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The Oil price is heading for a sharp fall

By David Scott | Monday 20 March 2017


 


High market prices are currently being supported by OPEC cutbacks, and these higher profits are funding the growth of American drilling. American oil explorers who survived the worst of the 2014-2016 market sell off are dismissive of the 14 percent slide in prices this year from a high of $55.24 to around $48 a barrel. The price would have to drop to the $30s or lower to dent the bottom line of many drillers now working U.S. shale fields, according to Katherine Richard, the CEO of Warwick Energy Investment Group, which own stakes in more than 5,000 oil and natural gas wells.

A number of producers have already locked in future returns with financial contracts that guarantee the price of their oil for most of the rest of the decade. Such resilience poses a big dilemma for countries that agreed to an OPEC-led production cut aimed at tightening supplies to raise prices and relieve their distressed national economies. Oil prices took another hit on Tuesday after Saudi Arabia dropped a bomb shell on fellow members of the Organization of Petroleum Exporting Countries.

The Saudis, heavyweight of the 13-nation cartel, raised its output last month to more than 10 million barrels a day, reversing about a third of the cuts it made the previous month. Though Saudi Arabia is still meeting its commitment even with the increase, other members are way off hitting agreed quotas  and the disclosure intensified concern that the group won’t be able to meet the promised cuts to strengthen the market. History shows that OPEC members’ normal cheat and the quota break down.
 
The Bank of England has paired up with artificial intelligence and blockchain specialists in a bid to keep up to date with the fast-growing financial technology sector. The central bank is testing an artificial intelligence system with Canadian start up Mind Bridge AI to allow it to spot abnormalities in financial transactions and "explore the benefit of machine learning technology for analysing the quality of regulatory data input."  It has also partnered with San Francisco-based start-up Ripple, which opened an office in London last year, to trial a blockchain-based technology that would make cross-border payments and the movement of currencies more immediate.

Blockchain is the technology which underpins crypto-currencies like bitcoin. The Bank said that its aim with Ripple is to "show how this kind of synchronisation might lower settlement risk and improve the speed and efficiency of cross-border payments." Over the weekend Bitcoin in china suffered a major setback as Chinese regulators circulated new guidelines that, if enacted, would require exchanges of Bitcoin to verify the identity of clients and adhere to banking regulations. The draft states that Chinese bitcoin exchanges would be subject to current banking and anti-money-laundering laws and be required to collect detailed information about customers.

If implemented, it would require exchanges to install systems for collecting and reporting suspicious trading activity to authorities; China’s central bank would be in charge of handling violations by the exchanges. Chinese investors have fled the market since authorities started scrutinizing bitcoin trading prompting exchanges some to install trading fees and, in some cases, to suspend withdrawal of bitcoin from their platforms. The central bank opened up investigations in January at the country’s three largest bitcoin exchanges, Huobi, OkCoin and BTCC, and delivered a stern warning last month that bitcoin platforms risk being shut down if they disobey rules on money laundering and foreign exchange.
 
Donald Trump's first budget draft revealed in the week does nothing to contain the spiralling costs of middle class entitlements and pensions that threats the United States solvency. Nor does it tackle America's productivity crisis. The document sent to Congress ring-fences Medicare, Social Security, and the giant programmes that make up $2.5 trillion of mandatory spending, and it raises defence spending by $54bn or 10pc. The Congressional Budget Office estimates that such policies will drive the budget deficit to $1 trillion in quick time, and to 5pc of GDP on a structural basis by the mid-2020s even if all goes well. Trump has forecast growth of 3pc or 4pc, but Other than a quick sugar rush his plan would leave the US economy mired in stagnation with long-term probably sliding from 1.5pc to nearer 1pc.

The deep cuts are entirely concentrated on the remaining sixth of the US federal budget. Science, research, the environment, diplomacy, rural support, the arts, and programs for the poor will bear the brunt of cuts. Infrastructure spending will also be hit badly. The plan entitled "America First: A Budget Blueprint to Make America Great Again" would cut the transportation department by 14pc, including the TIGER programme for roads, rail, bridges, and ports. A proposal to overhaul the U.S. tax code that favours exports over imports could have spill over effects to other economies as it would strengthen the dollar, International Monetary Fund chief economist Maurice Obstfeld said last Monday. “There are significant spill-over effects that we are looking into," Obstfeld said, adding that G20 finance ministers and central bankers will discuss the issue later this week at their meeting in Baden-Baden, Germany. “It’s a legitimate topic for discussion... It'll be discussed. There will be a lot of questions among the finance ministers," said Obstfeld, adding that a proposed border adjustment tax could impact other economies via the currency exchange rate channel. Emerging economies like Saudi Arabia would be most affected. 

