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Who’s To Blame For The High Price Of Oil?

I read the following the other day in a grocery store publication on Chicago’s northwest side. Regarding the high cost of oil and gasoline, the bureau chief of the paper wrote:

Whew! What is the answer? I think we should contact our elected officials, both state and national, and let them know we, the taxpayers, need some relief. Yes, I know about Bush’s economic stimulus package that is on the way- but I don’t want to put it all in my gas tank.

There’s no use arguing with most Americans over who’s to blame for high oil and gasoline prices. In their minds, “Big Oil” is the culprit, with a dash of President Bush, his oil buddies, and every level of government sprinkled in for good measure. But before you forward on that e-mail about a “gas station holiday” to five of your friends, consider this: Could it be possible that the high price of crude oil is mainly due to the basic principle of supply-and-demand? Just a thought. Bloomberg’s Mark Shenk wrote today:

China, India, Russia and the Middle East for the first time will consume more crude oil than the U.S., burning 20.67 million barrels a day this year, an increase of 4.4 percent, according to the International Energy Agency in Paris.

And here in the good old US of A?

U.S. demand will contract 2 percent to 20.38 million barrels daily, the IEA says.

Shenk noted that economic growth in China and India of more than 8%, coupled with increasing car ownership among the countries’ combined populations of 2.45 billion people, will more than compensate for declining demand in the United States. According to the IEA, global oil use will increase 2% this year largely because of emerging market growth.

Regarding the topic of car ownership, China’s passenger car sales jumped 22% to 6.3 million units sold last year. Reuters’ Joe Mcdonald reported on the Chinese auto sector today, and wrote:

Auto sales in China are booming, with analysts and automakers forecasting growth at 15-20 percent this year. But demand for the biggest vehicles is even stronger, with sales of luxury cars and SUVs expected to surge by 40-45 percent…

“Chinese buyers typically like bigger cars and they have the resources to go for them,” said Tim Dunne, J.D. Power’s director of Asia-Pacific market intelligence.

Source: China Daily

Mike Wittner, head of oil research at Societe Generale SA in London, told Bloomberg:

Does the U.S. matter anymore? Has the U.S. mattered for the last few years? It is debatable. As far as the oil market is concerned, demand growth is going to be continued to be driven by China and the Middle East.

Still feel like contacting your elected officials?

Sources:

“Emerging Market Oil Use Exceeds U.S. as Prices Rise (Update2)”
Mark Shenk
Bloomberg, April 21, 2008

“Gas guzzlers a hit in China, where car sales are booming”
Joe Mcdonald
Reuters, April 21, 2008

Recession Fears Grow As America Looks To Stimulus Plan

The Associated Press reported earlier today that President Bush and Federal Reserve Chairman Ben Bernanke have “embraced calls” for an economic stimulus package to avert recession. Bernanke warned Washington politicians, however, that any delays would be costly:

To be useful, a fiscal stimulus package should be implemented quickly and structured so that its effects on aggregate spending are felt as much as possible within the next 12 months or so.

While in Jordan today, U.S. Energy Secretary Sam Bodman told reporters that the probability of a U.S. economic recession is growing and high oil prices pose a significant problem for the world’s largest energy consumer. According to Reuters, Secretary Bodman said global oil supplies were not as high as the U.S. would like, but he stopped short of repeating President Bush’s call earlier this week for OPEC to boost supplies. Bodman revealed:

There are certainly signs that we are facing economic challenges and I think that the probability of a recession is now greater than it has been in the past… In my view, there is some evidence that suggests that supplies are less than we would like to see.

The Agence France-Presse (France) said yesterday that the International Energy Agency (IEA) attributed recent record oil prices above $100 per barrel to not only tensions in the marketplace, but also falling stocks in top consuming countries. In its monthly oil report, the IEA said:

The most recent rise would appear the easiest to explain: OECD stocks have been falling since July 2007, reflecting a tightening physical market… Total OECD oil inventories are now below five-year average levels.

