Emerging and Frontier Markets: Economic and Geopolitical Analysis

[LeveragedBuyout]

http://online.wsj.com/articles/imf-...it-guinea-liberia-and-sierra-leone-1411755113

IMF Expands Lending for Ebola-Hit Guinea, Liberia and Sierra Leone
Board Approves $130 Million Expansion of Zero-Interest Loans

By IAN TALLEY And MATINA STEVIS

Updated Sept. 26, 2014 4:34 p.m. ET

WASHINGTON—The executive board of the International Monetary Fund on Friday approved a $130 million expansion of zero-interest loans for the three West African nations worst hit by the Ebola crisis.

The new money will help the governments of Guinea, Sierra Leone and Liberia cover an estimated $300 million financing gap as the crisis overwhelms their budgets.

"Unless brought under control, the epidemic will reverse the advances that these countries have made in recent years under Fund-supported programs toward mending their still fragile economies," IMF Managing Director Christine Lagarde said in a statement after the board's approval.

Related

• Obama: Global Leaders Need to Better Prepare for All Kinds of Outbreaks
• Ebola Crisis: Obama Says World Falling Short in Response

• West Africa Risks Economic Disaster from Ebola, World Bank Chief Says

• World Bank Pledges $170 Million to Help West African Nations With Ebola

• Ebola Virus Cases May Hit 1.4 Million by Winter, U.S. Warns

President Obama addressed the United Nations Thursday on the Ebola epidemic, saying "we are not doing enough" and urging all nations and organizations to move faster and contribute more efforts.

The IMF chief echoed calls by PresidentBarack Obama and World Bank President Jim Yong Kim for an urgent,large-scale coordinated aid effort to help the governments contain the outbreak.

The fund's financing will only cover half the estimated financing gap, however. The World Bank has boosted its assistance in recent days, but more support will be needed to fill the remaining hole.

"It's not going to cover all their needs; it's about 40% of their total needs, which is why it's so important that other international institutions, other donors, actually contribute as well," Ms. Lagarde said in a separate video released by the IMF.

Aside from the mounting death toll, the epidemic is also slashing economic growth in the three countries. Fear of contagion has wreaked havoc on agriculture, trade and commerce. The fund estimates the epidemic will cut growth in Sierra Leone to 8% this year from a previous rate of 11.3%. Liberia's growth will more than halve to 2.5%. Guinea will see its prospects fall to 2.4% from a previously expected rate of 3.5%, the fund said.

Those estimates were before the U.S. Centers for Disease Control and Prevention said earlier this week that up to 1.4 million people could be infected by mid-January in Liberia and Sierra Leone.

Despite the serious fallout for the economies of the three countries struck by the epidemic, the impact on the broader region and the whole of sub-Saharan Africa was limited, Antoinette Sayeh, IMF's African department director, said in an interview.

"Provided the outbreak is contained as hoped ... the baseline outlook we have for sub-Saharan Africa remains very favorable," Ms. Sayeh said.

Neighboring countries, especially Gambia and Senegal, have taken a hit to tourism because of cancellations driven by the virus, she said. Transport hubs like Kenya and Ghana were also affected.

"If it takes longer to contain, or even potentially spreads, then we're in a different world," Ms. Sayeh added.

As international organizations and donors rush to meet immediate needs, Ms. Sayeh said they also need to focus on the medium- and longer-term economic impact of the epidemic.

For example, there could be a deeper loss for these economies through cancellations of infrastructure investments like in new mining enterprises in Liberia, she said.

 

[Aepsilons]

For example, there could be a deeper loss for these economies through cancellations of infrastructure investments like in new mining enterprises in Liberia, she said.

WASHINGTON—The executive board of the International Monetary Fund on Friday approved a $130 million expansion of zero-interest loans for the three West African nations worst hit by the Ebola crisis.

The new money will help the governments of Guinea, Sierra Leone and Liberia cover an estimated $300 million financing gap as the crisis overwhelms their budgets.

This is a much awaited blessing for the hard hit areas of Liberia. Was just reading news yesterday that int he capital of Monrovia, the major hospital system there has been closed due to ebola. There is, literally, no established national health system for the country. Besides the intervention of international health groups.

I do worry for the health and safety of international health workers. Sir @LeveragedBuyout , did you hear about those 8 health workers in Liberia who were butchered by villagers , believing that the health workers were instigating the problem ?

 

[LeveragedBuyout]

This is a much awaited blessing for the hard hit areas of Liberia. Was just reading news yesterday that int he capital of Monrovia, the major hospital system there has been closed due to ebola. There is, literally, no established national health system for the country. Besides the intervention of international health groups.

I do worry for the health and safety of international health workers. Sir @LeveragedBuyout , did you hear about those 8 health workers in Liberia who were butchered by villagers , believing that the health workers were instigating the problem ?

While I admire the desire to help, the previous article I posted about how Africa is now in a position to steer its own development is probably the answer to this. Africa has been plagued by some backwards ideas that outsiders will not be able to fix. I remember the revulsion that overcame me when I read how African men believed that they would be cured of AIDS if they raped virgins. Or when that thug Jacob Zuma said that he won't get AIDS because he showers after sex.

As the old saying goes, you can't fix stupid. In this case, it would be more precise to say that we can't fix stupid, but they possibly can, because leadership from Africa has the legitimacy to implement solutions for Africa. As long as Africa has its hand out for aid (not to pun), foreigners will never have legitimacy with the system, and Africa will never learn how to build strong institutions that will prevent the sorts of atrocities you describe, let alone educating the population about modern science.

China is doing the right thing in Africa by building infrastructure, even if it is for ulterior motives. The best thing the West can do (again, as referenced in the previous article, but also by scholars such as William Easterly) is open our markets to trade, so Africa can develop itself.

 

[LeveragedBuyout]

http://blogs.ft.com/beyond-brics/2014/09/30/capital-economics-ems-bad-latam-the-worst/

Capital Economics: EMs bad, LatAm the worst
Sep 30, 2014 5:32pmby Jonathan Wheatley

A double dose of gloom from Capital Economics on Tuesday. Its proprietary EM GDP tracker – compiled from monthly data on output and spending as an advance proxy for GDP – shows growth slowing across emerging markets to its slowest pace since early last year. A separate report shows that while EM assets have suffered across the board this month, the pain has been particularly severe in Latin America and especially in Brazil.

First, here are the charts from the GDP tracker. They show growth across EMs slowing to 4.3 per cent year on year in July, down from 4.5 per cent in June. Capital says preliminary data for August suggest growth will be even slower, at 4.1 per cent.


Source: Capital Economics. Click to enlarge

Among the weakest performers are Russia and Turkey, dragging down growth in emerging Europe. Latin America has suffered too, with trouble for the mining economies of Chile and Peru, Capital notes, “while there are few signs that Brazil’s economy will exit recession in Q3″.

