s all hope that the Greece spiral doesn’t get out of control. Everyday, in every conversation with clients we hear the timid signals of economic recovery. It would be very unjust if this timid recovery would be destroyed by another case of uncontrollable speculation.

Filed under: The economy, The market today

2010: bullish or bearish for energy markets?

Energy markets have a terrible habit of rising during the New Year’s period. On the 6th of January of the new year, the oil price ended the day at 81,89 dollar per barrel, well above the 80 dollar barrier that had been a rooftop on the market for the last four months of 2009. In the week before Christmas, the oil prices traded as low as 72,99 dollar per barrel, meaning that we saw a more than 12% price rise during the Holiday period. It looks like some people in the oil market left the table early this year for their trading desk. And it looks like they were in a bullish mood. Such surprise movements at a time when most people are on holiday always feel nasty. It’s like the market not giving you a chance to do something. Fortunately, the bullishness in the oil market didn’t spill over into the other energy markets. And even more fortunately, the bull party was quickly over. At the moment of writing these words, the oil price is back below 80 dollars at 77,22.

What inspired these New Year bulls? I personally believe that it was a clear case of ‘turning the page’ optimism. 2009 was a year of deep economic gloom. But as the end of the year came near, the picture started to look rosier. In their end-of-the year reports, most economists agreed that in 2010 the economy would do better than in 2009. Dubai and Greece were scary, but so far, these issues seem to be brought under control. This ‘things can only go better’ attitude spilled over into the oil market and caused prices to rise. Apparently, this wasn’t supported by fundamentals. The call for extra oil in the physical market wasn’t strong enough to justify oil prices over 80 dollar.

The market of the first weeks of 2010 therefore looks unclear: a rapid bullish start with an equally rapid bearish correction. How will this continue?

For oil markets, the past year has learned us that they are inclined to rise rapidly with the economic outlook. Oil is commodity that is traded worldwide. The improving economy was mostly supported by developments in China, which is doing remarkably well in terms of economic recovery. China consumed record levels of oil in 2009 and this was the main support for higher oil prices. Moreover, the easy-to-produce oilfields have recently been replaced by much more difficult and expensive sources such as tar sands, deep-sea off-shore production or bio-fuels. This causes rapid price rises at even very small increments in oil demand.

For natural gas markets, the outlook is different. Natural gas consumption is much more focused in Northern America and Europe. And these are the regions where the economic recovery and gas demand growth are slow. This has caused an important gap between oil prices and gas prices. Lower gas prices were also supported by reports of expanding gas reserves in the US based on improved recovery techniques for shale gas.

With this jump up and down of oil prices, it looks like 2010 will be another interesting year in the energy markets. The big question on my whiteboard is: will the decoupling of oil and natural gas persist? I’ll keep you informed.

Filed under: Energy demand, Market analysis, The economy, The market today

Why optimism is an economic duty

In the past weeks, we saw a lot of positive news regarding the economy.  The number one headline was the announcement that the US economy had climbed out of the recession in the third quarter with an annualized growth rate of 3,5%. Still, many observers were quick to dampen any euphoria that such news might cause. And with CIT, a large US bank and important lender to US medium-sized and small businesses, filing for bankruptcy, their arguments that the economy is still showing substantial weakness seem to be supported.

Still, such calls for caution slightly annoy me. You cannot deny that the outlook for the world’s economy looks a lot rosier than a year ago. Of course, the situation looks worse than say, two years ago, but what had you expected? That the world economy would return to pre-crisis growth rates just like that? In the past decades, the US built up a huge bubble based upon unsustainable credit largesse. Of course, it is going to be very painful to find an economic alternative for that in the US. We don’t want the US to just start blowing air into the burst bubble again, do we? Is it strange that a bank like CIT, depending on fragile companies paying back their loans goes broke? The reaction of financial markets, with no renewed sell-off, indicates that it was not surprising. Of course, recent growth was due to government economic support programs. And indeed, some of these programs expire or have expired. But were they ever meant to be a continued source of income for the industry? I don’t think so. They were supposed to kick-start the economic engine. And the 3,5% figure for Q3 seems to indicate that the policy has achieved that goal.

What annoys me about the cautious tone in the media is its effect on consumer’s psychology. If anything, the crisis of the past twelve months was a crisis of trust. Loss of trust in the banking system created the credit scarcity. And loss of trust with consumers created the backdrop in consumption that caused the industrial crisis. Therefore, all of us should hope that this positive news inspires trust in consumers. After months of quiet, the economic engine is producing some noise. We now have to pour in the fuel of extra spending to make it roar again. Will we spoil the successful kick-start by falling back to the economic gloom that we have grown accustomed to in the past year? My great inspirer Karl Popper famously said that optimism is a moral duty. I would like to add that today, it is an economic duty.

The most positive news that I recently heard came from the key steel sector. Mister Lakshi Mittal announced that he can start firing up more and more steel furnaces. And overall the steel sector expects demand to grow by 9,2% in 2010. If demand of steel is picking up, it is a clear sign that industrial output is on the rise again. The most positively surprising news comes from China. This country doesn’t stop surprising the world by doing better than expected. It has announced a growth rate of 8,9% for the thrid quarter of 2009! So, if you are looking for an explanation for rising oil prices, here you have one. Some observers even start to worry that energy markets become too dependent on Chinese growth figures.

If steel furnaces are producing again, if China keeps on growing, it means that worldwide demand for energy is rising. The bearish momentum for energy prices is weakening every day. We have already observed this in oil prices. European gas and power prices are still holding close to their historical lows. As always, the European economy is slower in its growth than other parts of the world. With many industrial companies still at very low output levels, the demand for energy is not growing fast enough for gas and power prices to react. But how long will this last?

Filed under: Energy demand, The economy