The OECD area includes the 30 member countries of the Organisation for Cooperation and Development, which includes North America, Europe and Asia’s most industrialized economies.

The AFP noted that the IEA statement appears to be at odds with OPEC Secretary General Abdullah al-Badri, who told the AFP yesterday that the market was adequately supplied and that OECD stocks were within their five-year averages. The IEA left its 2008 forecast for oil demand unchanged on Wednesday. The Paris-based organization predicts that strong oil demand will continue regardless of a U.S. economic slowdown.

“Shop Smart, shop S-Mart, you got that?”

Two recent Reuters polls also reflect the growing concerns over a recession in the United States. A survey of 100 analysts taken between January 11 and January 16 revealed yesterday that the risk of a U.S. recession has grown to 45% from 40% last month. According to Reuters, this percentage has steadily increased from 30% in October. Also on Wednesday, a Reuters/Zogby poll conducted on January 10 and 11 revealed that of 1,006 eligible American voters surveyed, 47.5% said they think a recession is likely in 2008. This figure was up from 43.4% in the prior month. For the first time since the recession question was added to the monthly poll back in September 2007, more people said a recession was likely than unlikely.

Canada Prepared For U.S. Recession

Tonight I came across an article in the National Post (Canada) entitled “Riding Out Global Gloom,” which claims that Canada is well-positioned to withstand a U.S. recession. According to Jacqueline Thorpe, the author of the piece:

The economic gloom deepened yesterday as the United Nations warned of the risk of worldwide recession, Goldman Sachs became the latest observer to forecast a U.S. contraction, shares of European retailers plummeted on fears a consumer retrenchment would cross the Atlantic, and safe-haven gold touched another record high of US$891.40 an ounce.

But amid the pessimism one economic stalwart stands out: Canada.

Ms. Thorpe referenced a Merrill Lynch forecast:

In an indication of just what this country has going for it, the same investment bank that said on Monday the United States was already in recession, predicted yesterday Canada would pull through with “the best relative performance … in modern times.”

David Wolf, Merrill Lynch’s Canadian analyst, forecast Canadian real GDP would trough at 1.3% year-over-year in the third quarter, down from 2.9% in the fourth quarter of 2007 and a nearby peak of 3.6% in the first quarter of 2006.

In the past, the Canadian economy fell victim to the same economic ills as its neighbor to the south:

In the 2001 U.S. recession by contrast, Canadian growth fell to just 0.7% from the cyclical peak of 5.9% in the fourth quarter of 1999. And history has been much less kind, with Canada suffering interminably during the early 1990s recession as the U.S. economy bounced back.

Indeed, in the six previous recessions of the past forty years, Canada has followed suit four times (1969-70 and 2001 being the exceptions), Mr. Wolf said. The average peak-to-trough drop in real GDP was 6.7 percentage points.

The Joke’s On US
Courtesy of BustedTees.com

Why is Canada better off this time around? The Merrill Lynch analyst points out that the Canadian housing market is healthier than its neighbor’s, “as activity and prices are still rising and, crucially, owner’s equity, which could be tapped for spending, exceeding 70% as opposed to around 50% in the United States.” In addition, while employment and wage growth would probably slow, Canadian consumers are in better shape, with Wolf predicting 3.9% consumer spending growth in 2008. Avery Shenfeld, senior economist at CIBC World Markets, told the Post that:

We have higher levels of employment; we have rising wage rates, rising house prices, so our consumer sector has no reason to do anything but shop.

Shenfeld is forecasting 2.7% growth for Canada this year.

On the flip-side, the potential for flattening commodity prices may affect Canadian exports, as will the strong Canadian dollar. Yet, the loonie’s strength will keep import prices cheap for the Canadian consumer, and “will keep a lid on inflation, giving the Bank of Canada the wiggle room it needs to cut interest rates,” according to the Ontario-based publication. Merrill Lynch’s Wolf predicts that Canada will move to a current account deficit of $10 billion in 2009 from a $14 billion surplus in 2007 as imports surge.