But Capital is more worried about Asia:

However, the most worrying aspect of the latest data is arguably that parts of Asia, which up until now had appeared relatively resilient, are now showing signs of slowing. (See Chart 4.) Admittedly, we wouldn’t read too much into one data point, but if sustained over the coming months this would be a severe blow to hopes of a more sustained pick-up in EM GDP growth. All of this supports our forecasts, which in general remain towards the bottom end of the consensus range for most EMs.​

There is more on Latin America in a separate report looking at the EM sell-off this month. As suggested above, falling commodity prices have been bad for many economies in the region while Brazil has suffered in “fading optimism that this weekend’s election might deliver much-needed reforms”.


Source: Capital Economics. Click to enlarge

As the charts show, while currencies in Argentina and Chile have suffered most year to data, Brazil’s real is the biggest loser this month. Brazil’s equities, too, have been leading the sell-off.

Capital ascribes part of the sell-off to worries over the approach of tighter monetary policy in the US and the rest to, again, falling commodity prices and Brazil’s election.

Its conclusion:

Looking ahead, we see scope for equity markets to rebound over the next year or so, not least because valuations are no longer as stretched as they once were. However, while the outlook for equities may brighten, we expect most currencies to weaken a little further from here. Indeed, in light of recent falls we have revised down our end-2015 forecast for the Brazilian real (from 2.50/$ to 2.60/$) and the Chilean peso (from 575/$ to 610/$).
​

 

[Aepsilons]

Looking ahead, we see scope for equity markets to rebound over the next year or so, not least because valuations are no longer as stretched as they once were. However, while the outlook for equities may brighten, we expect most currencies to weaken a little further from here. Indeed, in light of recent falls we have revised down our end-2015 forecast for the Brazilian real (from 2.50/$ to 2.60/$) and the Chilean peso (from 575/$ to 610/$).

This is an excellent read @LeveragedBuyout , one thing that I find awing is the volatility in capital markets. One thing that I notice , in trends, is that there is a drop in the market that may be a major cause of volatility. Can you enlighten us on some leverage reasons that may cause these drops in the market? And lastly, is it safe to assume that drops in the market will eventually lead to an increase in volatility ? Is it safe to assume that it is a cyclic process ? Thanks, Sir.

 

[LeveragedBuyout]

@Nihonjin1051 Happy to answer your question, but it may be several hours before I can respond, as I would like to write something more than a couple of sentences about it, and I have a business dinner tonight.

http://blogs.ft.com/beyond-brics/2014/09/30/serbias-pm-promises-austerity-but-cuts-are-limited/

Serbia’s PM promises austerity but cuts are limited
Sep 30, 2014 11:35amby Andrew MacDowall

Serbia’s prime minister has criticised his country’s culture of state handouts and its bloated public sector, vowing to create an economy of opportunity rather than one dominated by “charmed individuals”.

Aleksandar Vucic, a former ultra-nationalist elected in a landslide election victory in March, spoke to beyondbrics after announcing cuts in public sector salaries and pensions.

The measures were part of a “painful but necessary” austerity package that is a “long-overdue step towards a more modern Serbia,” Vucic said. Public sector salaries of more than 25,000 dinars a month ($268) would be cut by 10 to 10.5 per cent, while pensions over the same level would be cut by 3.1 to 10 per cent on a sliding scale.

That may sound draconian but the cuts are limited and temporary and may not reassure markets. Serbia’s budget deficit is the biggest in Europe at a forecast 8.4 per cent of GDP for 2014. Its debt has soared to nearly 70 per cent of GDP, well beyond a theoretical legal limit of 45 per cent.

“This plan for managed austerity will lay the foundations of a better, more efficient and more modern economy,” Vucic told beyondbrics. “We know the cuts will be painful but they are necessary if we are to create the foundations of a truly stable and healthy Serbian economy in the wake of troubled times and wasteful spending decisions taken in the past.”

The cuts come as Serbia faces a third year of recession since 2009 this year, thanks in part to disastrous flooding that choked off an economic revival. But their blow will be softened. The public sector wage cuts will be offset by the end of a ‘solidarity tax’ and pensioners will benefit from a ‘fairness package’ that includes free medicine, free travel on state railways and free telephone calls on landlines owned by state-run Srbija Telekom. The cuts will be phased in over three years and are less extensive than those proposed by Serbia’s own Fiscal Council; they will be reversed earlier if the fiscal situation allows.

“We are not looking for the easy way out but we have to be realistic about not cutting too drastically, too fast, which might damage the economic recovery,” Vucic said. “We also have a responsibility to protect some of the most vulnerable groups.”

Serbia spends 11 per cent of GDP on public-sector wages and 14 per cent on pensions, according to Bloomberg, so reducing both is an obvious way to reduce the fiscal burden. But critics have questioned whether even the steely Vucic has the determination to see through the reforms that Serbia needs, given the power of patronage created by state employment and the difficulty of imposing radical change on a society in which many still look back on the Communist period with nostalgia.

But Vucic insists that his reforms, which include changes to laws on labour, bankruptcy and privatisation, can transform the country. Some 500 state companies have been earmarked for privatisation and the government is touting them around the world, including in China. Few are thought to be economically viable in their current state.

“Our responsibility is to create a modern economy in Serbia, based on industry and business – not handouts from the state or a bloated public sector,” Vucic said. “Austerity is a much-needed and long-overdue step towards a more modern Serbia. We are creating conditions for competition and the market. We want young people to have an opportunity to find a job, for people to be able to work, instead of having a number of charmed individuals while nobody else is able to get their chance.”

Vucic’s reforms are likely to cause job losses, as he warned during his election campaign. He told beyondbrics the government was reviewing the administration of the public sector and state enterprises “to create efficiency savings and reduce the number of public sector and state enterprise employees”.

“The savings from this will be redirected to provide a further boost to the private sector, stimulating enterprise and job creation,” he said.

Serbia certainly has potential as an investment destination, given its location, favourable trade ties both with the EU and (for the time being) with Russia, its low cost of skilled labour and government support for export-oriented industry in particular. Patchy infrastructure, red tape, corruption and a shaky judicial system weigh on the other side.

As Vucic says, a long-awaited deal with the IMF would also help. The Fund suspended its last standby arrangement with Serbia in 2012 due to the country’s fiscal laxity. A new package would be “like a belt around the belly of someone who likes to eat too much”, in the words of Milan Parivodic, a former minister of economic portfolios who now advises investors.

“We will be in negotiations with the IMF in November 2014 and the timeframe is to be discussed,” Vucic said. “The IMF deal will have more impact on foreign investment, as it will provide security for our macro-economic financial plan.”

