Bank for International Settlements
Bank for International Settlements
News Article | April 15, 2017
For some time now savers have campaigned for a return to normal interest rates, by which they mean central bank rates more like 4%-5%. And it’s not just about earning more on their savings. This protest against the current 0.25% base rate also has a broader, altruistic bent. At least that is what they honestly believe. They argue that higher interest rates will restore a lost balance in the economy – taking it back to the way it was before the financial crisis, when things were so much better. And why wouldn’t they? Plenty of mainstream economists express the same concerns, including policymakers at the Bank of England, the International Monetary Fund, the OECD and the World Bank. After several years of year-on-year growth, runs the argument, higher interest rates will deter banks, insurers and even hedge funds and private equity funds from taking excessive risks to improve their profits. Low rates mean they need to generate huge volumes of business to make the equivalent profit, forcing them to embrace sub-prime borrowers, as they did in the early part of the century to such disastrous effect. A higher return on lending will strengthen the banking sector’s financial standing and give them the funds to spur investment and help in the all-important task of improving the nation’s output and productivity. At the same time, higher interest rates will benefit ordinary investors. With a cute and cynical emphasis, the focus is on the ordinary investor because they can be said to be deserving of everyone’s support – especially those who put money aside in a pension. Who can argue against higher interest rates if they prevent the collapse of final salary pension schemes? At the International Monetary Fund’s spring meeting this week, managing director Christine Lagarde is expected to highlight how another decade of ultra-low interest rates will depress growth and pose dangers for global financial stability. The IMF will warn that risks to growth remain on the downside as low interest rates sit in the column marked potential disasters alongside Brexit, Donald Trump’s emotional response to presidential decision-making, and Vladimir Putin’s drive to undermine western democracies . In a report last week before the gathering, which will give Philip Hammond a chance to catch up with his counterparts from around the world and countless central bank officials, the Washington-based lender of last resort said low interest rates in the UK, US and Europe meant the west was heading in the same direction as Japan and faced the prospect of decade after decade of low growth. It backed the savers’ argument that if there was much more of this, the developed world’s pension funds would be in jeopardy. But the IMF, like the influential Bank for International Settlements (BIS), which sits in judgment on the policies of central banks from its Swiss headquarters, can’t find a way to get from a low-interest-rate world to one where base rates are 4% and mortgage rates 6%. One problem is that they cannot agree on the reason for the current predicament. Claudio Borio, head of the BIS, made a stab at it earlier this year. He rejected the argument put forward most forcefully by Larry Summers, the former US Treasury secretary, that baby-boomer saving, excessive by historical standards, has created a mismatch of supply and demand in financial markets and that with a surfeit of funds chasing a handful of investment opportunities, it was inevitable lending would yield low returns. Higher taxes on wealth and stratospheric incomes are the answer to this trend. It would allow governments to upgrade their crumbling infrastructures with cash, and reduce their need to borrow – something Borio worries is at its limit. He accepted much of Summers’s thesis, but favoured those who say a better explanation is the weakness of the banks following the financial crisis and subsequent steep cuts in interest rates. However, the BIS, like the other international economic organisations, is impotent when urging that higher rates are a cure for the ills besetting the west, and to some extent the developing world. Many Brexiters argue that quitting the European Union provides the economic reset needed to achieve a better balance, at least for the UK. A permanently lower pound could spur growth and employment, and combined with lower immigration, could lead to higher wages. In response the Bank of England could justify putting up interest rates, and allow the economy to support a thriving banking sector that in turn supports a Goldilocks economy – that is neither too hot or too cold. Unfortunately for the Brexiters, a currency devaluation is also the option favoured by China, the eurozone and the US as a route to stronger growth and higher interest rates. Donald Trump’s call last week for a lower dollar shows that he is thinking the same way. With everyone pursuing the same goal, there is little chance of lasting success. So we are left with keeping interest rates low, probably for another decade. While Lagarde (and her contemporaries) could accept the logic of wealth and income redistribution as a route to rebalancing, that seems unlikely. She is a rightwing politician with a final salary pension.
News Article | October 12, 2016
New York is better placed than major European financial centres to benefit from any loss of business in the City of London as a result of Brexit, a deputy governor of the Bank of England has said. Amid attempts by Frankfurt, Paris and Dublin to catch possible fallout from London, Sir Jon Cunliffe said it was highly unlikely that any EU centre could replicate the services offered by the UK’s financial services industry. “I can’t see [what the City offers] being replicated in the foreseeable future in one place in the European Union,” he said, pointing out that huge parts of the UK financial services industry are based outside London. “It takes an awful lot of time, human capital, it’s based around the interaction of financial services. Theidea this ecosystem is transplanted somewhere else into Europe in the foreseeable future … I think to me is highly unlikely,” he told peers on the EU financial affairs subcommittee. Asked whether business would move to the US, Cunliffe said: “Could it be transported to New York? Well of course it already exists in New York.” It is a view that has been voiced by Xavier Rolet, chief executive of the London Stock Exchange, who had said European financial centres would not enjoy “easy pickings” after Britain leaves the EU and that New York would be more likely to benefit. The debate about how much of its financial services industry the UK will lose as a result of Brexit is raging. The major players are keen to retain access to the remaining 27 members of the European single market and so-called passporting rights making it easy to conduct business across the EU. The government appears to be leaning towards a “hard Brexit” under which such access to the single market is less certain. Another senior Bank of England figure, Anil Kashyap, a newly appointed independent policymaker, said this week that the UK would lose out from taxes paid by City workers if jobs moved out of London as a result of a hard Brexit. Cunliffe, who was careful not to drawn into the political debate, said it was important that the final outcome was reached “in a smooth and orderly way”. But he did say that the cost of raising loans would increase, not just for UK companies, if the current business conducted in London were to fragment. The deputy governor responsible for financial stability, Cunliffe also played down the suggestion that London would be forced to give up its role in clearing euro-denominated transactions. He said the result of the 23 June referendum had been surprise for the markets, and pointed to the impact of politics on the pound. “I think the hardest news for markets to process is political news. I think markets find political uncertainty very difficult to estimate as opposed to economic uncertainty,” he said. “As more news comes into the markets, markets will react.” Last week, a strategist at HSBC, David Bloom, said: “The currency is now the de facto official opposition to the government’s policies.” Appearing before the peers, Cunliffe also referred to the sudden moves in the pound last week. The Bank of England and the Bank for International Settlements – known as the central bankers’ bank – is scrutinising the events of last Friday when a so-called flash crash resulted in the pound falling 10% against the dollar in a matter of minutes before recovering some of its losses.
