By The Automatic Earth
DPC Ghosts in train concourse, Union Station, Washington DC 1910
Is the age of stimulus over? It may well be. That would expose global markets as the naked emperors they always were. From the point of view of America, it makes sense to taper. Not because of invented jobless and GDP growth data, though they do make it harder for the Fed not to quit QE. No, it makes sense because the negative impacts will be hugely outweighed by the positive ones. Or, to put it in different terms, the death of the bubble will hurt the US too, and probably badly, but it will hurt others much more. And that can be – seen as – a good thing.
Emerging economies, smaller and larger ones, have grown themselves over the past few years by gobbling up dollar-denominated debt, and using it as the foundation for highly leveraged credit instruments. Much of this (short-term) foundation needs to be rolled over on a regular basis. And that’s where the taper will start to bite something bad, soon. Because everybody on the planet is in the same predicament. Except the US.
Moreover, most commodities are traded in dollars. Countries may sign the occasional bilateral deal in other currencies, but that’s hardly relevant. The world’s life-blood, fossil fuels, will easily remain 90-95% traded in US dollars. And that at a point in time when everyone will at least start to fear a permanent shrinkage of supplies.
Shell, like its peers, announced large profits today. But Shell knows, as do Exxon and BP, that those profits look to be a fluke. And that’s before they’ve even considered their fresh Russian sanctions problems. The simple fact is, they’re running out of reserves, and they apparently have little hope more will be found anytime soon, even if they’ll never say it out loud. Look what they do, not what they say. The Guardian:
Shell has committed itself to spending over $30 billion buying back its shares and handing out higher dividends over two years. The promise came as the Anglo-Dutch business more than doubled second quarter profits to $5.1 billion as measured on a current cost of supplies basis. The company has taken advantage of high oil prices and a better performance but took another almost $1 billion in writedowns for US operations that have fallen in value. These are believed to cover shale gas assets, some of which are being sold off along with other poor value fields in Australia, Canada and Brazil. Ben Beurden, the new chief executive, said Shell has already started to improve under his watch and had “huge potential” for growth.
“We are making progress with the priorities I set out at the start of 2014: to balance growth and returns by focusing on better financial performance, enhanced capital efficiency, and continued strong project delivery,” he explained. And he said the company would be increasing the payout to investors by 4% in the second quarter just ended. “We are expecting some $7–$8 billion of share buybacks for 2014 and 2015 combined, of which $1.6 billion were completed in the first half of this year.
“These expected buybacks and dividend distributions are expected to exceed $30 billion over the two-year period. All of this underlines the company’s recent improved performance and future potential.” Buying back shares reduces the number in circulation so should boost their value and be welcomed by investors. But some financial critics always argue that buybacks are of no proven value and a waste of money.
If Shell really had the “huge potential” for growth the CEO cites, it wouldn’t be wasting capital on buybacks and dividends, it would invest in developing new projects. But there ain’t any, or not nearly enough. Buying back shares at least makes a company look better short term, and dividends make shareholders hang on.
Obviously, a lot of the cash involved is borrowed on the ultra cheap, and that softens the whole thing somewhat. But still, none of this is a good sign. And now they will have to deal with the sanctions headache. Shell has huge interests in Russia. Q2 2015 numbers could look a whole lot different.
And there’s even more trouble brewing. What happens when there’s no more cheap money for the taking? Wolf Richter does a good write up on the shale industry, which both Nicole and I have said for a long time is about monetary – land – speculation, not energy. We’ve known all along that there is the danger of the rapid oil and gas depletion in shale fields, but now we must add the danger of credit depletion:
Fracking [..] is causing the balance sheets of oil and gas companies to blow up. Now even the Energy Department’s EIA has checked into it and after crunching some numbers found: Based on data compiled from quarterly reports, for the year ending March 31, 2014, cash from operations for 127 major oil and natural gas companies totaled $568 billion, and major uses of cash totaled $677 billion, a difference of almost $110 billion. To fill this $110 billion hole that they’d dug in just one year, these 127 oil and gas companies went out and increased their net debt by $106 billion.
But that wasn’t enough. To raise more cash, they also sold $73 billion in assets. It left them with more cash (borrowed cash, that is) on the balance sheet than before, which pleased analysts, and it left them with a pile of additional debt and fewer assets to generate revenues with in order to service this debt. It has been going on for years. In 2010, the hole left behind by fracking was only $18 billion. During each of the last three years, the gap was over $100 billion. This is the chart of an industry with apparently steep and permanent negative free cash-flows:
And those shortages in each year forced the companies to raise more debt and sell assets to fund more drilling, other capital expenditures, operational costs, dividends, and stock buybacks. Of the three sources of cash – operations, net increase in debt, and asset sales – during the first quarters going back six years, net increases in debt accounted for over 20% of the incoming cash since 2012. For instance, In 2013, cash from operations supplied only 60% of the cash needs; most of the rest was borrowed, and some was covered by asset sales:
How much longer can the shale industry survive? I’m convinced that the Americans who play today’s big power game have this wrong, like so many others. Shell played at least part of it smartly, selling off shale plays. But many others keep diving in deeper all the time. While the situation is just getting worse. Before interest rates start to rise.