The Fund would probably demand deeper and longer-lasting cuts than those currently being implemented but it could provide Vucic with useful political cover for the next stage of reforms.

Vucic has played this game before. His repeated claims over the past year that Serbia was on the verge of bankruptcy were widely seen as an attempt to prime the electorate for reform and spending cuts. Now those cuts have been revealed as less brutal than expected and reform laws have been passed, he has changed tack to emphasising the progress made by his administration.

“Serbia is a thousand miles away from bankruptcy,” he said, adding that the measures on bankruptcy, labour law and privatisation “have boosted our position on international financial markets”.

Whether this is so may be tested soon, as Serbia is reportedly eyeing a bond issue in the wake of the pension and wage cuts. Investors have been hoovering up central and eastern European issues this year but yields are expected to trend upwards as the US Federal Reserve moves towards tighter monetary policy and economies across the region cool in the second half.

Hypo Alpe Adria, a regional bank, wrote in a note:

The very recent movement of Serbian spreads is a sign enough that it would take a lot more to convince the markets about the government’s consolidation intentions. We think that the announced 10-10.5 per cent public wage cuts (which merely replace the solidarity tax) and 3.1-10.0 per cent pension cuts would not be enough to reach the targeted consolidation, and the newest measures should be accompanied by a 2pp VAT hike. The future about the IMF support is also uncertain.​

Juraj Kotian, of CEE macro research at Erste Group Bank, said Vucic’s reforms were welcome but only the start of a difficult programme to repair the economy.

“The Serbian economy definitely needs strong fiscal steps, both quantitatively and qualitatively,” he told beyondbrics. “The budget deficit is too large and structural reforms are needed to increase productivity and reshape the public sector. The labour law and the bankruptcy law were necessary first steps. If the spending side of the budget can be streamlined and better targeted, that can improve the efficiency of the state sector, and can make more room for the private economy. Nonetheless, this is easier said than done. Such steps are usually not well received by former beneficiaries. In addition, the fiscal hole is not negligible to say the least, which increases the difficulty of the task. The path ahead will likely be very narrow between political priorities and the need to reform the economy.”

 

[LeveragedBuyout]

Can Election Put Brazil Back on Path to Fast Growth? - Real Time Economics - WSJ

• 

• September 30, 2014, 7:00 AM ET

Can Election Put Brazil Back on Path to Fast Growth?
ByPaulo Trevisani
Brazilians face many options in the Oct. 5 vote, but for economists and investors the options are clear: It is reform or die.

Some economists say that even if incumbent President Dilma Rousseff is re-elected, she will be forced to undertake reforms to keep the economy from cratering.
Agence France-Presse/Getty Images
Latin America’s largest economy has weakened in the past four years and now growth is near zero, inflation is high and business confidence is depressed. Central-bank interventions keep the currency from a free fall.

But with unemployment low and many voters satisfied with greatly expanded welfare programs, incumbent President Dilma Rousseff may well end up getting a second term.

Still, some economists say that even if re-elected, she will be forced to undertake some reforms to keep the economy from cratering. Most believe reforms are more likely if Socialist Party candidate Marina Silva, who is in a statistical tie with Ms. Rousseff in the polls, wins the vote.

Some are already doing the math.

“If all remains as it is, Brazil will grow around 2% a year until 2018, while if adjustments are made growth will suffer substantially in the first two years and then jump to 4%,” said Marcos Casarin, from London-based economic consultancy firm Oxford Economics. He said the estimates result from a model that uses economic proposals made by the candidates.

Ms. Rousseff has so far defended her policies, saying that they protected jobs and have lifted millions from poverty. Ms. Silva has pledged to be more conservative.

Socialist Party candidate Marina Silva, who is in a statistical tie with Ms. Rousseff, has pledged to be more conservative.
Agence France-Presse/Getty Images
At stake is where Brazil can resume the fast growth that made it an investor darling in the last decade.

Buoyed by a global commodities boom, Brazil adhered to fiscal discipline in the early 2000s as the economy stabilized after a sovereign-debt default in 1987 and more than a decade of hyperinflation. In 2008, Brazil’s debt got an investment grade for the first time in history.

Brazil got investor love by systematically posting a primary surplus – or government savings before interest payments – equal to around 3% of gross domestic product for several years.

It all changed in the aftermath of the global financial crisis, when Brazil put fiscal discipline on hold to avoid falling prey to the recession that grabbed the U.S., Europe and others. Mammoth state-controlled banks opened the credit spigot and a massive affordable-housing program was launched, among other measures. It worked, but even after the global crisis thinned out, Brazil never managed to roll back those so-called “counter-cyclical measures.”

The country is now struggling to reach a 1.9% of GDP primary surplus target. Meanwhile, the government’s gross debt in July equaled 59% of GDP, up from 52% in July 2008, according to central bank data.

If policies don’t change, the ratio will reach 70% of GDP by 2018, by Mr. Casarin’s math, leading to financial disaster. With debt payments consuming around 8% of GDP, “Brazil would have to get help from the IMF,” he said.

Reflecting those concerns, Brazilian markets have swung with electoral polls. Stocks fall when voter surveys show Ms. Rousseff gaining ground. It’s the reverse when Ms. Silva’s numbers improve.

Even if Ms. Rousseff, after a possible re-election, pushes for policy changes, investors could be nerve-wracked.

“Guessing where the new normal would be is difficult,” said Daniel Freifeld, founder of Callaway Management, an investment firm focused on emerging markets.

 

[LeveragedBuyout]

This is an excellent read @LeveragedBuyout , one thing that I find awing is the volatility in capital markets. One thing that I notice , in trends, is that there is a drop in the market that may be a major cause of volatility. Can you enlighten us on some leverage reasons that may cause these drops in the market? And lastly, is it safe to assume that drops in the market will eventually lead to an increase in volatility ? Is it safe to assume that it is a cyclic process ? Thanks, Sir.

@Nihonjin1051 I changed my mind, looking at my schedule, it's better to get this done now. NB I am not a professional trader (different department, so to speak), so I am approaching this from a non-professional perspective, and perhaps @Peter C might be a better source of more technical information if you're interested (or he can correct mistakes I make below). I will speak simplistically here, as it's fairly easy to find technical details through Google if you want to get heavier on the math, the regulatory requirements (e.g. the specific levels of maintenance margin for various instruments), what credit analysts look at to determine creditworthiness (e.g. debt coverage ratios, debt to total enterprise value, etc.), or other details.