News Article | December 22, 2016
A long, hard look at the way the Bank of England has conducted monetary policy since 2008 is long overdue so the announcement by the Treasury select committee that it is launching an inquiry into ultra-low interest rates, quantitative easing and forward guidance is welcome. It is worth recalling that when Threadneedle Street slashed the cost of borrowing to 0.5% and began using asset purchases to print money both were seen as temporary measures to deal with an immediate crisis. The UK economy is no longer collapsing as it was during the winter of 2008-09 but unconventional monetary policy has become a permanent fixture. Indeed, the aftermath of the Brexit vote saw the Bank cut interest rates still further to 0.25% and increase the size of its QE programme. The measures taken during the slump were appropriate at the time. Low interest rates were designed to reduce borrowing costs for companies and individuals, and to persuade them to spend rather than save. Quantitative easing was a way in which central banks could counteract the sharp contraction in private credit creation by commercial banks. But that was eight years ago. As Claudio Borio, the head of the monetary and economics department at the Bank for International Settlements, noted back in 2011, the certainties of the “Great Moderation” – the pre-crisis years when growth was strong and inflation stable – are gone. Central banks, Borio noted, were sailing in uncharted waters. There are three big charges that Mark Carney will face when he gives evidence to the Treasury committee. The first is that monetary policy has only really worked by raising asset prices, and by doing so has widened the gap between those who own shares and houses and those that don’t. The Bank has always argued that the poor would have been even worse off had it not slashed interest rates and used QE, because the recession would have been deeper and unemployment higher. The second charge is that unconventional monetary policy has led to misallocation of capital on a grand scale. One explanation for the UK’s woeful productivity record since the financial crisis is that too many poorly-performing companies have survived courtesy of ultra-low interest rates while growing firms have been starved of investment. Finally, and perhaps most importantly, there is the charge that by keeping unconventional measures in place for too long, the Bank of England has helped create the conditions for the next crisis and will lack the firepower to deal with it when it comes. Whether the inquiry leads to any changes in policy remains to be seen. It certainly should. Monetary policy has been hyperactive while fiscal policy – tax and spending – has been sucking demand out of the economy. The theory behind austerity was that monetary stimulus would generate the growth and the tax revenues to enable the government to fix the hole in the public finances. Instead of taking advantage of historically low interest rates to borrow for much-needed public investment, George Osborne relied on the Bank to stimulate growth through private borrowing. The conclusion the select committee should reach is that this unbalanced approach didn’t work last time and it won’t work next time either.
News Article | March 2, 2017
As President Trump struggles to staff his administration with sympathisers who will help transpose tweets into policy, the exodus of Obama appointees from the federal government and other agencies continues. For the financial world, one of the most significant departures was that of Daniel Tarullo, the Federal Reserve governor who has led its work on financial regulation for the last seven years. It would be a stretch to say that Tarullo has been universally popular in the banking community. He led the charge in arguing for much higher capital ratios, in the US and elsewhere. He was a tough negotiator, with a well-tuned instinct for spotting special pleading by financial firms. But crocodile tears will be shed in Europe to mark his resignation. European banks, and even their regulators, were concerned by his enthusiastic advocacy of even tougher standards in Basel 3.5 (or Basel 4, as bankers like to call it), which would, if implemented in the form favoured by the US, require further substantial capital increases for Europe’s banks in particular. In his absence, these proposals’ fate is uncertain. But Tarullo has also been an enthusiastic promoter of international regulatory cooperation, with the frequent flyer miles to prove it. For some years, he has chaired the Financial Stability Board’s little-known but important Standing Committee on Supervisory and Regulatory Cooperation. His commitment to working with colleagues in international bodies such as the FSB and the Basel Committee on Banking Supervision, to reach global regulatory agreements enabling banks to compete on a level playing field, has never been in doubt. Already, some of those who criticised him most vocally in the past are anxious about his departure. Who will succeed him? The 2010 Dodd-Frank Act created a vice-chair position on the Federal Reserve Board – which has never been filled – to lead the Fed’s work on regulation. Will that appointee, whom Trump now needs to select, be as committed as Tarullo to an international approach? Or will his principal task be to build a regulatory wall, protecting US banks from global rules? We do not yet know the answers to these questions, but Fed watchers were alarmed by a 31 January letter to Fed chair Janet Yellen from Representative Patrick McHenry, the vice-chairman of the House committee on financial services. McHenry did not pull his punches. “Despite the clear message delivered by President Donald Trump in prioritising America’s interest in international negotiations,” McHenry wrote, “it appears that the Federal Reserve continues negotiating international regulatory standards for financial institutions among global bureaucrats in foreign lands without transparency, accountability, or the authority to do so. This is unacceptable.” In her reply of 10 February, Yellen firmly rebutted McHenry’s arguments. She pointed out that the Fed does indeed have the authority it needs, that the Basel agreements are not binding, and that, in any event, “strong regulatory standards enhance the stability of the US financial system” and promote the competitiveness of financial firms. But that will not be the end of the story. The battle lines are now drawn, and McHenry’s letter shows the arguments that will be deployed in Congress by some Republicans close to the president. There has always been a strand of thinking in Washington that dislikes foreign entanglements, in this and other areas. While Yellen’s arguments are correct, the Fed’s entitlement to participate in international negotiations does not oblige it to do so, and a new appointee might argue that it should not. Such a reversal would generate tensions within the Fed, and where it would leave the FSB, or indeed the Basel Committee, is unclear. In the early days of the Bank for International Settlements (where the Basel Committee’s secretariat is located) in the 1930s, the US government declined to take a board seat, and the US was represented by JP Morgan. It is a little hard to see that arrangement working well today. These questions are of more than passing interest in Europe. European capital adequacy directives typically transpose Basel accords into EU law. If the Basel process stalls, transatlantic deals, which are the crucial underpinning of western capital markets, will be far harder to reach. There is a further complication arising from Brexit. Absent any special deal between the EU27 and the UK, British and EU regulators will come together in Basel, not in the European Banking Authority. If Basel becomes a talking shop, without the ability to set firm standards, another key link in the chain will be broken, and it will be harder for the UK to argue that if London’s banks meet international standards, they should be granted equal treatment in the EU. As central bankers bid farewell to the devil they know, financial regulation has entered a period of high uncertainty – and high anxiety for policymakers as they await an announcement from Mar-a-Lago. No likely Federal Reserve Board candidates have been spotted at poolside, or being interviewed on the golf course, but a decision cannot be far off. Nothing can be taken for granted. The financial world is holding its collective breath. •Sir Howard Davies, the first chairman of the UK’s Financial Services Authority (1997-2003), is chairman of the Royal Bank of Scotland. He was director of the London School of Economics (2003-11) and served as deputy governor of the Bank of England and director-general of the Confederation of British Industry.
