Dallas Federal Reserve CEO Robert Kaplan
The US Federal Reserve warns that the world is flooded with surplus oil and starting to run out of places to store the excess, with no market stability in sight for the oil industry until 2017 at the earliest. Robert Kaplan, head of the Dallas Fed, dispelled rumors of a fresh oil boom this year saying that the US shale industry has taken far longer to cut output than many expected.
“As we sit here today, Dallas Fed economists estimate that global daily oil production exceeds daily consumption by more than 1 million barrels per day,” he told the Official Monetary and Financial Institutions Forum in London.
“Excess inventories in the OECD member countries now stand at approximately 440 million barrels. This is a record level and has raised concerns about whether there is sufficient storage capacity in certain geographic areas,” he said.
Floating storage for crude is skyrocketing, which is a certain sign of troubled times ahead. Meanwhile, oil prices have surged by 80% since touching bottom at $26 in mid-February. West Texas crude reached a five-month high of $46.70 this week.
Speculative long positions on crude oil are at all-time highs on the futures markets, a sign that the rebound has lost touch with established principles. A fleet of oil tankers sits idly by up in the North Sea, while the indications from China show that May deliveries are falling. “We think China has for now stopped filling its strategic petroleum reserve. They have filled up the sites,” said Ian Taylor, President and CEO of Vitol. Commerzbank is subtly warning of impending financial collapse. “We see worrying parallels to 2015, when oil prices rose sharply well into May before collapsing in the second half of the year,” it said.
Mr Kaplan, a former banker at Goldman Sachs, said the oil markets have taken “too much comfort” from talk of a production freeze between the OPEC cartel and Russia. The cold hard truth is that Iran is colluding with them to increase output towards pre-sanctions levels. The Dallas Fed’s team of energy experts is carefully monitored for indications about the future of the shale industry in Texas. Mr Kaplan said the break-even price of oil for US frackers has dropped to $35 to $50, lower than many have been led to believe. He insists that there will be “more bankruptcies” as over-leveraged drillers buy the farm, but still claims this poses no risks to US banking system as a whole. There is no reason to compare this situation to the 2008 financial crisis. “People will lose money but it is not systemic,” he said.
Meanwhile, Mr. Kaplan downplayed the stunning decline of US growth in the first quarter as a temporary blip and issued a stern warning that the Fed must tighten monetary policy ahead of schedule. “The markets may well be underestimating how soon we might move based on what I have seen. You’ll find the economic data in the second quarter may rebound,” he said. Futures contracts are obviously not preparing for a rise in interest rates at the Fed’s next meeting in June. The markets are effectively calling the Fed’s bluff, a dangerous gamble as China is quietly leveraging it’s new reserve currency status and the emerging market worries are actively ignored.
The oil rigs in the US are being stacked again but output has not dropped nearly as much. The Dallas Fed’s in-house indicator of underlying price pressures for the US – trimmed mean 12-month PCE inflation – has broken free from its suppressed range over the last two years and has ticked up to between 1.8% and 1.9%. This needs watching as it could to lead to a spike in inflation. Mr. Kaplan implied that profound changes in the global economical system have demonopolized companies and their power to set prices across a range of industries and sectors. The first step was the integration of China into the world economy: the second step today is technological ‘disruption’ by unseen forces.
Together they seem to have created lasting deflationary headwind that will supposedly the Fed to target a lower unemployment rate than in the past. Even if the Fed tightens hard this year, the message is that rates will probably not return to historic levels for the foreseeable future. It is a brave new world.