First, we need to define volatility. There are two common ways of defining volatility: one is the simple mathematical calculation of the standard deviation in price changes over a defined period of time (historical volatility), and the second is the volatility index, referred to as VIX for the S&P 500-related measure, but also exists for each that is optionable (implied volatility). VIX is a bit more complicated, since its value is derived from options pricing, specifically using a formula to derive expected volatility by averaging the weighted prices of out-of-the-money puts and calls. Again, I'm not sure if you're familiar with options, but the short and simple version is that options are the right to buy or sell an instrument at specific price (called a strike price) within a certain time frame. This "right to buy or sell" can itself be priced based on how far the underlying instrument is trading from the strike price, how much time is left in the contract, how volatile the underlying instrument is, and a few other factors.

The first definition of volatility dictates that when the standard deviation of price changes increases, volatility by definition is increased. For example, if a stock moves by 1% a day for a while, and then all of a sudden moves by 3% a day (up or down), it can be said that its volatility has increased. This could be due to stock-specific reasons (i.e. news, thin trading volume in the stock, etc.) or could be due to general market conditions (everyone is looking to dump stocks, any stocks, because of poor market conditions).

The second definition of volatility is a function of trading activity in the options, as I described. For this reason, if we talk about VIX when describing volatility, then volatility doesn't necessarily increase when the market drops, because the players trading the stocks may have expectations that the market will rebound, and thus do not bid up the price of puts. On the other hand, VIX can also rise when the market is rising, if the players involved are heavily buying puts (and thus bidding up the price) to hedge their positions. If you want the mathematical details, please see the CBOE site's primer on the VIX (CBOE Futures Exchange -  Education ). That said, VIX does tend to spike in response to "fear" in the market (the market drops, traders buy puts to protect themselves), and it tends to subside in bull markets.

OK, that intro out of the way, how is leverage involved? First, options themselves are leverage. To steal from Investopedia:

"Leverage can be created through options, futures, margin and other financial instruments. For example, say you have $1,000 to invest. This amount could be invested in 10 shares of Microsoft stock, but to increase leverage, you could invest the $1,000 in five options contracts. You would then control 500 shares instead of just 10." Futures instruments are also a form of leverage, where a smaller amount of required cash in the account (called maintenance margin) can control an instrument worth multiples of the maintenance margin.

The second form of leverage is margin debt, where traders borrow money to invest in instruments. For retail traders, if you have $100,000 to invest, you can borrow another $100,000 from your broker, and trade with $200,000. Of course, if the value of your investment declines too much, you will get a "margin call," where the broker asks for an immediate cash injection to maintain your position, or otherwise the broker will forcibly liquidate your position to reclaim the cash it lent to you. You can see how in a market that moves against your position, this can lead to a cascade effect. For example, if you are long a stock, and the stock declines, you may get a margin call, and be forced to sell your stock, which causes the stock to decline further. Writ large across multiple players, you can see how this could quickly effect the broad market. Events can cause sharp changes in the market (e.g. the failure of Lehman Brothers, the announcement of QEx, etc.) which can catch people out on the wrong side of a trade, and as they scramble to close their positions, it causes volatility to increase.

The third form of leverage is corporate debt. Corporations borrow money from banks and sell bonds to investors in order to raise money to fund their operations, and occasionally, in order to pay out dividends to shareholders. Debt isn't free, and requires cash flow to cover the interest payments, and sufficient cash to pay off the principal when the debt is due (or roll over the debt into a new bond). When the economy is doing well, debt is cheap, and cash flow tends to be strong, so corporations can easily pay the interest. When the economy starts doing poorly, capital becomes more scarce, and the cost of debt (i.e. interest) rises, and cash flow weakens, so the interest on the debt is harder to pay. When companies get into trouble, they default on their debt, which causes losses to investors, who in turn may be forced to sell other instruments to raise enough cash to maintain their own capital requirements--so you can see the cascade effect there, as well. Of course, this cascade of debt defaults also strangles the real economy, as investors demand higher interest rates precisely when companies need capital the most. Since the debt markets generally follow the business cycle, corporate leverage also rises and falls on a cyclical basis.

Sorry, out of time, I have to end it here. Hopefully that gets you started for further research, if you are interested.

 

[Aepsilons]

@Nihonjin1051 I changed my mind, looking at my schedule, it's better to get this done now. NB I am not a professional trader (different department, so to speak), so I am approaching this from a non-professional perspective, and perhaps @Peter C might be a better source of more technical information if you're interested (or he can correct mistakes I make below). I will speak simplistically here, as it's fairly easy to find technical details through Google if you want to get heavier on the math, the regulatory requirements (e.g. the specific levels of maintenance margin for various instruments), what credit analysts look at to determine creditworthiness (e.g. debt coverage ratios, debt to total enterprise value, etc.), or other details.

First, we need to define volatility. There are two common ways of defining volatility: one is the simple mathematical calculation of the standard deviation in price changes over a defined period of time (historical volatility), and the second is the volatility index, referred to as VIX for the S&P 500-related measure, but also exists for each that is optionable (implied volatility). VIX is a bit more complicated, since its value is derived from options pricing, specifically using a formula to derive expected volatility by averaging the weighted prices of out-of-the-money puts and calls. Again, I'm not sure if you're familiar with options, but the short and simple version is that options are the right to buy or sell an instrument at specific price (called a strike price) within a certain time frame. This "right to buy or sell" can itself be priced based on how far the underlying instrument is trading from the strike price, how much time is left in the contract, how volatile the underlying instrument is, and a few other factors.

The first definition of volatility dictates that when the standard deviation of price changes increases, volatility by definition is increased. For example, if a stock moves by 1% a day for a while, and then all of a sudden moves by 3% a day (up or down), it can be said that its volatility has increased. This could be due to stock-specific reasons (i.e. news, thin trading volume in the stock, etc.) or could be due to general market conditions (everyone is looking to dump stocks, any stocks, because of poor market conditions).

The second definition of volatility is a function of trading activity in the options, as I described. For this reason, if we talk about VIX when describing volatility, then volatility doesn't necessarily increase when the market drops, because the players trading the stocks may have expectations that the market will rebound, and thus do not bid up the price of puts. On the other hand, VIX can also rise when the market is rising, if the players involved are heavily buying puts (and thus bidding up the price) to hedge their positions. If you want the mathematical details, please see the CBOE site's primer on the VIX (CBOE Futures Exchange - Education ). That said, VIX does tend to spike in response to "fear" in the market (the market drops, traders buy puts to protect themselves), and it tends to subside in bull markets.

OK, that intro out of the way, how is leverage involved? First, options themselves are leverage. To steal from Investopedia:

"Leverage can be created through options, futures, margin and other financial instruments. For example, say you have $1,000 to invest. This amount could be invested in 10 shares of Microsoft stock, but to increase leverage, you could invest the $1,000 in five options contracts. You would then control 500 shares instead of just 10." Futures instruments are also a form of leverage, where a smaller amount of required cash in the account (called maintenance margin) can control an instrument worth multiples of the maintenance margin.