News Article | April 19, 2016
Oil production can be confusing because there are various “pieces” that may or may not be included. In this analysis, I look at oil production of the United States broadly (including crude oil, natural gas plant liquids, and biofuels), because this is the way oil consumption is defined. I also provide some thoughts regarding the direction of future world oil prices. Figure 1. US Liquid Fuels production by month based on EIA March 2016 Monthly Energy Review Reports. US oil production clearly flattened out in 2015. If we look at changes relative to the same month, one-year prior, we see that as of December 2014, growth was very high, increasing by 18.0% relative to the prior year. Figure 2. US Liquids Growth Over 12 Months Prior based on EIA’s March 2016 Monthly Energy Review. By December 2015, growth over the prior year finally turned slightly negative, with production for the month down 0.2% relative to one year prior. It should be noted that in the above charts, amounts are on an “energy produced” or “British Thermal Units” (Btu) basis. Using this approach, ethanol and natural gas liquids get less credit than they would using a barrels-per-day approach. This reflects the fact that these products are less energy-dense. Figure 3 shows the trend in month-by-month production. Figure 3. US total liquids production since January 2013, based on EIA’s March 2016 Monthly Energy Review. The high month for production was April 2015, and production has been down since then. The production of natural gas liquids and biofuels has tended to continue to rise, partially offsetting the fall in crude oil production. Production amounts for recent months include estimates, and actual amounts may differ from these estimates. As a result, updated EIA data may eventually show a somewhat different pattern. Taking a longer view of US liquids production, this is what we see for the three categories separately: Figure 4. US Liquid Fuel Production since 1949, based on EIA’s March 2016 Monthly Energy Review. Growth in US liquid fuel production slowed in 2015. The increase in liquid fuels production in 2015 amounted to 1.96 quadrillion Btus (“quads”), or about 59% as much as the increase in production in 2014 of 3.34 quads. On a barrels-per-day (bpd) basis, this would equate to roughly a 1.0 million bpd increase in 2015, compared to a 1.68 million bpd increase in 2014. The data in Figure 4 indicates that with all categories included, 2015 liquids exceeded the 1970 peak by 16%. Considering crude oil alone, 2015 production amounted to 98% of the 1970 peak. Figure 5 shows an approximate breakdown of crude oil production since 1945 on a bpd basis. The big spike in production is from tight oil, which is another name for oil from shale. Figure 5. Oil crude oil production separated into tight oil (from shale), oil from Alaska, and all other, based on EIA oil production data by state. Here again, US crude oil production in 2015 appears to amount to 98% of the 1970 crude oil peak. Thus, on a crude oil basis alone, we have not yet hit the 1970 peak. Prospects for an Oil Price Rise Most recent analyses of oil prices have focused on the amount of mismatch between supply and demand, and the need to craft a temporary agreement to reduce oil production. The thing that is missing in this discussion is an analysis of buying power of consumers. Is the problem a temporary problem, or a permanent one? In order for the demand for oil products to keep rising, the buying power of consumers needs to keep rising. In other words, some combination of wages of consumers and debt levels of consumers needs to keep rising. (Rising debt is helpful because with more debt, it is often possible to buy goods that would not otherwise be affordable.) We know that in many countries, wages for lower-level workers have stagnated for a number of reasons, including competition with wages in lower-wage countries, computerization, and the use of automation (Figure 6). Thus, we know that low wages for a large share of consumers may be a problem. can you sniff xanaxFigure 6. Chart comparing US income gains by the top 10% to income gains by the bottom 90% by economist Emmanuel Saez. Based on an analysis IRS data, http://www.theenergycollective.com/how-long-does-a-xanax-high-last/. Figure 7 shows that world debt has been falling since June 30, 2014. This is precisely the time when world oil prices started falling. http://www.theenergycollective.com/buy-lipitor-in-united-states-with-no-prescription/Figure 7. Total non-financial world debt based on Bank for International Settlements data and average Brent oil price for the quarter, based on EIA data. One reason for the fall in world debt, measured in US dollars, is the fact that the US dollar started rising relative to other currencies about this time. Oil is priced in dollars; if the US dollar rises relative to other currencies, it makes oil less affordable to those whose currencies have lower values. The big rise in the level of the dollar came when the US discontinued quantitative easing in 2014. World debt, as measured in US dollars, began