“If it’s too good to be true, it probably is” — goes for bad news too
In early 2000, the NASDAQ was over 5000. Qualcomm’s price target was $1000 a share. eToys and pets.com were well-known companies. There was a company called AllAdvantage that actually paid you for browsing the internet. Almost nobody was saying we were in the midst of a huge bubble that was about to end — it was the new economy, it was different this time; if it was too good to be true, it just looked that way, because the rules had changed. Of course in reality they had not. Today, Qualcomm is $43 a share, the other companies are history, and the NASDAQ is still down over 60% from its peak. Today, the wags are saying that high oil prices — double what the were a year ago, triple what they were a few years ago — are here to stay. The game has changed; it’s different this time; it’s a new-new economy because of China, say the bright boys. Pardon us if we are skeptical.
Since we bought Exxon Mobil puts the other day, we’ve got a vested interest in being right about our bet that oil prices are about to come down. By the same token, if we are wrong, we’d like to know that earlier rather than later. More and more, the evidence suggests to us that some unsustainable anomalies have caused oil to peak, and that the fall could be a bit nasty.
For starters, let’s look at how far out of whack either the price of oil or the price of gold is. The ratio of the price of gold to the price of oil is currently at historically unprecedented levels:
But which is it? Is the price of gold about to spike, or is the price of oil about to sink. For a little perspective on the strange and unanticipated price rise in oil over the last two years, let’s see what Andy Xie, Morgan Stanley Economist, observes about the major swing factor in oil demand — China:
Economic overheating, primarily in China, has exaggerated energy demand in the past three years. BP estimates that total demand for energy grew by 4.3% in 2004, 3.3% in 2003, and 3.4% in 2002, compared with annual growth of 1.2% between 1991 and 2001 and 2.1% between 1981 and 1991. China accounted for 52% of this growth between 2001 and 2004. Global energy demand ex-China grew by 1.9% between 2001 and 2004, versus annual growth of 1.1% between 1991 and 2001 and 1.7% between 1981 and 1991…..
China’s oil demand grew by 15.8% in 2004, versus 7.7% in 2003, 6.9% in 2002, and 7.6% per annum between 1991 and 2001. Last year’s extraordinary growth was distorted by China’s electricity shortage. As China’s electricity generation capacity catches up with demand this year, demand for oil should decline (see Oil vs. Coal, January 17, 2005). Despite a 16.3% increase of industrial production in the first five months of 2005, China’s oil imports have declined this year.
I believe China’s oil imports are likely to decline in 2005 and may fall further in 2006, as China’s investment cycle turns down. The economic fundamentals for oil look very weak at present and into next year.
So the boomlet created by China’s electricity problems appears to have abated. (China normally relies on coal for 65% of its primary energy needs, by the way.) We keep waiting for the inevitable blip in China’s export-led growth to happen, which would further dampen Chinese demand. So far it has not happened, but the pressures for a correction continue to intensify. The textile wars are one part; as the Economist noted: “Chinese textile imports have risen by 97% in the six months since quotas were lifted, in January.” The WSJ adds more on the pressures on China which would cause lower growth:
At least two anti-China bills are looming in Congress. One, sponsored by Sens. Charles Schumer (D., N.Y.) and Lindsey Graham (R., S.C.) would impose a 27.5% tariff on all Chinese goods entering the U.S. to counterbalance the allegedly unfair advantage the yuan’s weakness gives Chinese companies over their U.S. competitors.
The administration opposes that bill as far too sweeping a punishment, and after talks with Mr. Snow and Federal Reserve Chairman Alan Greenspan this summer, the sponsors agreed to hold that bill back in anticipation of what turned out to be China’s July 21 announcement of its new approach to the yuan. The bill is likely to resurface, however, particularly if Sens. Schumer and Graham feel the administration isn’t being tough enough on China, by, for example, failing to brand China a currency manipulator in the October report. A separate bill, already passed by the House and awaiting action in the Senate, would allow the Commerce Department to impose import duties against Chinese goods to counter the effects of government subsidies to Chinese firms.
“Protectionist pressures are really there,” said the Treasury official. “Aside from something Katrina-related, there would be no more popular bill on the Hill right now than something protectionist aimed at China.” The Chinese authorities “have to recognize that,” the official said.
Protectionism, or the threat of protectionism, could be a triggering mechanism for a slowdown in China’s growth. We have written a lot on the inevitability of a correction in China’s growth, and the only question is when it will occur. From the dramatic fall in shipping rates this year, to the corruption and incompetence in its banking system, to the wild overstatements about the wealth of this poor country, to the predictions of uber-strategist Barton Biggs, it appears that there will soon be a blip in the impressive 20-year trend line of China’s 9% annual GDP growth. This will dampen oil demand in a key growth area — and we note that China is issuing calls in its official media for energy conservation as well. Meanwhile, in the rest of the world, the high oil prices are highly destructive; they are killing other economies around the world. George Magnus in the FT outlined the projected damage in a recent piece:
But what if oil prices were to remain high over the medium-term? The impact one year ahead, for example, of a permanent change (from $45 this time last year) to today’s levels above $60, with all things constant, would be to cause GDP to fall by 1-2 per cent in South Korea, Taiwan, Turkey and South Africa and by up to 1per cent in China, most of Europe, Japan and the US.