The second form of leverage is margin debt, where traders borrow money to invest in instruments. For retail traders, if you have $100,000 to invest, you can borrow another $100,000 from your broker, and trade with $200,000. Of course, if the value of your investment declines too much, you will get a "margin call," where the broker asks for an immediate cash injection to maintain your position, or otherwise the broker will forcibly liquidate your position to reclaim the cash it lent to you. You can see how in a market that moves against your position, this can lead to a cascade effect. For example, if you are long a stock, and the stock declines, you may get a margin call, and be forced to sell your stock, which causes the stock to decline further. Writ large across multiple players, you can see how this could quickly effect the broad market. Events can cause sharp changes in the market (e.g. the failure of Lehman Brothers, the announcement of QEx, etc.) which can catch people out on the wrong side of a trade, and as they scramble to close their positions, it causes volatility to increase.

The third form of leverage is corporate debt. Corporations borrow money from banks and sell bonds to investors in order to raise money to fund their operations, and occasionally, in order to pay out dividends to shareholders. Debt isn't free, and requires cash flow to cover the interest payments, and sufficient cash to pay off the principal when the debt is due (or roll over the debt into a new bond). When the economy is doing well, debt is cheap, and cash flow tends to be strong, so corporations can easily pay the interest. When the economy starts doing poorly, capital becomes more scarce, and the cost of debt (i.e. interest) rises, and cash flow weakens, so the interest on the debt is harder to pay. When companies get into trouble, they default on their debt, which causes losses to investors, who in turn may be forced to sell other instruments to raise enough cash to maintain their own capital requirements--so you can see the cascade effect there, as well. Of course, this cascade of debt defaults also strangles the real economy, as investors demand higher interest rates precisely when companies need capital the most. Since the debt markets generally follow the business cycle, corporate leverage also rises and falls on a cyclical basis.

Sorry, out of time, I have to end it here. Hopefully that gets you started for further research, if you are interested.

Thank you for that well written and very informative answer, Sir @LeveragedBuyout ! You covered all areas that I was a bit blurry on. Again, Thank You.

 

[LeveragedBuyout]

Middle East & North Africa See Deepest Cuts in IMF Growth Forecast - Frontier Markets News - Emerging & Growth Markets - WSJ

• 

• October 7, 2014, 4:42 PM ET

Middle East & North Africa See Deepest Cuts in IMF Growth Forecast
ByAsa Fitch

Note: Data for some countries are based on fiscal years. 1Movements in consumer prices are shown as annual averages. 2Percent of GDP. 3Percent. 4Includes Bahrain, Libya, Oman, and Yemen. 5Includes Djibouti and Mauritania. Excludes Syria because of the uncertain political situation.
IMF
The International Monetary Fund has revised its 2015 economic growth projection downward for the Middle East and North Africa by a greater margin than any other country or region in the world in its latest economic outlook, reflecting expectations of a fragile global recovery and ongoing regional political instability.

The IMF on Tuesday lowered its projections for global growth this year and next year, painting a picture of a slower-than-anticipated recovery in advanced economies coupled with emerging markets that are expected to struggle because of lackluster demand and lower world trade growth.

Globally, the IMF said growth this year will be 3.3%, a downward revision from a July estimate of 3.4%.

In the Middle East and North Africa, where conflict and political instability have raged in Iraq, Syria, Libya and Yemen this year, the IMF is forecasting 2.6% growth in 2014 followed by 3.8% growth next year. The 2015 growth figure is a full percentage point lower than the IMF’s estimate in July, the largest downward revision of any region or country it examined in its world economic outlook.

The challenges in the Middle East aren’t uniform. In the Gulf Arab oil-exporting countries, growth is expected to be steady, helped by a modest increase in oil production and a much bigger contribution from the non-oil sector.

The story is different in places where political upheaval and violence have been most acute. In Iraq, where Islamic State militants have taken large swaths of territory since the summer, the IMF expects GDP to decline by 2.7% this year. The IMF didn’t even measure Syrian GDP, citing the unstable political situation there more than three years into a civil war.

The IMF’s prescriptions for Middle East growth are familiar ones. For oil exporters, the IMF recommends fiscal consolidation to help rein in budget deficits that ballooned after the financial crisis and Arab Spring unrest. Oil-rich countries have used their deep pockets to bolster social infrastructure – schools, hospitals, homes for nationals and other projects – but economists warn that the pace of spending growth isn’t sustainable in the long run.

For oil importers, major structural reforms are still necessary in many countries to keep them competitive and solve rampant unemployment, the IMF said.

 

[LeveragedBuyout]

I've been too busy to keep up with this thread recently, but back to business as usual.

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http://blogs.ft.com/beyond-brics/2014/10/10/wealth-redistribution-and-bolivias-boom/

Wealth redistribution and Bolivia’s boom
Oct 10, 2014 8:21pmby Andres Schipani

Bolivia’s president, Evo Morales – along with his deputy Alvaro García Linera, a suave Marxist mathematician – seems to be sailing towards his third presidential victoryin Sunday’s election, thanks to a self-styled socialist agenda, popular among impoverished Bolivians.

Despite the government’s sometimes fiery anti-capitalist rhetoric, Morales has managed to triple the size of the Andean country’s economy, which is forecast to grow at South America’s fastest clip this year.

In the country’s capital, La Paz, Warwick-educated finance minister Luis Arce explained to beyondbrics the Bolivian model behind the economy’s success:

Bolivia, a small country with different ideas and [a] different model, is doing very well . . . We use the national resources to increase production in Bolivia, and then we distribute the benefits among people. This is a distribution model, which gives to everybody, especially to the people who never had money. Now, those [people] have money. They are becoming richer, so this is the main idea of the model. We think [if] a country has better income distribution among people, you have faster growth rates, so that’s the main idea behind the model.​

The combination of the recent commodities boom, nationalisations, and prudent macroeconomic and redistributive policies, has financed higher wages and cash transfer schemes to the elderly, schoolchildren and pregnant women – all of which fuelled a consumer boom.

As Arce says:

In order to protect poor people, we preserve the macroeconomic stability. So by having this scenario where you have macroeconomic stability, you are increasing the standard of living of poor people . . . We’ve put many measures in place for more people to have much more money, and this increased the internal demand. In the past we had the neoliberal model, which was based on net exports. A former president of Bolivia used to say “exports or die”. We changed it. It is important to export, but it is more important to look at the internal demand, and we are increasing internal demand.​

Indeed, shopping centres and restaurants have sprawled in one of Latin America’s poorest countries, and consumer companies appear happy. Supermarket sales rocketed from $71m, before Morales took office, to $444m last year, while restaurant sales grew 686 per cent in the same period.


Source: EPC-UCB

But to sustain the growth that allows Morales, who is an avid football player, to satisfy the demands of the diverse social groups that form his power base while the commodities super-cycle eases, he needs funds and expertise to move away from over reliance on natural resource extraction.