to fall as the US dollar rose. Figure 8. World Oil Supply (production including biofuels, natural gas liquids) and Brent monthly average spot prices, based on EIA data. As long as the US dollar is high relative to other currencies, oil products remain less affordable, and demand tends to stay low. Another issue that struck me in looking at world debt data is the way the growth in debt is distributed (Figure 9). Debt growth for households has been much lower than for businesses and governments. Figure 9. World non-financial debt divided among debt of households, businesses, and governments, based on Bank for International Settlements data. Since March 31, 2008, non-financial debt of households has been close to flat. In fact, between June 30, 2014 and September 30, 2015, it shrank by 6.3%. In contrast, non-financial debt of businesses and governments have both risen since March 31, 2008. Government debt has shrunk by 5.6% since June 30, 2014–almost as large a percentage drop as for household debt. The issue that we need to be aware of is that consumers are the foundation of the economy. If their wages are not rising rapidly, and if their buying power (considering both debt and wages) is not rising by very much, they are not going to be buying very many new houses and cars–the big products that require oil consumption. Businesses may think that they can continue to grow without taking the consumer along, but very soon this growth proves to be a myth. Governments cannot grow without rising wages either, because the majority of their tax revenue comes from individuals, rather than corporations. Today, there is a great deal of faith that oil prices will rise, if someone, somewhere, will reduce oil production. In fact, in order to bring oil demand back up to a level that commands a price over $100 per barrel, we need consumers who can afford to buy a growing quantity of goods made with oil products. To do this, we need to fix three related problems: Low wages of many consumers World debt that is no longer rising (especially for consumers) A high dollar relative to other currencies These problems are likely to be difficult to fix, so we should expect low oil prices, more or less indefinitely. Lack of oil supply may bring a temporary spike in oil prices, but it cannot fix a permanent problem with consumer spending around the world. Original Post
Avalos F.,Bank for International Settlements
Journal of International Money and Finance | Year: 2014
It is frequently argued that biofuel (and ethanol) promotion policies in the United States have created a link between oil and corn prices that has accentuated the recent rally in the price of that crop and its substitutes (especially soybeans). Even though it is intuitively appealing, one problem with this hypothesis is that ethanol policies have been in place in the US for more than 35 years, whereas the run up in food prices dates back only to 2006. However, a significant change in US biofuel policy during that year provides an adequate framework to test for the existence of a structural break in the stochastic properties of the corn and soybean price processes. The results show that structural stability is rejected, and the transmission of oil price innovations to corn prices has become stronger after 2006 (no changes with respect to soybeans). There is also a significant transmission of corn price innovations to oil and soybean prices. Moreover, the data show evidence of a previously non-existent cointegration relationship between oil and corn prices. © 2013 Elsevier Ltd.
News Article | November 10, 2016
BASEL, 09-Nov-2016 — /EuropaWire/ — At their meeting at the Bank for International Settlements in Basel this weekend, the central bank Governors of the Global Economy Meeting (GEM)1 appointed Ms Jacqueline Loh, Deputy Managing Director at the Monetary Authority of Singapore (MAS), as Chair of the Markets Committee. The Markets Committee is a forum where senior central bank officials jointly monitor developments in financial markets and assess their implications for market functioning and central bank operations. Ms Loh’s appointment is for a term of three years starting in mid-January 2017. She succeeds Guy Debelle, Deputy Governor of the Reserve Bank of Australia, who has chaired the Committee since June 2013. At MAS, Ms Loh oversees the central banking functions of Monetary Policy and Markets & Investments, and is also in charge of the Development & International as well as the Fintech & Innovation Groups. Since joining MAS in 1987, Ms Loh has worked in different functions, including reserves and domestic markets management, monetary policy, macro-surveillance, markets development, risk management and financial technology. 1 The members of the GEM are from the central banks of Argentina, Australia, Belgium, Brazil, Canada, China, France, Germany, Hong Kong SAR, India, Indonesia, Italy, Japan, Korea, Malaysia, Mexico, the Netherlands, Poland, Russia, Saudi Arabia, Singapore, South Africa, Spain, Sweden, Switzerland, Thailand, Turkey, the United Kingdom and the United States and also the ECB.