Asked about the European Central Bank's ultra-loose monetary policy, which some conservative policymakers want the ECB to unwind, Obstfeld said the bank was doing a good job and the IMF was not advocating a premature tapering. He also said the divorce negotiations between Britain and the European Union should aim for a deal as soon as possible to avoid uncertainty.
 
Governments must push through more fundamental reforms to boost growth, cut inequality and protect workers from rapid changes in technology if they are to win back the trust of voters, the west’s leading economic think-tank has warned. The Organisation for Economic Cooperation and Development says stagnating living standards in many countries have left people disenchanted and unwilling to support more changes by their governments in areas such as jobs markets. In its annual check on the pace of such reforms, the OECD says progress has slowed over the past five years and it warns governments to change tack or risk another protracted period of sluggish economic growth and damaging inequality. For the UK, the OECD recommends greater spending on education and training to raise skills and boost productivity, which would in turn help raise wages. Better housing supply would improve labour mobility and reduce skill mismatches, resulting in additional income gains, it added. 

Thanks to a pickup in global oil prices, the annual inflation rate in the developed world jumped to 2.3 percent in January 2017, the highest rate since April 2012, according to a recent report from the Organisation for Economic Co-operation and Development, a Paris-based think tank. Rising prices often accompany faster economic growth. But that's not happening, according to the group's latest global economic outlook. Although inflation is picking up, the global economy will remain stuck in low gear through next year, according to the OECD's forecast. U.S. GDP growth is expected to hit just 2.8 percent in 2018, down from a November estimate of 3 percent, according to the report.
 
On three separate occasions since 2013 the US Federal Reserve sent shock waves through the global financial system when it tried to tighten monetary policy, and each time it was forced into partial retreat to stop the global chaos. The Fed has now come to terms with its unwelcome role as the world's central bank, a monetary superpower that cannot set liquidity conditions for the US only. The international rebound into the US economy from any mistake is instant and brutal. Over recent months the Federal Open Market Committee has been careful to take the global Picture into consideration this week’s quarter point rise in the federal funds rate to 1pc has been so signalled in advance that investors have already adjusted. But nobody really knows whether the world can handle a total of six rate rises over the course of 2017 and 2018 as outlined in the Fed's 'dot plots' scenario of the future. One big worrying of certainty is that the post-War world has never been so leveraged to the dollar or so sensitive to US borrowing costs.

Offshore dollar debt in US currency has risen fivefold to $10 trillion since 2002. This is the consequence of globalisation and the Fed's policies of zero rates and QE, which has unleashed a flood of cheap and seducing dollar liquidity into emerging markets and lured them into the West's debt experimental gamble. According to Analysis from Bank for International Settlements this leverage is an accident waiting to happen and it suggests that the potential trigger is a strong dollar, which automatically causes a contraction of bank balance sheets through the structure of hedging contracts.

They were the only super national body to warn about 2007.What is striking about this rate rise is that the US economy itself appears to be slowing a good historical gauge is The Atlanta Fed's instant GDP tracker which has abruptly dropped to an annual growth rate of 0.9pc for the first quarter.  The Fed certainly fears falling behind the curve on inflation and having to slam on the brakes later. Interest rates should already be 3.9pc under the Taylor Rule. Core PCE inflation in the US is up to 1.7pc, although it has been a gradual rise. The Shiller CAPE price earnings ratio on Wall Street is 28.66, higher than at any time in 130 years other than the extreme peaks of 1929 and 2000.“The market is way over-priced,” says the creator of the cape Schiller index, Nobel laureate Robert Shiller. It is discounting fiscal stimulus and radical tax reform by the Trump administration before a deal is has been agreed, never a good thing.
 
Economic retrenchment and radical change is a process, not a singular moment in time. This lengthy process lulls the masses into complacency as they are waiting for a cinematic moment of revelation, a financial explosion, when really, the whole disaster is happening in slow motion right under their noses. Economic monetary systems do not implode, they drown as the water rises one inch at a time. For the global economy in this instance excess debt is the drowning and relentless agent.

David Scott works for investment Manager Andrews Gwynne


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