The Oil Drum

One of the more interesting things about this Friday's economic news was the very obvious connection between the unemployment number and oil prices. What links the two is debt, the defining feature of what I have called the Anglo Disease, ie the highly unequal economy whereby the rich and the financial sector (almost the same thing these days) capture most of the income but hide it by providing cheap debt to the middle classes so that they can continue to spend.

Oil has played a fascinating side role in my Anglo Disease series, allowing the debt bubble to go on for much longer than expected. But now, instead, it is accelerating the crash. Let me take you through the whole cycle.

Anglo Disease diaries
Countdown to $200 oil diaries

This is me in front of the windfarm which I helped finance two years ago. It's up and running, and will be generating clean energy for the next 20-25 years - at a price guaranteed not to increase for the whole period. It was inaugurated yesterday and christened Princess Amalia windfarm, after the young daughter of the Dutch crown prince.

All my wind diaries are now listed in this Windpower index story.

This is a guest post by DoDo, a frontpager over at the European Tribune (and best known for his great Train Blogging series). This is an updated and adapted version of Oil prices in Euros, a story initially posted last October. In the past half-year, we often saw simultaneous crude oil and Euro/dollar rallies. The question emerges, how would oil prices look in Euros?

(Click to enlarge)

Below the fold, I'll explain what data is displayed on the diagram, and show a few more diagrams.

[UPDATE] JP Morgan agrees to buy Bear Stearns for $2 a share (Stock closed Friday at $30).
Also, Fed cuts rates (on Sunday) from 3.5% to 3.25%.

The WSJ has a decent article describing the current financial crisis and pulling no punches:

Debt Reckoning: U.S. Receives a Margin Call

The U.S. is at the receiving end of a massive margin call: Across the economy, wary lenders are demanding that borrowers put up more collateral or sell assets to reduce debts.

The unfolding financial crisis -- one that began with bad bets on securities backed by subprime mortgages, then sparked a tightening of credit between big banks -- appears to be broadening further. For years, the U.S. economy has been borrowing from cash-rich lenders from Asia to the Middle East. American firms and households have enjoyed readily available credit at easy terms, even for risky bets. No longer.

There are regularly stories in the media or in the blogosphere about various pipeline projects that are announced with much publicity, and are seen to have major strategic consequences, or conversely about projects that are more discreet but are seen as the "real" justification for various military or diplomatic acts. For instance, the announcement last month of an agreement between Russia and several central Asian republics about a new pipeline was widely interpreted as a major move against European energy security. Similarly, the war in Afghanistan has often been blamed on a long mooted Turkmenistan-Afghanistan-Pakistan pipeline.

These analyses (which are absurd to anyone with a basic knowledge of the oil&gas industry) completely ignore the dynamics of what it takes to actually get a pipeline deal done, and what it means for relations between the parties involved. Therefore they fail to understand the significance (or lack thereof) of announcements by energy companies or governments and wrongly interpret the geopolitical implications of both pipelines, and announcements of pipelines.

So, in order to help oildrummers better interpret pipeline news, here's a primer on why and how pipelines get built - which essentially means how they get financed.

(Note: this was written Thursday for European Tribune. There's a lot of additional info in the original thread, including insider info from several French bankers. I also posted an add-on on the (partisan) political lessons emphasising the last part of this text this morning on DailyKos, where the recent Fed decision is also discussed.)

As the markets keep on going through turbulence, and many conflicting opinions are heard as to whether this is just a harbinger of things to come (my position) or just a "welcome correction" (still that of most "serious" pundits and the conventional wisdom), what's most striking to me - and very revealing on its own - is how suddenly everybody is talking about the real estate bubble as it if were the most obvious thing.

The very people that, in many instances, denied that there was any kind of bubble, or that house prices were a problem in any way, and denied that market valuations of certain assets were completely unreasonable, are now saying, in hindsight, that it was indeed a bubble and, while they are still saying that nothing much will really happen fro mthe end of the bubble (other than silly people getting punished), they are already hard at work trying to pin the blame elsewhere.

"A cheerleader, moi?", they ask, outraged.

But their new attitude ensures, right now, that the crisis WILL spread. Let me tell you why.

Something is happening in the credit markets...

(Note: this text was written Tuesday. For a more polemical take written this Thursday, taking into account the most recent developments of the day (including the unprecedented $130 bn liquidity injection by the European Central Bank) you can go read this new story on European Tribune.)

on the front page of the Financial Times, 7 August

The above is the price of corporate loans in the secondary market - i.e. on the market where banks trade IOUs from corporations. If you have a contract that says that a company owes you 100, you can usually sell it (to other banks or financial investors) for 100 or thereabout - a bit more if the buyer thinks the interest rate on the loan is really good, or a bit less if it thinks the interest rate is not quite enough to cover the risk that the company might go bankrupt before paying its debt back.

As you can see above, the price of an IOU of 100 dropped brutally this month from 100 to 95 in the US (and to 97 in Europe). This is the lowest level ever for that market, and an unprecedented drop.

This is a credit crunch.

I've been developing in a couple of recent diaries over at the European Tribune (The Anglo Disease - Financiers worried about end of great bull run and Anglo Disease (2) - Martin Wolf's take, with afew adding input of his own in Anglo-Disease Sidelights (1): UK = Tax Haven) a concept which I think can usefully describe our current economic system, that of the Anglo Disease, mirrorring the "Dutch disease", a term coined in the 70s to describe the economic effects of the rapid development of one sector (in that case, natural gas, today, the financial industry) on the rest of the economy.

This text is meant as an attempt to explain what this 'disease' might be, trying to be as pedagogic as possible. You are my guinea pigs, so all comments and questions are welcome - indeed, they are hoped for - so that this text can be improved upon and refined.

This post is not directly about energy, but it is about one of the other big imbalances of our times - the giant financial bubble that has been inflating for the past few years, on the heels of the prevous bubble, the now-infamous dotcom bubble. It is about how society can be blind to trends that are obvious to many - including amongst those that are in a position to act and should know better than to do nothing.

I'm on record saying (repeatedly) that we have a huge, unsustainable asset price bubble, and that banks are doing insane things right now. And those of you that have read me previously may remember my quip that a good banker is not one who is right, it is one who is wrong at the same time as the other bankers (and thus bankers right now have no incentive not to participate to the increasingly aggressive deals one can see around).

The scariest thing is that a large number of senior bankers are aware of what I'm saying, are on the same line - and are doing nothing about it.

A headache awaits when the credit party fizzles out

A few days ago in London, a senior banker made a striking admission to me: in his long career, he had almost never seen such bubble-like conditions in the credit markets as exist now. “Perhaps back in the 1980s – just before the collapse,” he muttered, with a despairing chuckle, over an elegant (and expensive) lunch.

That is alarming stuff. But worse is to follow: this very same banker makes a living by arranging loans and bonds to risky companies – and he freely admits there is little chance that his institution is about to switch off this financial tap.