News Article | October 2, 2016
‘Why are you going to the Labour conference?” asked the Liverpool taxi driver. “Well, I’ve got used to attending funerals this year.” This somehow captured the mood of a conference where the enthusiasm of the “Corbynistas” contrasted with the unutterable gloom and dire forebodings of such traditional Labour party supporters and MPs as had bothered to turn up at all. Here we have a government that is crying out to be challenged on so many fronts, yet the main occupation of the Labour party has been to oppose itself. I confess that, in common with not a few other observers, I could not quite take the atmosphere of the conference and beat a hasty retreat on the Tuesday. Thus it came about that I found myself watching Jeremy Corbyn’s speech on television back at home. It received an execrable reception in the media – as did shadow chancellor John McDonnell’s speech the day before – with cries amounting to “same old story: tax rises, more public spending, masses of borrowing” etc. Now, I fully understand the wrath of the anti-Corbynistas over the widely reported bullying tactics of Corbyn and McDonnell’s “bovver boys”, and the antipathy towards a “Trotskyite takeover” of the party. When I said to one senior former cabinet minister “it’s just like the early 1980s”, he replied: ‘‘It’s worse than that. At least then we were in control.” But there were some good things in the speeches of both Corbyn and McDonnell: they are obviously leading with their chins to boast about “socialism”, even though this word that frightens the media was used in the past by Roy Hattersley, John Smith and even Tony Blair. Once upon a time socialism was closely associated with communism, and the British left had some embarrassing moments with this over the years. Way back in the 1950s, Tony Crosland wrote an influential book entitled The Future of Socialism and phrases such as “democratic socialism” became widely used, and the “mixed economy” became all the rage. After the fall of the Berlin wall in 1989, and the collapse of the Soviet Union in 1991, many people, including me, were concerned about the triumphalism that followed, as we saw an acceleration of the deregulation that had begun with Reagan and Thatcher, and the obeisance to rampant markets. Then came the global financial crash, the impact of which we are still experiencing – with the ultimate irony that the prospect of a massive fine on Deutsche Bank is even being talked about as a last straw that might precipitate the next financial crisis! Now, while I can understand the despair of the parliamentary Labour party, I wonder whether the rightwing press that excoriates Corbyn and McDonnell are aware of the wider debate that is going on. We now have the International Monetary Fund and, less surprisingly, the United Nations Conference on Trade and Development, bemoaning the abysmal state of the post-crisis economy and crying out for governments to intervene to boost economic demand. It is now widely accepted that monetary policy has reached its limits, and may, via the effect on savers, be having a perverse impact on attempts to boost demand. Too many corporations are sitting on cash piles and not investing. The concentration of so much of the increment in national income in the hands of the top 5% means they themselves have plenty to spend but the sum total is not enough to boost world demand and ward off mounting fears of another recession. Corbyn and McDonnell call for increased government borrowing, at negligible rates of interest, to boost infrastructure. So do the most orthodox central banking institutions, such as the Bank for International Settlements, based in Basel. The reaction to their calls has been little short of hysterical in some places. They should not be excoriated for this. More to the point are the widespread concerns that for other reasons, not least their abysmal poll ratings, they are not electable. Anyway, they should be going for this government, which has lamely accepted the wish of 37% of the electorate to leave the EU (ie, although 52% of those who voted were for Out, only 37% of those eligible to vote were, God forgive them, Brexiters). Which brings us to the recent speech by George Osborne in Chicago. He said the British people had not voted for a “hard Brexit”. He was right. Only 37% voted for a hard Brexit. For what does leaving the EU mean other than a hard Brexit? And if you allow for all those under-18s who are keener on Europe than their grandparents, the proportion of population that wish to leave the EU must be closer to 25%. I bet that a fair proportion of the 37% did not appreciate the implications of what they were doing. The vultures are already descending, in the shape of foreign embassies in London approaching financial institutions and offering “helpful” advice about moving their operations elsewhere. And Nissan is just one of many multinationals considering the impact of Brexit on their future investment plans. How can a nation such as ours be so stupid? To coin a phrase, we need our country back. Our sovereign parliament must veto this absurd and self-destructive policy.
News Article | November 28, 2016
Regardless of the outcome of the meeting on 30 November, the future of OPEC looks uncertain. The organisation is facing a perfect storm, squeezed as it is between the revolution in shale oil, which has increased global supply and brought down prices, and the prospect of a global peak demand stemming from climate policies and falling costs of alternatives. Some have even declared the death of OPEC, but according to Thijs Van de Graaf, professor at the Ghent Institute for International Studies, this is premature. He believes it is more likely that OPEC will evolve from an output-setting cartel into an information clearing house. In fact, he writes, OPEC was never a cartel to begin with – and certainly never a powerful one. OPEC is facing some of the most severe threats in its 56-year history. The ‘fracking revolution’ has unlocked large swaths of new oil and gas supplies, contributing to a global glut. Alternative energy technologies are seeing impressive falls in costs—with solar photovoltaics prices dropping more than 60 percent between 2009 and 2016. A new climate treaty was adopted by 195 nations in December 2015, aiming to limit climate change to ‘well below’ 2 degrees Celsius, which would render the bulk of fossil fuel reserves ‘unburnable’. On top of that, the dramatic fall in oil prices since mid-2014, after a four-year period of relatively stable and high prices, has exposed the economic fragility of many OPEC countries who are heavily reliant on revenues from the foreign sales of crude oil, most notably Venezuela, which saw its economy shrink by 5.7% in 2015. The self-proclaimed cartel has failed to adopt a coherent, united stance in response to these challenges. At a dramatic meeting in November 2014, OPEC opted to let market forces play out. The inability of OPEC to agree to production cuts triggered a battle for market share, both inside and outside the cartel (see Figure 1). An attempt to forge a ‘production freeze’ (not to be conflated with a production cut) between OPEC countries and Russia at a meeting in Doha in April 2016 utterly failed. The talks collapsed at the 11th hour after Saudi Arabia refused to sign a deal without Iran, which in turn did not want to participate in a production freeze, arguing it needed to recapture market share lost while it was under international sanctions. Another attempt in September 2016 seemed more successful, with OPEC countries agreeing to adopt a production target ‘ranging between 32.5 and 33.0 mb/d’. On 30 November, the OPEC members will make a formal decision on this plan. But even if OPEC may reassert itself at this meeting, questions remain, in particular whether (i) OPEC countries will actually follow through on this commitment; and (ii) whether such a production cut could have major knock-on effects on global prices, in light of the large inventory overhang that needs to be cleared first. What is more, the battle for market share is only half the story. With its vast and cheap oil reserves, Saudi Arabia has long been wary of ‘demand destruction’ and wants to keep oil consumers hooked to oil, as was illustrated in a US Department of State cable that was made public by Wikileaks. ‘Saudi officials are very concerned that a climate change treaty would significantly reduce their income,’ James Smith, the U.S. ambassador to Riyadh, wrote in a 2010 memo to U.S. Energy Secretary Steven Chu. ‘Effectively, peak oil arguments have been replaced by peak demand.’ It thus seems reasonable to assume that for Saudi officials, low oil prices also serve as a hedge against a rising tide of fuel economy, biofuels, electric vehicles, natural gas vehicles, advances in energy storage, et cetera. Some analysts suggest that the cartel’s failure to reach a united position ‘is not merely a sign that its influence is at a cyclical low ebb, but rather a portent of a more structural shift into irrelevance.’ By announcing a national plan to wean the kingdom’s economy off oil revenue, Saudi Arabia is said to ‘sounding the group’s death knell.’ Even within the organisation itself, the view is gaining root that the club is in decay. At the May 2016 OPEC board of governors meeting in Vienna, a representative from a ‘non-Gulf Arab country’ pronounced OPEC dead. Predictions of OPEC’s demise have a long history, of course, and so far they have always proven to be exaggerated. Yet, some analysts, such as Ed Morse from the investment bank Citigroup, maintain that ‘this time around might well be different,’ because the shale revolution has heralded a ‘new oil order.’ Certainly it’s difficult to deny that OPEC does indeed face a dramatically altered external environment, brought about by three main trends: the fracking revolution and the risk of prolonged low oil prices, tightening climate policies, and cheaper alternatives to oil. The conventional view of energy geopolitics has long been underpinned by the expectation that global demand for oil will continue to grow unabatedly. The geopolitics of energy was then framed as a struggle for access to scarce oil and gas reserves—a dominant image that is still often reproduced in the media. That common wisdom has now changed. The new geopolitics of energy is characterised by abundance rather than scarcity, even at low prices. In fact, OPEC countries might not be able to burn through all their fossil fuel reserves due to climate change regulation, leaving them with stranded assets. Key trends in efficiency, fuel-switching and market saturation are pointing into the direction of a demand peak for oil instead of a supply peak. Oil producers are coming to realise that oil in the ground is not like ‘money in the bank’ but that these resources might someday be less valuable than oil produced and sold in the short term. The first crack in this conventional view of energy geopolitics arose due to the recent shale and fracking revolution, which has unlocked large new oil and gas deposits for commercial extraction. To be sure, tight oil and shale gas production comes at a price compared to conventional extraction, both in terms of higher exploration and production cost, a lower energy return on investment (EROI), and grave environmental and social risks. These costs and externalities, though, have not prevented the rapid and vast boom of the shale gas and tight oil industry in the United States, which alone added almost 4 mb/d of oil to the world’s oil production between 2007 and 2015 (see Figure 1). The IEA expects a number of countries to follow into the footsteps of the United States, with China likely in the vanguard, though it will take a few more years before their efforts to tap shale gas and tight oil deposits at a large scale will bear fruit. There are other emerging sources of supply, next to shale oil, including biofuels, oil sands, deepwater deposits, and growing conventional production from countries like Iraq, which might substantially increase the global reserve base. Coupled with OPEC’s rising internal demand and stagnant or even falling upstream capacity, the group’s share of the export market might be eroded over time. But the advent of the shale and tight oil industry stands out for three reasons. First, by unlocking vast resources that had long been deemed uneconomical, the fracking technology has dispelled ‘peak oil’ worries just as rising climate concerns have begun to cast doubt on the long-term outlook for oil demand growth. This has fueled speculation that a huge ‘carbon bubble’ is in the making, that large amounts of oil would have to ‘stay in the ground’, and that some of OPEC’s resources might end up being ‘stranded assets’. This might change the revenue-maximising strategy of low-cost producers like Saudi Arabia and give them an incentive to speed up, rather than slow down, oil extraction. Second, the shale revolution accelerates the eastward migration of the global oil market, whereby the center of gravity of oil consumption, and hence oil trade flows, are decidedly shifting to the so-called ‘East of Suez’ region. That leaves oil exporters competing with each other for an increasingly concentrated Asian market, which is itself dominated by supergiant Chinese oil trading companies with considerable market power. This situation provides another deterrent for OPEC to implement production cuts. Last but not least, what stands at the center of the shale oil revolution is that it has changed the cost curve and elasticity of oil supply. The fracking industry operates on a much shorter investment cycle than the conventional oil industry: upfront costs are relatively low, decline rates are steep, lead times and payback times are short. There is no real exploration process to speak of because the location and broad characteristics of the main plays are well known. The time from an investment decision to actual production is measured in months, rather than years, making the tight oil industry far more nimble and responsive to price signals. On the demand side, the Paris Agreement concluded in December 2015 might prove to be a game-changer. Even though the text of the Agreement nowhere mentions the words ‘oil’, ‘gas’, ‘energy’, ‘fossil fuels’ or even ‘carbon’, the deal effectively implies a complete overhaul of the world’s energy mix. By agreeing on the political goal of limiting the average global surface temperature increase to ‘well below’ 2°C above preindustrial levels and even try to keep it below 1.5°C, the Paris Agreement boils down to a commitment to phase out fossil fuels before the end of the century. Under a scenario where fossil fuel use is reduced to limit global warming to 2°C, oil will probably be phased out slower than coal which is far more polluting and has more substitutes. Yet, oil will certainly not be able to expand at the same rate as it used to. The IEA’s latest 450 scenario, which is consistent with a 50% chance of less than 2 °C of global warming, projects global oil demand to reach a peak of 93.7 million b/d in 2020 but thereafter fall to 74.1 million b/d by 2040. This would imply that the oil industry’s decades-old expansion would come to a halt, and enter a permanent decline, implying that oil would become an ex-growth sector. This could trigger a ‘race to sell oil’ among petrostates. McGlade and Ekins have calculated that, globally, a third of oil reserves, half of gas reserves and over 80% of current coal reserves should remain unused from 2010 to 2050 in order to have a better-than-even chance of meeting the target of 2 °C. These ‘unburnable reserves’ do not decrease very much in a scenario with widespread deployment of carbon capture and storage (CCS). For example, the amount of ‘unburnable’ oil inches slightly downwards from 35% to 33% of all reserves if CCS is widely deployed. The modest effect of CCS is due to the fact that CCS will take decades to scale up globally, the technique might not be more cost-effective than renewables or nuclear and it is not entirely carbon-free. Table 3 depicts the shares of fossil fuel reserves that should be kept under the ground to have a medium chance of limiting warming to 2 °C in a scenario with CCS deployment. Admittedly, there are good reasons to be skeptical about the actual results of COP21. However, even if the 2 °C goal