$100 Trillion Up in Smoke
“We aren’t addicted to oil, but our cars are.”
– James Woolsey
“The greatest asset, even in this country, is not oil and gas. It’s integrity.”
– George Foreman
If energy powers the world, then whoever owns that energy must have power over the world. That’s certainly been the case for the last century or two. Ownership of our primary energy source, crude oil, is what made billionaires of John D. Rockefeller, H.L. Hunt, and assorted Middle Eastern kings, emirs, and sheikhs.
Oil in the ground is wealth only on paper – you may own that oil, but it earns you nothing until you recover and sell it. Yet paper wealth is still wealth. It goes on your balance sheet as an asset that you can sell. You can use it as collateral to borrow cash and buy other assets.
The ongoing oil price collapse is having a severely negative impact on the wealth of those who own oil reserves. The numbers, as you will see below, are almost incomprehensibly big. They are so big, in fact, that many analysts have simply tuned out. The attitude seems to be, “These numbers blow up my models, so I will ignore them.”
Today we’ll stop dancing around the truth and call the oil collapse what it is: global wealth destruction of epic proportions.
In mid-2014, crude oil prices were about $100, depending on which grade you wanted to buy. Now prices hover near $30 – roughly a 70% decline in 18 months. That’s well-known, but we usually discuss the price collapse in terms of particular countries or companies: we don’t look at the bigger picture.
Last week someone showed me this from Twitter. I almost fell out of my chair.
Stop for a minute. Let that sink in. The total value of all the world’s oil reserves is over $100 trillion less than it was just a year and a half ago.
(By the way, I verified Mr. Levine’s reserve total by consulting the CIA’s World Fact Book.It says total world “proved” oil reserves were 1.656 trillion barrels as of January 1, 2015.)To put these figures in perspective, consider that Google’s parent company, Alphabet (GOOG), briefly surpassed Apple (AAPL) last week as the planet’s largest publicly traded company. Both are worth around $500 billion, depending on the day. The lost value in crude oil is equivalent to a couple of hundred Googles and Apples going up in smoke.
If stock values were crashing to that degree, we would call the losses earth-shattering. Yet otherwise intelligent people are saying the oil collapse is a minor issue.
It is true that the loss of value is somewhat less dire than the raw numbers imply. The companies and countries that own the world’s oil reserves don’t usually value them at the market price. They mark the value up or down gradually, using long-term average prices or other discount mechanisms. They also account for production costs.
Nevertheless, if your wealth is tied up in oil reserves, your asset valuation is down sharply since a couple of years ago. The collective balance sheet hit adds up to a staggering amount of money.
Set aside the accounting considerations for a moment, though. Economists talk about the “wealth effect” that occurs when asset values go up. If your stocks, real estate, or other assets gain in value, you derive no immediate benefit unless you sell them. Yet you feelwealthier and more confident. That confidence changes your behavior, so you spend more freely. You’ll buy that second home, nicer car, or diamond ring. You’ll take more risks with your investments.
The wealth effect is a real phenomenon, and it has economic consequences. In a consumer-driven economy like the United States, higher spending from asset-wealthy people lets businesses expand and create jobs. Politicians and Fed officials tout the effect as a beneficial consequence of their genius plans. Yet they seldom remind us of thenegative wealth effect that occurs when asset values decline.
When your perceived wealth contracts, you cut spending and turn cautious. Your altered strategy also has macroeconomic consequences – but sometimes they aren’t immediately obvious. I recall reading back during the 2009 recession that lawnmower sales had spiked higher. That seemed odd at first, but then I understood: affluent people who had lost jobs or income fired their yard services and started mowing their own grass. A good move for them, but terrible for yard workers.
So, whatever the audited financial statements reflect, it’s safe to say that the owners of those 1.656 trillion barrels of oil are feeling much less wealthy now. Their paper losses are affecting their behavior as surely as falling US home prices affected consumer behavior in the last recession.It isn’t just oil, either: Other commodity prices have also collapsed. All the industrial metals – copper, zinc, nickel, lead, palladium, platinum, silver, and aluminum – suffered double-digit percentage losses in 2015. Ditto for coal, natural gas, and iron ore.
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.
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