Until the rebound yesterday and today (Friday), world financial markets were dropping for several reasons. Among them is the steady increase of various geopolitical and economic problems.
Of course, there's Ebola, ISIS, Russia, etc. The euro zone is the foremost worry: It's struggling to avoid a third recession since the financial crisis, and the risk of European deflation also is increasing. Growth is slowing elsewhere too, such as in China and other emerging markets.
In many ways, the oil market tumble sums it all up. First, the drop was a direct result of global economic weakness. In fact, both oil and European stocks started to sag in late June.
But the oil price decline was exacerbated by worsening supply-demand fundamentals. The price of Brent crude, a global benchmark, recently was at $87 per barrel after tumbling to $83 earlier this week, down some 28% from the June high of $115.
No commodity is more closely tracked, extensively analyzed and frequently discussed than oil. Yet just last spring, the consensus view was that while U.S. oil output was climbing steadily, production growth in the rest of the world was barely inching ahead and there was still increasing global demand, particularly from the emerging markets.
But now there seems to be a glut. Oil prices this week fell to levels not seen since 2011 because demand for petroleum products is declining worldwide, particularly in Europe, just as the global market is flooded with oil. And this week, the International Energy Agency cut its full-year oil-demand growth forecast to the lowest level in five years.
Here in the U.S., production has increased 56% since 2004, while demand for gas and other fuels has declined 8%, according to estimates. And U.S. oil exports have yet to take off. "There is an abundance of geopolitical risk, but there is an even greater abundance of oil," as one observer put it.
Another key factor in the volatility, particularly in the oil markets, has been the actions of hedge funds and other confused market participants. They were long oil, short government bonds and overleveraged. With those markets turning against them amid growing anxiety about global growth, the hedgies and others were forced to exit such positions. They also had to sell other more liquid assets, including stocks, and cover their wrong-way interest-rate bets in order to raise cash.
It was a similar dynamic of forced liquidations that accounted for much of the extreme volatility during the 2008-09 financial crisis. To be clear, however, the current situation is nowhere near the equal of that epic turmoil.
Otherwise, the oil price drop is mostly good news for much of the world because it reduces costs for consumers and businesses. Here in the U.S., falling gasoline prices, for instance, invariably have been presented as the equivalent to a tax cut that should boost consumer spending.
Still, the news isn't as good as it used to be, as the U.S. has steadily increased its own oil production. We've reduced our dependence on imported oil both through expanded domestic production and increased energy efficiency. But the U.S. oil and gas industry added 400,000 jobs since 2003, by one estimate, with many more in transportation, construction and manufacturing due to the oil boom. So the improvement for our economy from lower prices is less than it used to be.
For other major oil producers around the world, the falling price of oil creates various difficulties. The oil price at which major oil exporters' national budgets break even varies from $125 a barrel for Iran to less than $75 for Kuwait, according to Deutsche Bank.
Iran, along with Russia and Venezuela, which hardly have been U.S. allies, could face significant economic pressures if prices stay near current levels for an extended time. Russia and Iran also are suffering from Western economic sanctions. But the price decline hurts Iraq, which already is struggling to finance its fight against the Islamic State (ISIS).
Under a currently popular scenario, Saudi Arabia isn't unhappy with lower prices because it wants to squeeze Iran and Russia while also putting pressure on shale oil producers in the U.S.
However, Saudi Arabia, the dominant producer in the Organization of the Petroleum Exporting Countries (OPEC), also may not want to be solely responsible for production cutbacks to support prices. And if longer-term pressures on demand occur, Saudi Arabia is best equipped to boost market share at the expense of other producers,
Despite the evident current fundamentals of slow global growth and excessive oil supplies, we caution against assuming that prices will stay weak indefinitely. For one thing, Iraq and Libya both face the risk of instability and turmoil that could shut down their oil fields. Then there are the speculators. What goes down can go up, too.
This article originally appeared in the Mind Over Markets column. Never miss an issue. Sign up to receive Mind Over Markets by email.
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