is not met, there are significant drivers that could lead to a peak in global oil demand, including lower economic growth (especially in emerging markets), the falling cost of renewables and electricity storage, the emergence of prosumers with a keen interest in electric vehicles, the spread of more stringent policies to mitigate air pollution or water stress, and the growing decoupling between oil consumption and economic growth due to greater efficiency. In short, the writing is on the wall that oil will never again grow at its historic rates. As Figure 2 shows, in only 9 of the past 50 years did the global demand for oil contract. In all other years it grew, quite often by more than 3% on an annual basis. Over the whole period (1966-2015), the compound annual average growth rate of oil demand was 1.94%. Throughout all of the IEA’s scenarios (2013-2040), this rate will slow down to 0.88% (Current Policies Scenario), 0.43% (New Policies Scenario), or even -0.85% (450 Scenario). In light of these challenges, observers have declared OPEC dead as a cartel. There are four major reasons why this view is misguided. First, OPEC never really was a cartel, let alone an omnipotent one. It only began to enact production targets since 1982, 22 years after it was founded, and even then it was not very successful. Despite OPEC’s efforts to function as a cartel, the oil price plummeted in the first half of the 1980s. Most, if not all OPEC countries cheated on their allocated production targets until Saudi Arabia’s patience was exhausted and the Kingdom decided to flood the market in 1986, in order to regain market share and punish the cheaters. Colgan (2014) finds that the cartel has overproduced a staggering 96 percent of the time in the period 1982-2009. Second, OPEC’s reserves are not stranded yet. OPEC still commands the largest conventional oil reserves. Especially the Gulf members of OPEC have very low production costs. If oil is stranded due to climate policies, it will most likely be the most expensive, risky and polluting fields, such as the Arctic, the ultra-deepwater fields, and the tar sands. Cherp et al. (2013) find that a peak in oil demand due to climate policies could even lead to a higher concentration of production in the hands of those states holding the largest conventional oil reserves, which are generally cheaper and less carbon-intensive. Third, OPEC has demonstrated a remarkable flexibility and resilience during its lifetime. The organisation has survived various price crashes, as well as the emergence of the North Sea in the 1970s, Alaska in the 1980s, offshore oil production in the 1990s and biofuels in the 2000s—all of which were seen as existential threats. Crucially, OPEC even hung together when the Saudis inflicted a lot of pain on their fellow cartel members in the late 1980s. Most curiously, OPEC oil ministers have continued to meet in Vienna even when they were at war with each other, such as Iraq and Iran in the 1980s (see picture 1), Iraq and Kuwait in the 1990s, and Iran and Saudi Arabia today (who are fighting proxy wars in Yemen and Syria). As Antoine Halff, a former IEA oil market specialist, has convincingly argued: ‘OPEC has changed and the idea that giving up on supply management means repudiating what the group is all about only focuses on a limited period of its history and confuses one stage of policy with the essence of the group.’ In this flexibility also lies the key to understand why OPEC is the only commodity organisation to have survived, whereas earlier commodity agreements (including for tin, coffee, and natural rubber) have faltered and disappeared. OPEC does not have a legal clause on how to intervene in specific market conditions, thus allowing it to respond flexibly to changing circumstances. Finally, OPEC will not wither away quickly because it still proves useful for its member countries, as is most vividly illustrated by the recent re-entries of Indonesia and Gabon to the club. The re-entry of Indonesia is most remarkable since the country has become a net importer. Yet, for its members, OPEC is useful as a forum to share information, as a forum for deliberation, and most notably, a source of prestige. There is a persistent rational myth that OPEC is a powerful cartel. International media are obsessed with OPEC meetings, outcomes and declarations, even if the group’s (long-term) impact on oil prices is heavily disputed. But what these reports are missing is that its output-setting function is not the primary reason for OPEC’s existence. OPEC is just as much a high-level, influential international organisation of oil exporters. OPEC’s endurance amidst the tectonic changes that have taken place in the global petroleum market has been called an ‘enigma of world politics’, and the organisation itself has been referred to as a ‘striking anachronism’. Students of international relations know however that international organisations rarely die. Robert Keohane famously stated that international institutions are ‘easier to maintain than to construct.’ There are many examples of international organisations that have outlived their original mandate. Think of NATO’s resilience after the end of the Cold War, the World Bank’s endurance after the postwar reconstruction of Europe, or the Bank for International Settlements surviving the Great Depression and the Second World War. In the same vein, it is conceivable that OPEC survives the transition to a post-carbon society, as long as it finds a niche for itself that proves valuable to its member states. Other international energy organisations such as the IEA have been busy for years to adapt to major shifts in the global energy landscape. The IEA has been quite successful in this regard, and is touted as a model for the reform of other global institutions. Yet, other international energy bodies have been much slower to adapt and some even stick around without being very meaningful. A case in point is the Energy Charter Treaty, which has been in complete disarray since Russia’s formal withdrawal in 2009, despite recent attempts to reinvigorate the organisation. The key question thus becomes whether OPEC countries will engage in a far-reaching examination of the organisation’s mission and toolbox, or whether the club will sink into oblivion. A systematic account of the history of global energy governance has shown that oil exporters might engage in institutional innovation when they are dissatisfied with the level of their oil revenues. The current low oil prices might thus provide a window of opportunity to reform OPEC. Over the short to medium term, OPEC might continue to serve as a forum to facilitate attempts at managing oil supply. For all the doubts expressed about it, the recent Algiers signals that there still exists a willingness to intervene and stabilise oil markets in spite of the rhetoric that the oil market should now manage itself. Toward the longer term, as the world shifts away to cleaner fuels, OPEC could provide a valuable framework for exchanging critical information among member states about the implications of this shift. This could be technical cooperation on technologies such as CCS, which may play their role in the transition and prove to be another source of income for OPEC countries out of their depleted oil and gas wells. But it could also entail the sharing of best practices of how to make a national economy less dependent on the revenues from the foreign sales of crude. Despite many attempts to diversify petro-economies, there are only scant examples of success (e.g., Indonesia, Malaysia and Dubai), and it can be questioned whether these models can be replicated. OPEC’s Secretariat could become an information clearing-house to share information on what works and what does not in particular circumstances. Thijs Van de Graaf [email@example.com] is an Assistant Professor of International Politics at the Ghent Institute for International Studies, Ghent University. His research focus is on global energy governance and energy policy. This article is an edited and shortened version of a fully annotated academic paper to be published in the journal Energy Research and Social Science.