As Maplecroft, the risk consultancy, said in a recent report:

The country’s exposure to the price of commodities, particularly hydrocarbons, constitutes an area of vulnerability. In particular, any substantial fall in global oil prices could precipitate a major change in Bolivia’s economic fortunes despite its strong track record of growth. This also has implications for the stability of fiscal policy, as expanding extractive revenues have been key in allowing the government to avoid fiscal deficit in a context of growing social spending.​

Although it adds some value to primary production, analysts say, Morales’ industrialisation plans for his likely next term are still largely based on extractive development. The prickly issue, some say, will be to attract investors after a stream of state takeovers and other strifes with private investors.

His re-nationalisations of strategic sectors were applauded by his backers, as the privatisations during the “neoliberal” 1990s are seen as having been bad for the country by a large section of the population. Meanwhile, over the years, Morales’ indigenous power base has exerted pressure on the government to take a bigger role in the management of the country’s resources.

However Arce says:

We explained to investors that we are not going to nationalise everything. That we were going to nationalise only the companies and natural resources which belonged to the Bolivian people before. So you are not going to have in the future any nationalisation of any company which came to Bolivia invested, and it was a genuine private investment.
​

Arce still sustains that “capitalism is an old man”, while his foes counter this as simply another example of “state capitalism”, a rentier model fuelled by a charismatic populist. As a local economist known for his policy critiques says:

This is the apex of consumerism. Call this model however you want. But please, do not call it socialism, or anti-capitalism, have some respect for Marx, please!

​

 

[LeveragedBuyout]

Weaker Oil Receipts May Whet Gulf Appetite for Sukuk, S&P Says - Middle East Real Time - WSJ

• 

• October 13, 2014, 11:53 AM ET

Weaker Oil Receipts May Whet Gulf Appetite for Sukuk, S&P Says
ByNicolas Parasie

A development site in Riyadh. The world’s top oil exporter has boosted spending sharply in the past couple of years – starting big infrastructure projects.
Reuters
As declining oil prices could strain future budgets, governments across the Arab Gulf will likely review their available funding options for the planned infrastructure upgrades that will require hundreds of billions of dollars in the coming years.

One obvious source is to tap the still nascent capital markets in the region, in particular instruments such as Islamic bonds, according to Standard and Poor’s.

“The GCC can see that the capital markets are a good opportunity to share some of the burden away from national banks and the governments,” said Karim Nassif, a Dubai-based credit analyst at S&P. “If there is to be a real change in the commodity pricing, it is very useful to have that market available to them.”

A sizeable chunk of any capital markets financing will be inevitably done in the form of Islamic bonds or sukuk as financing according shariah principles continues to gain ground in the Middle East and around the globe.

The broader Islamic finance industry has been growing at an average annual pace of around 17% in recent years and could transform into a $3 trillion industry in the near future, according to S&P’s global head of Islamic Finance, Mohamed Damak.

Going via the sukuk route offers issuers access to a different class of investors while its fundamental underlying principles like the prohibition on interest, speculation and funding of sectors such as gambling are appealing to a growing number of people, not least the estimated 1.6 billion Muslims worldwide.

But aside from the usual challenges the Islamic finance industry wrestles with – lack of standardization, sufficient human resources and clear regulation – the question remains whether sukuk alone can fill the void for governments seeking fresh revenue sources should oil prices go down.

“At this moment in time it’s more of an optionality rather than a necessity,” said Mr. Nassif. “The reality is that we’re still early days in terms of using sukuk directly to fund project finance–type infrastructure but the potential is there,” he said.

The potential role sukuk can play in helping governments fund their large infrastructure investments coincides with Dubai’s efforts to establish itself as the world’s leading Islamic finance center, an ambition it is on course to realize if one looks at this year’s new sukuk listings.

But whether promoted by governments across the region or not, issuers will ultimately look at pricing and availability when considering Islamic bonds. In other words, sovereigns or corporates still demand a compelling financial reason to issue sukuk rather than conventional bonds.

“Can you get the tenors that you need, can you get the amounts that you need so that it is competitive? The factors have to be there to propel them to choose sukuk and continue to do that,” said Mr. Nassif.

 

[Aepsilons]

Weaker Oil Receipts May Whet Gulf Appetite for Sukuk, S&P Says - Middle East Real Time - WSJ

View attachment 130529

• View attachment 130530

• October 13, 2014, 11:53 AM ET

Weaker Oil Receipts May Whet Gulf Appetite for Sukuk, S&P Says
ByNicolas Parasie
View attachment 130531
A development site in Riyadh. The world’s top oil exporter has boosted spending sharply in the past couple of years – starting big infrastructure projects.
Reuters
As declining oil prices could strain future budgets, governments across the Arab Gulf will likely review their available funding options for the planned infrastructure upgrades that will require hundreds of billions of dollars in the coming years.

One obvious source is to tap the still nascent capital markets in the region, in particular instruments such as Islamic bonds, according to Standard and Poor’s.

“The GCC can see that the capital markets are a good opportunity to share some of the burden away from national banks and the governments,” said Karim Nassif, a Dubai-based credit analyst at S&P. “If there is to be a real change in the commodity pricing, it is very useful to have that market available to them.”

A sizeable chunk of any capital markets financing will be inevitably done in the form of Islamic bonds or sukuk as financing according shariah principles continues to gain ground in the Middle East and around the globe.

The broader Islamic finance industry has been growing at an average annual pace of around 17% in recent years and could transform into a $3 trillion industry in the near future, according to S&P’s global head of Islamic Finance, Mohamed Damak.

Going via the sukuk route offers issuers access to a different class of investors while its fundamental underlying principles like the prohibition on interest, speculation and funding of sectors such as gambling are appealing to a growing number of people, not least the estimated 1.6 billion Muslims worldwide.

But aside from the usual challenges the Islamic finance industry wrestles with – lack of standardization, sufficient human resources and clear regulation – the question remains whether sukuk alone can fill the void for governments seeking fresh revenue sources should oil prices go down.

“At this moment in time it’s more of an optionality rather than a necessity,” said Mr. Nassif. “The reality is that we’re still early days in terms of using sukuk directly to fund project finance–type infrastructure but the potential is there,” he said.

The potential role sukuk can play in helping governments fund their large infrastructure investments coincides with Dubai’s efforts to establish itself as the world’s leading Islamic finance center, an ambition it is on course to realize if one looks at this year’s new sukuk listings.

But whether promoted by governments across the region or not, issuers will ultimately look at pricing and availability when considering Islamic bonds. In other words, sovereigns or corporates still demand a compelling financial reason to issue sukuk rather than conventional bonds.