Morgan Stanley Asia’s Chairman Issues U.S. Recession Warning

Morgan Stanley Asia’s chairman, Stephen Roach, spoke to Sky News earlier today while visiting Australia and warned that while the U.S. economy is entering a recession, the Federal Reserve, along with the rest of the world, doesn’t appear to grasp its significance. While the Fed cut interest rates the last time they met, Roach feels their work is far from done. He said:

They will move again, most assuredly. The US is going into a recession, they’ve a lot more work to do. They could cut their policy short term interest rate by one to 1.5 percentage points over the next nine to 12 months.

During the interview, Roach spoke about the indifference of the global economy to the prospect of an economic recession in the United States. He warned:

There is a view that the world has somehow decoupled from the American growth engine. I think that view will turn out to be dead wrong and this is a global event with consequences for Asia and Australia.

The head of Morgan Stanley Asia also told Sky News that he didn’t believe growing demand from India and China will be able to “save the global economy.” He explained:

The US is a US$9.5 trillion consumer. China is a US$1 trillion consumer. India’s a US$650 billion consumer. Mathematically, it is almost impossible for the young dynamic consumers of China and India to fill the void that would be left by what is likely to be a significant shortfall of US consumer demand.

Back in a November 2 post, I discussed Roach’s views on “decoupling,” which he shared in a speech given in Mumbai, India:

I think the thing that worries me the most, and this is where I would really underscore the point for you in India, is that equity markets in this region, including your own, are discounting this optimistic, rosy scenario called decoupling. There is the strong belief that because the US has slowed so far, and Asia hasn’t, that any further slowdown will leave Asia unscathed. Think about it for a second. The slowing that’s occurred in the US right now has been in homebuilding activity. It’s America’s least global sector. You stop building a house in America, there’s almost no impact on Asian exports to the US. The slowing that will be coming over the next year will be in the consumer demand sector, which is America’s most global sector. So, we are going to see the US slowdown go from a domestically driven to a globally driven slowdown. I am sorry, as bullish as I am about Asia, Asia will not be an oasis of prosperity in a softer global demand climate. To the extent that emerging market equities are buyers of the global decoupling thesis, including in your own market right here, I think there could be a significant correction in emerging market equities that certainly could hit the Indian stock market quite hard.

Roach is well-known on Wall Street as a perennial “bear” on the U.S. economy. In November 2004 (while still Morgan Stanley’s chief economist), he attended a meeting with a select group of fund managers and shocked the audience with his observation that the U.S. had no better than a 10% chance of avoiding an economic “Armageddon.”

Sunday Edition: November 25, 2007

Subprime Mortgage Crisis Growing
According to the Wall Street Journal yesterday, calculations by the Bank of America Corp. show that interest rates are set to rise on $362 billion worth of adjustable-rate subprime mortgages in 2008. Banc of America Securities, a unit of Bank of America, estimates that $85 billion in subprime mortgages will reset this quarter, another $85 billion will reset in the first quarter of 2008, and $101 billion of mortgages will reset in the second quarter of 2008. The estimates include loans packaged into securities and held in bank portfolios. In addition to the $362 billion of subprime ARMs that are scheduled to reset during 2008, Banc of America Securities said $152 billion in other loans with adjustable rates are scheduled to reset next year, including “jumbo” mortgages of more than $417,000 and Alt-A loans, a category between prime and subprime.

According to the Journal:

Many of the subprime mortgages that have driven up the default rate went bad in their first year or so, well before their interest rate had a chance to go higher… Now the real crest of the reset wave is coming, and that promises more pain for borrowers, lenders and Wall Street. Already, many subprime lenders, who focused on people with poor credit, have gone bust. Big banks and investors who made subprime loans or bought securities backed by them are reporting billions of dollars in losses… The reset peak will likely add to political pressure to help borrowers who can’t afford to pay the higher interest rates.