News Article | December 15, 2016
The future is not good for oil, no matter which way you look at it. A new OPEC deal designed to return the global oil industry to profitability will fail to prevent its ongoing march toward trillion dollar debt defaults, according to a new report published by a Washington group of senior global banking executives. But the report also warns that the rise of renewable energy and climate policy agreements will rapidly make oil obsolete, whatever OPEC does in efforts to prolong its market share. The six-month supply deal brokered with non-OPEC members, including Russia, could slash global oil stockpiles by 139 million barrels. The move is a transparent effort to kick prices back up in a weakening oil market where low prices have led industry profits to haemorrhage. The Organization of Petroleum Exporting Countries (OPEC), whose members include major producers from Saudi Arabia to Venezuela, have been hit particularly badly by the weak oil market. In 2014, OPEC had a collective surplus of $238 billion. By 2015, as prices continued to plummet, so did profits, and OPEC faced a deficit of $100 billion. The immediate impact of the deal was a 4 percent price rally that saw Brent crude (the benchmark price for worldwide oil prices) rise to $56.64, its highest since mid-July. But according to Michael Bradshaw, Professor of Global Energy at Warwick Business School, a price hike would not solve OPEC's deeper problems. In fact, it could speed up the transition away from oil. As oil gets more expensive again, there is more incentive to use alternative, cheaper forms of energy. "The current agreement is only for 6 months and decisions about investment in oil and gas are based on a 20 to 30 year view of future demand," Bradshaw told me. "On that time scale, none of the uncertainties are addressed by the current agreement and oil exporting states need a strategy beyond achieving a short-term agreement on production—they need to start preparing for a world after fossil fuels." As oil gets more expensive again, there is more incentive to use alternative, cheaper forms of energy—like solar photovoltaics, which can now generate more energy than oil for every unit of energy invested. "They will also incentivise more unconventional oil production that will challenge OPEC production. Clearly there is a balance to be struck and it is not a return to $100 a barrel," Bradshaw said. He warns that higher prices might kick-start US tight oil production, which would increase competition with OPEC, making the production cut agreement moot. They also might add "inflationary pressures in the economy" that could prolong sluggish economic growth. Both factors could end up keeping prices lower than OPEC wants. "We are not in a business as usual world," Bradshaw said. "Higher prices for oil and gas will drive investment in efficiency and demand reduction and also substitution, so they may actually promote structural demand destruction." It's not just OPEC that needs to be prepared. A report published in October by the Group of 30 (G30), a Washington DC-based financial advisory group run by executives of the world's biggest banks, warns investors that the entire global oil industry has expanded on the basis of an unsustainable debt bubble. The oil industry's long-term debts now total over $2 trillion. G30's leadership includes heads and former chiefs of the European Central Bank, JP Morgan Chase International, and the Bank for International Settlements. The industry's long-term debts now total over $2 trillion, the report concludes, half of which "will never be repaid because the issuing firms comprehend neither how dramatically their industry has changed nor how these changes threaten to soon engulf them." The report is authored by Philip Verleger, a former economic advisor to President Ford who went on to head up the US Treasury's Office of Energy Policy under President Carter, and Abdalatif al-Hamad, Director General of the Arab Fund for Economic and Social Development. Its main finding is that permanent shifts in global energy markets will inevitably overwhelm oil companies, along with all economies which depend primarily on fossil fuel production. The attempt to rally prices, the report confirms, is a somewhat futile effort to avoid a major debt crisis by lifting revenues. But it won't work because the global oil industry is in denial about the bigger trends disrupting energy markets as we know them. Oil majors, the report says, are holding on to a number of fatal delusions. They believe that the oil price decline is "transitory"; that oil consumption will grow despite ongoing economic stagnation; that the industry will be magically immune to public and policy demands to reduce greenhouse gas emissions; that technological progress will never be able to "displace fossil fuels such as oil"; and, finally, that fracking will not produce enough supply to undermine OPEC's market monopoly. Oil majors, the report says, are holding on to a number of fatal delusions. But if these assumptions are wrong: "They represent an ossified industry that will gradually fade away [and] hundreds of billions if not trillions in debt issued by these firms and countries may never be repaid." So what's the alternative? Instead of tinkering with production quotas, Bradshaw said: "They [oil producing countries] should also be promoting greater energy efficiency and renewable energy in their domestic economies to preserve their exportable surplus as some will struggle otherwise due to rapidly increasing domestic demand." To its credit Saudi Arabia's Vision 2030 plan is a step toward this. But a HSBC research note in May found that the plan would not do enough to avoid the kingdom entering "a protracted period of marked economic decline." In the meantime, a trillion dollar collapse in the oil market is coming because oil simply cannot compete with new energy technologies. If Bradshaw is right, then OPEC's efforts to 'shock' the markets into boosting prices are only going to prolong the fossil fuel pain. Get six of our favorite Motherboard stories every day by signing up for our newsletter.