“Can you get the tenors that you need, can you get the amounts that you need so that it is competitive? The factors have to be there to propel them to choose sukuk and continue to do that,” said Mr. Nassif.

What is your opinion on the Middle East's growth projection , sir ?

 

[LeveragedBuyout]

What is your opinion on the Middle East's growth projection , sir ?

Not good, and I will illustrate below with two articles that are essentially self-explanatory. In the past, I would have posted these on PDF to help tell the story through news, as I liked to do in my "Road to War" series, but I find myself gradually pulling back from PDF these days.

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First, the recent fall in oil prices is going to hurt the petrodollar-dependent Middle East very hard.

http://online.wsj.com/articles/oil-price-slump-strains-budgets-of-some-opec-members-1412952367

Oil-Price Slump Strains Budgets of Some OPEC Members
Oil-Producing Countries Face Steep Deficits If Price War Continues

By BENOÎT FAUCON, SARAH KENT and SUMMER SAID

Updated Oct. 10, 2014 1:03 p.m. ET

The continuing slump in global oil prices is punching holes in the budgets of oil-producing countries, including some OPEC members such as Iraq and Libya that are struggling with severe political and security problems.

Many members of the Organization of the Petroleum Exporting Countries need oil prices to average way above the current Brent crude oil price of $90 a barrel to balance their books. They have ratcheted up annual spending since the Arab Spring in 2011—and rely heavily on oil-export receipts for income.

More

• Crude Prices Extend Fall
• OPEC Oil Supply Highest Since 2013
• Price Drop Tests Oil Drillers
• Analysis: More Pain for Oil-Field Services

But most Gulf monarchies with relatively small populations, such as OPEC’s biggest producer, Saudi Arabia, can cope with lower oil prices for some time, making it less urgent for them to cut output to boost prices.

Saudi Arabia said Friday it had increased crude output by 107,000 barrels a day in September to 9.7 million barrels daily. OPEC in total increased output last month to its highest level in more than a year.

That means the current price war within OPEC is set to continue, putting further pressure on weaker nations.

This week, Iran cut the price at which it sells light crude oil to Asia to its lowest level since December 2008, far below the $140 a barrel that analysts say it needs to balance its budget. The country is already subject to stifling international sanctions that have led to a protracted economic contraction.

“While Saudi Arabia, Kuwait and the United Arab Emirates could withstand a…drop in oil prices, many OPEC members will likely feel financial strain, making it hard to come to a consensus,” Morgan Stanley MS +0.97% analysts said in a recent note.

Concern is rising fast in Iraq, where pressure to spend more on security is intense amid the advance of radical Islamic State fighters. It needs oil prices at around $106 a barrel to avoid an annual budget deficit, the International Monetary Fund estimates, a break-even level already 12% higher than in 2011.

“Our budget 95% depends on oil, so if there’s any decrease in the price, sure, it will negatively affect our budget,” said Najeeba Najeeb, a lawmaker with the Kurdistan Democratic Party. An Iraqi government spokesman didn’t respond to a request to comment.

Libya’s government estimates its budget may have to assume a sharp fall in oil prices, meaning pressure to cut outlays is getting higher, according to a government official. But as it battles rebels often aligned with al Qaeda and Islamic State, spending on “security and military defense is paramount,” said Salah al-Suhbi, a Libyan parliament member.

Algeria raised its welfare spending after neighbors Libya and Tunisia toppled their leaders in 2011. But it now needs oil prices at $121 a barrel to avoid a budget deficit, the IMF estimates, and could slip into the red in 2014 for the first time in 15 years. Algeria’s finance ministry declined to comment.

Struggling OPEC members are suffering partly for failing to diversify their economies when oil prices were high, analysts say. They also haven’t invested enough in their oil industries to sustain them through leaner times.

Countries faced with mounting deficits will now “hardly be able to fund their share of [exploration and production] investment” said Ali Aissaoui, a consultant at Arab Petroleum Investments Corp., a bank owned by Arab oil producers.

Nor will tapping international debt markets be easy. Major ratings firms don’t even assign credit ratings to Iraq and Libya. They rate the debt of fellow OPEC members Angola and Nigeria as speculative, making funding very expensive. The cost of servicing Nigerian debt has doubled in four years, according to its Debt Management Office.

Even Saudi Arabia’s finances are getting tighter. It needs oil to average $93 per barrel to stay in the black, Deutsche Bank DBK.XE -0.67% estimates. But with gross government debt at only 2.7% of gross domestic product in 2013, according to the IMF, the kingdom can suffer budget pain much more easily than its OPEC peers.


---

Second, the same forces that broke OPEC's oil embargo in the 1970s are reasserting themselves, and between this and the continued shale/fracking developments, we are unlikely to see a spike in oil prices in the medium term. China's continued slowing will also put considerable pressure on oil prices.

http://online.wsj.com/articles/opec-members-rift-deepens-amid-falling-oil-prices-1413136848

OPEC Members’ Rift Deepens Amid Falling Oil Prices
Rival Producers Moving in Sharply Different Directions

By BENOÎT FAUCON, SUMMER SAID and SARAH KENT

Updated Oct. 12, 2014 9:10 p.m. ET

An oil installation operated by Venezuela’s PDVSA. Venezuela is among producers least able to weather lower prices. Reuters

A rift between OPEC members deepened over the weekend, as producers in the cartel moved in different directions amid falling oil prices.

Venezuela, which has been one of the most outspoken proponents of a production cut by the Organization of the Petroleum Exporting Countries, called over the weekend for an emergency meeting of the group to respond to falling prices. But Kuwait said Sunday that OPEC was unlikely to act to rein in output.

More

• OPEC Competition Pushes Crude Lower

Saudi Arabia, meanwhile, appeared to expand on its recent move to defend its market share at the expense of other members by aggressively courting customers in Europe. Traders said Saudi Arabia is now asking for stronger commitments from some of its buyers in Europe, a move that would lock in those customers, including any new ones it would gain with recent price reductions.

Also on Sunday, Iraq’s State Oil Marketing Company cut the price of Basrah Light crude in November for Asian and European buyers by 65 cents to a discount of $3.15 a barrel below the Oman/Dubai benchmark for Asian customers and $5.40 below the Brent benchmark for European customers, according to official selling prices published by the company.

The moves and countermoves are the latest in a time of particular discord in OPEC. The organization was founded to leverage members’ collective output to help influence global prices. In recent periods of low prices, Saudi Arabia—OPEC’s top producer and de facto leader—has managed to cobble together some level of consensus.

But even modest cooperation between many members has broken down, and Saudi Arabia, in particular, has moved to act on its own. While it cut output earlier this summer, other members didn’t go along. Since then, it has dropped its prices.

