The Crude Reality. Part 1

It’s not rosy for everybody

Despite having bounced nearly 25% from its lows earlier last month, the WTI benchmark crude oil still remains a good 75% below its peak in 2008, and 60% below its 2014 high. January also saw crude close below its recession peak’s low of 30.28, and saw it test its 12 year technical support.  The recent rebound in oil prices was fueled primarily by rumors that Saudi Arabia might cut production by up to 500,000 barrels per day, the notion that Iran may not be ready to start pumping and selling oil as fast as the market had predicted, and most recently Venezuela’s oil talks with OPEC and Russia.  Regardless, oil inventories remain at historic highs.

Low oil is usually considered good for the economy, since it affects directly or indirectly everything in our lives.  From transportation (for ourselves as well as for the products we buy, and the parts it takes to make them), foreign trade, plastics, textiles, chemicals, etc.  There are very few instances where the oil price doesn’t affect us in one way or another.

So, low oil prices good, right? Well, not so fast.  Of course low oil prices lower the price of everyday goods including food; lowers the cost of transportation, therefore people tend to buy more/larger cars; makes going on vacations cheaper, leaving more disposable income to be spent on the economy or saved/invested in the markets.  However, low oil prices seriously affect the countries that produce it, and these effects can have serious repercussions on John and Jane Q. Public.

4 out of the top 5 sovereign wealth funds in the world are owned by oil producing countries.  The gulf countries amount to 5 of the top 10 SWFs in the world.  When mono-producer countries, like Saudi Arabia, take a 75% hit in their income, they will eventually need to tap into their reserves i.e. liquidating positions in their SWFs.  Since said funds are invested in stocks and bonds around the world, prices will undoubtedly come under pressure when these investments are sold. SWF funds from oil and gas peaked in March 2015 at $4.15 trillion. Towards December their value had dropped by in $132 billion, and is estimated a further $100 billion have been withdrawn in January pushing the markets lower.  This is affecting investors worldwide that have seen their assets lose value (approximately 8% in January alone).

During recent years, Russian, Arab, and Chinese billionaires have spent fortunes bidding up the London high-end real estate market (New York and Hong Kong being close behind) as well as art, soccer clubs, etc.  Many of these properties were bought on oil profits, and some of these investors will need to start liquidating assets soon.  Should the slump in oil prices continue for another year, it is very likely that the high-end property market (specifically houses and apartments going for over $25 million) will see a serious slowdown directly affecting pension funds invested in real estate.

Art, previously considered an uncorrelated asset class, has also been affected by the recent oil crash.  Picassos, Monets, and Matissses were sold at auction for the first ime below their purchase price.  Christie’s and Sotheby’s have seen lower investment in art over the last couple of quarters.  Unlike dividend paying stocks or bonds, art is a non-performing asset, meaning the sole purpose of purchasing it as an investment is to sell it later at a profit.  If there is no profit to be made, we could soon see art pieces flooding the market, driving prices down and hitting art funds and all those who invest in them.  So much for uncorrelated assets.

Finally there is the Russia problem.  Russia is bleeding money because of the low price of oil, if this is sustained it could drive the country to desperation, and nothing is more dangerous than a desperate Putin, with no money and a lot of nuclear weapons.  Turning it from an economic problem to a world security issue.

…to be continued