Owners of all these resources are right now experiencing a severely negative wealth effect. They are changing their behavior, and the resulting trends are not good for you if your own wealth depends on their continued spending and investing.
We can’t put an exact number on this perceived wealth loss, but it is certainly in the tens of trillions – equivalent to a massive, worldwide bear market in stocks. Yet it is happening beneath the radar, almost unnoticed and unremarked.
Drowning in Oil?
Western oil companies and OPEC member states aren’t so worried about oil reserves in the ground; their more immediate headache is too much oil on the surface. Supply far outstrips current demand – which, as we know from Econ 101, yields lower prices. The International Energy Agency said in its January market report that “Unless something changes, the oil market could drown in oversupply.”
Is that really true? Drowning is certainly a poor analogy. Drowning is final: you don’t recover from it. We might be bearish on the oil market, but we haven’t written it down to zero.
The problem is finding the balance between supply and demand. The current situation is primarily a result of higher supplies and only secondarily of demand weakness. The world still burns plenty of oil and will keep doing so for many years.
The higher supply has come largely from US and Canadian shale fields as well as the 2014 Saudis’ decision to maintain production levels. Iran’s forthcoming return to the market will add even more supply.
These factors add up to an interesting group dynamic. All oil producers would benefit if production fell and prices rose – but they would not benefit proportionately unless the production cuts were also proportionate. There is no mechanism or incentive to make it happen that way. Even OPEC, which in theory is a cartel with strict quotas on its members, has no way to enforce its will.
(One thing we know about OPEC members is that they cheat. Always and everywhere, when it is possible, they cheat. Saudi Arabia simply got fed up with being the fall guy. The reasons behind the Saudi strategy are complex, but I am sure an ancillary benefit, from their point of view, is that current Saudi production demonstrates to their fellow OPEC members what noncompliance on quotas will cost them all.)
Add in the further complication that shale oil fields, by their nature, are easy to turn on and off. If your oil costs $40 a barrel to produce and you can sell it for only $35, you can cap your wells and wait for higher prices. But here we hit another problem.