The Mortgage Bankers Association estimates that 1.35 million homes will enter the foreclosure process this year with another 1.44 million homes in 2008, up from 705,000 in 2005.

U.S. Recession May Harm Emerging Markets
London-based HSBC Asset Management told Reuters yesterday that an economic recession in the United States will affect emerging markets, even though some believe that decoupling from U.S. growth has taken place. Christian Deseglise, head of HSBC AM’s $85 billion global emerging markets business, told Reuters that the possibility of a U.S. recession was looking real now compared to earlier this year. Deseglise said:

Talk of recession in the US economy has increased lately so the story of decoupling from the US economy is being looked at more carefully … this may be causing the latest bout of nervousness. In February-March, there were fears but no evidence of slowdown. Now we are not dealing just with fears, but with something that is really out there. There are real issues with many sectors that may have a slowdown impact on the rest of the world.

Deseglise talked about the fallout from a U.S. recession:

If the US were to go down to one percent growth, emerging markets have the inner strength to grow within themselves. But if the US were to enter into a prolonged and severe recession that will have a detrimental effect. Emerging markets don’t need a fast growing US economy but they still need a growing US economy… I don’t think a recession is priced into the market.

HSBC Asset Management wouldn’t be the first to dispel the notion of decoupling from the United States. On November 2, I talked about how Stephen Roach, Chairman of Morgan Stanley Asia, told an audience in Mumbai, India, that he didn’t buy into the theory of decoupling:

I think the thing that worries me the most, and this is where I would really underscore the point for you in India, is that equity markets in this region, including your own, are discounting this optimistic, rosy scenario called decoupling. There is the strong belief that because the US has slowed so far, and Asia hasn’t, that any further slowdown will leave Asia unscathed. Think about it for a second. The slowing that’s occurred in the US right now has been in homebuilding activity. It’s America’s least global sector. You stop building a house in America, there’s almost no impact on Asian exports to the US. The slowing that will be coming over the next year will be in the consumer demand sector, which is America’s most global sector. So, we are going to see the US slowdown go from a domestically driven to a globally driven slowdown. I am sorry, as bullish as I am about Asia, Asia will not be an oasis of prosperity in a softer global demand climate. To the extent that emerging market equities are buyers of the global decoupling thesis, including in your own market right here, I think there could be a significant correction in emerging market equities that certainly could hit the Indian stock market quite hard.

Supporters of decoupling disagree. Reuters said:

Some observers say solid fiscal and monetary policy, healthy balance of payments, and China’s rise as a counterweight to the United States has helped emerging nations decouple from US growth and act as a safe haven from developed market turmoil.

In addition, they argue that the United States takes in just 16% of emerging market exports now, compared with 25% in 2001. In 2006, exports to other emerging nations overtook the volume of goods and services sent to developed nations.

Parting Shot
On the Euro Pacific Captial website, president and investment advisor Peter Schiff talked about how the actions of Wall Street and the U.S. government are forcing Gulf and Asian nations to reconsider their efforts in propping up the U.S. economy. In “Heads We Win, Tails You Lose” from November 23, Schiff said:

Perhaps the icing on this “let them eat cake” mentality was provided by Wall Street itself. In a year with record losses, Wall Street firms announced that they would also be paying record bonuses to their employees. The rationale for this PR fiasco was that since the losses were not the fault of the employees (really?), they should not be made to suffer. So rather than sharing the pain being endured by their firms’ shareholders (clearly even less culpable then themselves), Wall Street’s fat cats will rub salt in their owners’ wounds by compounding their losses with the additional expense of lavish bonuses. Following the outlandish pay packages already given to ousted CEO’s who clearly were responsible for the losses, Wall Street’s “heads we win, tails you lose” attitude will not go over well abroad.

Enjoy it while it lasts… which won’t be for much longer.

Have a wonderful week,

Christopher E. Hill
Editor
editor@boom2bust.com