Oil industry vicious cycle ‘sparking downturn’
THE global oil industry is caught in a self-feeding downward spiral as falling prices cause producers to boost output even further in a desperate effort to service $3 trillion of dollar debt, the world’s top watchdog has warned.
The Bank for International Settlements fears that a perverse dynamic is at work, in which energy companies in Brazil, Russia, China and parts of the US shale belt are increasing production in defiance of normal market logic, leading to a bad “feedback loop” that is sucking the whole sector into a destructive vortex.
“Lower prices have not removed excess capacity from the market, but instead may have exacerbated it. Production has been ramped up, rather than curtailed,” said Jaime Caruana, the general manager of the Swiss-based club for central bankers.
The findings raise serious questions about the strategy of Saudi Arabia and the core Opec states as they flood the global crude market to knock out rivals in a cutthroat battle for export share. The process of attrition may take far longer and do more damage than originally supposed.
Oil exporting nations are embracing austerity and slashing government spending, leading to fiscal tightening that is slowing the global economy.
Speaking at the London School of Economics, Mr Caruana said the sheer scale of leverage in the oil and gas industry was amplifying the downturn since companies were scrambling to eke out extra production to stay afloat.
The industry has issued $1.4 trillion (£0.97 trillion) of bonds and taken out a further $1.6 trillion in syndicated loans, driving up the combined debt threefold to $3 trillion in less than a decade.
Many of these energy groups are giant “parastatals”, such as Rosneft, Petrobras, or China National Offshore Oil Corporation.
The bank said state-owned oil companies increased debt at an annual rate of 13pc in Russia, 25pc in Brazil, and 31pc in China between 2006 and 2014, much of it in the form of dollar debt through off-shore subsidiaries. These oil companies do not respond to pure market pressures since they are cash cows for government budgets.
The nexus of oil and gas debt is just one part of an overstretched financial system increasingly exposed to the dangers of a “maturing financial cycle” and punishing moves in the global currency markets.
Mr Caruana said an “illusion of sustainability” blinded both borrowers and debtors, lulling them into a false of security when credit was easy and asset prices were rising. This illusion can die in the blink of an eye. “The turning of the financial cycle can be quite abrupt,” he said.
The bank calculates that debt in US dollars outside the US has surged to $9.8 trillion, a five-fold rise since 2000, an unprecedented level.
Mr Caruana said the eye of the storm was being approached.
“The feedback loop between deleveraging and emerging market currency depreciation presents challenges that should not be underestimated. The policy room for manoeuvre has been shrinking,” he said.