Home Blogs Chemicals and the Economy “Houston, we have a problem!”

“Houston, we have a problem!”

Economic growth
By Paul Hodges on 13-Jan-2015

WTI v natgas Jan15Suddenly, far too late, the world is catching up with reality.  Goldman Sachs and others yesterday halved their forecast for Brent oil to $42/bbl from $80/bbl.  But this isn’t forecasting, this is simply catching up with events long after they happened.  Brent, after all, opened at $45/bbl this morning.

As readers will remember, I forecast back in August that Brent oil prices were about to fall to “at least $70/bbl and probably lower“.   I coupled this with a forecast in early September that the US$ was about to see a “strong move upwards” as the Great Unwinding of stimulus policies began.  Then in October, I published my original forecasts in a Research Note, and also highlighted the key issues in the Financial Times.

Then, when the $70/bbl level was reached in early December, I published a new Research Note highlighting the potential for further major falls:

Astonishingly, most commentators remain in a state of denial about the enormity of the price fall underway. Some, failing to understand the powerful forces now unleashed, even believe prices may quickly recover. Our view is that oil prices are likely to continue falling to $50/bbl and probably lower in H1 2015, in the absence of OPEC cutbacks or other supply disruption. Critically, China’s slowdown under President Xi’s New Normal economic policy means its demand growth will be a fraction of that seen in the past.

“This will create a demand shock equivalent to the supply shock seen in 1973 during the Arab oil boycott. Then the strength of BabyBoomer demand, at a time of weak supply growth, led to a dramatic increase in inflation. By contrast, today’s ageing Boomers mean that demand is weakening at a time when the world faces an energy supply glut. This will effectively reverse the 1973 position and lead to the arrival of a deflationary mindset….

Asian producers and traders now have large inventories of almost every oil-related product. Buyers have simply stopped buying in recent weeks as prices have collapsed. So the question is whether China’s demand will now increase in January, before markets close for Lunar New Year in mid-February. A lot of money is now riding on this issue.

If these hopes prove false, and the West enjoys a mild winter, there would seem little to stop prices heading back towards historical levels of $25/bbl – $30/bbl. This would be good news long-term, as $25/bbl is an ‘affordable’ price for the global economy, at 2.5% of GDP.

But it would be very bad news for investments based on the two myths that (a) oil will remain at $100/bbl forever and (b) China’s demand will increase exponentially as it becomes middle class. Equally important is that a sustained price fall will mean deflation becomes inevitable in the Eurozone and Japan, irrespective of any further QE initiatives.”

That was published a month ago, not yesterday.  Today it is clear there has been no increase in China’s demand ahead of Lunar New Year, and the West is having a mild winter.  So the price is now highly likely to return to historical levels of $25 – $30/bbl.

All these experts who have missed the obvious for so long need to look at themselves in the mirror, and ask the simple question, “How did we get this so wrong“?  And more importantly, “What are we going to do now, to help those who believed our forecast and now face bankruptcy“?

Equally, Western central banks must now give up on the myth that printing money can somehow create demand and inflation.  They are primarily responsible for this looming earthquake by creating the ‘correlation trade’ in the first place.  As the chart shows, this caused oil (red line) and stock market prices (blue) to rise exponentially together.

They too need to look in the mirror, and focus urgently on the real task ahead – “How do we position the global economy to survive the deflation shock that is now about to hit?”