An editorial in the Financial Times notes the similarity between the volatility in traditional financial markets documented by economist Hyman Minsky and the new volatility in the oil market:
“A period of stability leads to rising investment, financed by borrowing, which drives up asset prices until cash flows generated by those assets can no longer support the debt taken on to buy them. Eventually there is what has been dubbed the “Minsky moment”: a dash for the exits as asset prices plunge. After the bubble bursts, the debt burden remains and can depress activity for a long time.”
This is not new. Industry insiders refer to the process as the “choke chain” – the point where supply exceeds demand and prices fall… bringing investors back down to earth. What makes this time different is the “financialisation” of oil – the vast sums invested in high-yield junk bonds that allowed the fracking companies to open up US shale oil. At present, the anticipated $2.5 trillion losses are unlikely to trigger a full-blown global banking collapse. But:
“The threat of further upheavals, including corporate and country defaults could destabilise financial markets.”
Although the editorial’s authors understand the danger of oil price volatility, they are overly optimistic about the potential for demand destruction:
“The US shale revolution has created an important new source of crude that can be financially viable at about $50-$60 a barrel, which should help to keep a lid on prices.”
This was only true in the past. When prices hit $140 per barrel, in a zero interest rate financial climate and at a time when central banks were pumping vast sums into the markets via quantitative easing, it made a perverse sense to invest in fracking. This allowed the more effective companies in the “sweet spots” to bring their break-even price below $50. But the $50-$60 a barrel break-even price does not translate across the industry. And at much more than $60 per barrel, consumers stop using oil in the quantities needed to maintain demand.
Looking forward, the difficulty is that what remains is expensive. Fracking (and tar sands mining and Arctic and deep water drilling) has followed the low-hanging fruit principle in which the cheapest sources have been drilled first. When global oil prices rise in future, investors are not going to jump straight back in. They will want to see sustained high prices over months if not years. They will also want to see clear evidence that oil can indeed be produced for less than $50 in order to guarantee a return on investment. This pretty much guarantees that prices will need to get back above $100 before any sustained re-investment will translate into new wells being drilled and fracked. And as we already know to our cost, $100 oil destroys consumption and triggers recession.
What we are actually looking at is what physicist David Korowicz refers to as “oscillation” and systems ecologist Charles A Hall calls the “bumpy plateau” – it is not the cyclical economic pattern observed by Hyman Minsky in which the cycle returns to its starting point and begins again. On the contrary, what we are witnessing is the transition from a cheap and abundant, to an expensive and scarce energy environment. The apparent goldilocks zone of $40-$60 oil where consumers can afford to buy and producers can make a profit is disappearing. In future, the price at which investors will put their money into new production will rise above $60 (most likely above $100) while the price at which consumer demand falls away will shift below $40.
The precise impact on the wider economy is unclear. And it is doubtful whether the treatment prescribed by the editorial could be accomplished in time:
“The long-term solution to oil price volatility is curbing demand by improving fuel efficiency and shifting to electric vehicles; measures that can have environmental benefits for local pollution and climate change as well as building economic resilience. It is important not to slacken up on developing those technologies just because fuel is now cheap.”
The more realistic proposition is simply that ever fewer of us are going to be driving in future.