Each member has a different tolerance for lower prices. Kuwait, the United Arab Emirates and Saudi Arabia generally don’t need prices quite as high as Iran and Venezuela to keep their budgets in the black.

Late Friday, Venezuelan Foreign Minister Rafael Ramirez, who represents Caracas in the group, called for an urgent meeting to tackle falling prices. The group’s next regular meeting is set for late next month.

But on Sunday, Ali al-Omair, Kuwait’s oil minister, said there had been no invitation for such a meeting, suggesting the group would need to stomach lower prices. He said there was a natural floor to how low prices could fall—at about $76 to $77 per barrel—near what he said was the average production costs per barrel in Russia and the U.S.

“I don’t think there is a chance today that [OPEC] countries would reduce their production,” Mr. al-Omair said, according to the official Kuwait News Agency. A cut in OPEC production “may not necessarily boost prices” because of high output by other producers, he said.

Last week, OPEC’s average basket of crude fell to its lowest level since December 2010, while the Brent international benchmark fell near a four-year low at one point before bouncing back to close Friday at $90.21.

Saudi Arabia has cut its Asian prices, and traders said it was asking European buyers to commit to maximum shipments, after cutting European prices, too.

This month, state-owned Saudi Aramco stunned the rest of OPEC by slashing its November prices to defend its share of Asia’s growing market. Saudi Arabia also said it increased its output in September.

After Saudi Aramco cut its November prices in Europe, traders said it was also asking refiners to commit to full, fixed deliveries in talks to renew contracts for next year, where it had previously offered a formula allowing flexibility of more or less 10% of contracted volumes, the most commonly used.

Write to Benoît Faucon at benoit.faucon@wsj.com, Summer Said atsummer.said@wsj.com and Sarah Kent at sarah.kent@wsj.com

Corrections & Amplifications

Iraq’s State Oil Marketing Company on Sunday cut the price of Basrah Light crude in November for Asian and European buyers by 65 cents to a discount of $3.15 a barrel below the Oman/Dubai benchmark for Asian customers and $5.40 below the Brent benchmark for European customers, according to official selling prices published by the company. A previous version of this article misstated both discount figures.

 

[LeveragedBuyout]

A nice follow-up to the previous post. On a side note, the conclusion should settle the argument: the FT is a left-of-center newspaper. After all, the solution to every problem is more government, right?

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http://ftalphaville.ft.com/2014/10/14/2005952/when-the-cartel-bursts-brent-edition/

When the cartel bursts, Brent edition
Izabella Kaminska Author alerts | Oct 14 14:04

When you look at things hard enough you realise almost everything in society can be reduced to a cartel, monopoly or perfect (and chaotically disruptive) competition model.

While cartels come in many shapes and forms, the purpose is common: stability.

In other words, as long as everyone plays by the rules of the cartel, what’s best for that particular participatory group can be guaranteed.

On which basis, government itself can be reduced to a cartel-type system. As can central banks.


Until, of course, the incentive to go against the rules begins to outweigh the incentive to abide by them.

So what are the factors that drive cartel collapse?

The first, arguably, is when the most dedicated cartel member realises that he’s the last man standing on the compliance front. Everyone else has not only been breaking the rules for a long time, but they’ve been breaking the rules predominantly at a cost to him. He no longer wishes to play the role of the altruistic balancing muppet and pulls out.

The second, meanwhile, is when the break-even rate of the entire system becomes impossible to defend because external competition has undermined it. This can be reduced to the “what’s the point?” factor.

What we see in the oil market right now is potentially a scenario in which both of these situations are beginning to play out.

If so, it could initiate a race to the bottom unless a new cartel agreement can somehow be struck between all players pronto (because we’re not yet at the phase where we can do without oil):



And as the IEA added on Tuesday (our emphasis):

Recent price declines have sparked speculation about their potentially supportive impact on demand. The price elasticity of oil demand tends to be asymmetric in nature: oil demand falls on high prices more easily than it expands on lower prices. Looking at the last five incidences of crude oil price declines of 15% or more over a four‐month period (as occurred, at the time of going to press, June‐through‐ October), only in one case (in 2006) was a noticeable uptick in demand seen.

The immediate impact tends to be weakening demand reducing oil prices, as opposed to lower prices triggering additional deliveries, which is very much lagged. The dramatic price decline of late 2008/early 2009, for example, was not followed by a noticeable uptick in global oil demand growth until 2H09, many months after prices had started to rebound. Oil price changes will naturally affect demand differently depending on whether they are themselves supply‐ or demand‐driven. The price drop in 2008 was overwhelmingly demand led, whereas recent declines appear to have been largely in response to rising supply. Nevertheless, recent price movements are not expected to significantly lift demand in the short term, especially since crude price drops are not fully carried through to retail product prices.​

And here’s that global race-to-the-bottom price surge in chart form (also via the IEA):



Not that any of these factors are new.

To quote Daniel Yergin’s The Prize, referring to the oil collapse of the Great Depression era:

By the end of the decade, the gloomy predictions of the early 1920s had been washed away by the flood of oil that seemed to flow unendingly out of the earth. American consumers simply could not absorb all the oil that was being produced, and more and more of it poured out of the ground, only to flow into a growing army of storage tanks around the country. But oil men were still driven to produce to the maximum. The effects were devastating. Flush production — “too many straws in a tub” — damaged reservoirs, reducing the ultimate recoverable resource. And the huge oversupply of crude totally disrupted the market and rational planning, thus creating sudden price collapses.​

How did they deal with it back then?

Again from Yergin:

Yet, ironically, as discovery followed discovery, adding further to the unprecedented glut, opinion in the industry began to shift toward Henry Doherty’s remedy for shortage — conservation and production control. The reason was no longer to forestall an imminent shortage, since the mounting proof of the opposite was now all too evident. Rather , it was to prevent the ruinous floods of flush production that so violently shook the pricing structure.
​

And when break-even rates look like this (H/T Neil Hume):



You suddenly see the rationale of awarding an economist who has made a name for himself studying the stabilising effects of dynamic oligopolies, if regulated correctly, a Nobel memorial prize.

From Tirole’s work on dynamic oligopolies in 1988:

For the exogenous timing version of the model, we show that there exists a unique symmetric MPE. In this equilibrium, only one firm produces (thus the model may be considered more an example of monopoly than duopoly) and, furthermore, for discount factors that are not too low, operates above the pure monopoly level in order to deter entry.

———-

Shocks that call for a price reduction will tend to be accommodated swiftly, because downward adjustments are not costly. By contrast, raising one’s price involves a short-run loss in market share, so that such adjustments are likely to be delayed. This fear of losing market share by raising one’s price during booms, we feel, is the essence of the traditional kinked demand curve story.

​

Hence the need for an internationally governed “central energy bank” to navigate us to a new equilibrium sweet spot point that serves all our best interests in the long run.