The graph says things have been getting progressively worse for all 5 years running. In 2013, only 60% of operational costs could be covered with production (the 2014 bar should be ignored, that’s an EIA estimate, and therefore 100% unreliable). What happens to this industry when borrowing costs double or triple? It’s a scary thing to ponder. How does ‘get out while you can’ sound?
That the age of stimulus, and thereby the bubble era, may be nearing its end is a point brought home by Ambrose Evans-Pritchard. It’s not just the Fed that’s tapering, the People’s Bank of China does it too, though in a less overt fashion. Together they’ve been good for almost unimaginable amounts of stimulus over the past 5+ years ($20 trillion?), joined at the hip by the Bank of Japan when Shinzo Abe launched his tragic new domestic policies.
If China goes, that’s it, that’s all she wrote. The BOJ is failing miserably, Europe won’t pick up the slack in any serious way, and cheap credit in global markets will vanish. Then you can scrape the emerging nations off the black top one by one. Every single one of them will be screaming for dollars, and that will make them a lot more expensive than they are today. It’s not going to be pretty. Ambrose:
The spigot of global reserve stimulus is slowing to a trickle. The world’s central banks have cut their purchases of foreign bonds by two-thirds since late last year. China has cut by three-quarters. These purchases have been a powerful form of global quantitative easing over the past 15 years, driven by the commodity bloc and the rising powers of Asia. They have fed demand for US Treasuries, Bunds and Gilts, as well as French, Dutch, Japanese, Canadian and Australian bonds and parastatal debt, displacing the better part of $12 trillion into everything else in a universal search for yield.
Jens Nordvig, from Nomura, said net foreign reserve accumulation by central banks fell to $63 billion in the second quarter of this year, from $89 billion in the first quarter, and $181 billion in the fourth quarter of 2013. [..] “There are major shifts going on in global capital markets. People have been lulled into a false sense of security by low volatility and they haven’t paid attention.
The world superpower in this game is China, with reserves just shy of $4 trillion. Mr Nordvig estimates that China’s purchases dropped to $27 billion in the last quarter, down from $106 billion in the preceding quarter. This looks like a permanent shift in policy. Premier Li Keqiang said in May that the reserves had become a “big burden” and were doing more harm than good, playing havoc with monetary policy, as global economists have been warning for a long time. China’s policy of holding down the yuan for mercantilist trade advantage caused it to import excess stimulus from America at the wrong moment in its own cycle, causing China’s credit boom to go parabolic as loans rose from $9 trillion to $25 trillion in five years.
The implication of the global reserve data is that this form of QE is being run down just as the US Federal Reserve runs down its own QE by tapering bond purchases, and then prepares to tighten. The global central banks have been buying around $250 billion of bonds a month in one form or another for most of the past three years. This is being cut to a fraction.
Global reserve accumulation works like QE by the Fed, which openly admits that the purpose is to drive up asset prices [..] … the global variant [of QE] has been much larger, soaring from 5% to 13% of world GDP since 2000. Edwin Truman, from the Peterson Institute in Washington, says the figure is nearer 22% – or $16.2 trillion – if sovereign wealth funds are included.
[..] A recent survey of central banks, wealth funds and government pension funds by the monetary forum OMFIF estimated that they have $29 trillion invested in global markets, and that they too have joined the scramble for yield.
We should add that, on top of the PBOC’s stimulus, a lot more fresh credit was created in China’s shadow banking system, through highly leveraged loans, investment funds, debt instruments and creative solutions such as the multiple collaterizations of – ghost? – commodities that we’ve seen (or did we?) in the warehouses of Qingdao. These things tend to add up.
Why China pulls out now is not immediately clear. But when European bonds yields are the lowest since before Columbus first sailed west, why should they bother any longer? Maybe the Chinese have dreams of empire just like the Americans. And maybe they just feel that it had to stop somewhere, so why not here, why not simply follow suit? Maybe they, realizing there’s no way out, just don’t want to make things even worse than they are.
The Chinese, too, will be naked emperors to an extent. But not as much as Brazil, Turkey, and some of the other major emerging nations. Perhaps not even as much as Europe. As for Putin, he may well be the odd one out. Russia has much less of a financial bubble than just about anyone out there. And it has massive resources, certainly compared to its population numbers.
Still, for everyone, you’re looking at the beginning of the end of the biggest bubble in history. Say bye! And then grow some veggies. And make sure you have your dear ones near. It’s going to be a wild ride.
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