Such decreases in global GDP growth translate into smaller incomes and savings in individual households; no results of individual conservation efforts are present in the statistics to date, but they will show up significantly in the coming months. Finally, the world is awash in oil today. If there is any problem at all, it is a refinery problem, not a crude oil problem. Reuters:
While the perception among some consumer countries is that OPEC has starved the world of crude, IEA figures show the cartel has come close to matching the pace of demand growth, even before extra non-OPEC oil. The IEA says that from 2002 to 2005 global demand has risen 5.8 million bpd while OPEC, assuming steady output for the remainder of this year, has added 5.6 million bpd of supply. Non-OPEC producers led by Russia, have pumped an additional 2.5 million bpd since 2002.
That means global crude supplies have risen 10.5 percent over the past 3 years, outweighing the 7.5 percent of demand growth over that period by 2.3 million bpd. Refinery capacity though has not matched demand growth, rising by just 0.5-1.1 percent per annum worldwide since 2000, according to oil major BP, causing supply bottlenecks in consumer countries.
Refiners are having their rare day in the sun — a couple of really good years per decade. They are making hay while the sun shines, as all good capitalists do. However, in our view, they run the risk of regulatory, voter, and consumer reprisals if it is determined they have been price gouging — which of course they have. (All price gouging really is is using the laws of supply and demand to temporary advantage, and no doubt congressional investigations would show some — in retrospect — suspicious decisions to suspend certain refinery operations for “maintenance” at times, or decisions not to build inventories at points when they could have easily done so.) The refiners had better be careful, which they show no signs of at this point.
Summary
The price of crude oil is likely to fall sharply in the near future, since excess demand from China has disappeared and worldwide economic growth is getting hammered by high prices. Moreover, the results of individual conservation efforts have to date not shown up in any statistics. Further, the world is awash in crude oil. While there are refinery bottlenecks, refiners have acted unwisely in seeming unconcerned about the huge price escalations and their even huger profits — decisions that could play out to their long-term disadvantage politically. Therefore, from a number of different perspectives, there appear to be pressures building mostly in the direction of falling oil prices.
September 22nd, 2005 at 9:12 pm
> Almost nobody was saying we were in the midst of a huge bubble that was about to end — it was the new economy, it was different this time; if it was too good to be true, it just looked that way, because the rules had changed. Of course in reality they had not.
I tend to disagree. I don’t disagree that the above is correct in basis, or that things went south, because obviously they did — But there is a “New Economy” — the people running things just got a lot of its underpinnings wrong, in thinking that they did not have to pay attention to ANY of the old rules, when many still applied.
We are well along in the process of shifting from an Industrial Economy to an IP/Services Economy — all real substantial new value is going to be derived, in one form or another, not from making widgets but from improving and expanding on IP and/or Services. The number of men required to make all the widgets humans need is going to decline from wherever it is now to a much smaller per capita number just as the number of people required to grow this nation’s food has dropped precipitously in the last 100+ years. This will great a fair amount of economic dislocation as people who used to make widgets now find jobs providing services or making IP. One might even argue that a large part of the cause of the boom and collapse of the 20s and 30s was the shift from an Agrarian economy to an Industrial one, as workers shifted from farm labor to manufacturing.
This economy is going to be as different from its predecessor at least as much as an Industrial Economy (based on goods and factories, central organizing precept being the Corporation) differed from its predecessor, the Agrarian economy (based on food and land, central organizing precept being the Feudal Enclave).
I’d even argue that the difference between an IP/Services economy is going to be extremely different from its predecessor economies, for the simple reason that digital property, an important component of the IP/S economy is radically different from so-called “real” property, to the extent of representing a phase change in the notion of property. Clearly, they are related, much like water and ice — but their behaviors in response to things are radically different. This will necessitate a qualitative change in the way we deal with property and distribution thereof in return for labor output.
Hence the notion of a “new economy”. People could sense that things were different, they just weren’t sure HOW. After the boom, of course, everyone has gone to the other ridiculous extreme of thinking there is no difference at all. The truth lies, as it so often does, between the two extremes. Some of the old rules apply. Some don’t. Some will need to be applied in new ways and new configurations.
The New Economy of the 90s wasn’t wrong. It was just a First Draft.
November 23rd, 2006 at 8:08 pm
I tend to agree with OhBloodyHell. It’s quite difficult to tell what was wrong with 90s bubble. We may have to pick up good from it instead of throwing it away as a whole.