‘ZOMBIES’ JUST KEEP SHUFFLING.
Conditions that created them are still in play
My grandparents used to have these j oke coasters at their cottage. Made of wood and illustrated in ink, each coaster ( the kind for your glass of booze) had a pithy drink- or sex- related joke etched on it, which seemed like the wisdom of the ages to an eight- year- old. One of my favourites read: “I’m not drinking anymore … but then again, I’m not drinking any less!” Ah, childhood memories. Anyway, this particular bad joke sprang to mind last week, when Saudi Arabia and Russia (along with Venezuela and Qatar) announced a preliminary deal to “potentially” freeze oil production at current levels.
Which is kind of like saying, “We’re not over- producing anymore … but then again, we’re not over-producing any less!”
Markets responded with justified skepticism.
For one thing, the “deal” fixes production at January levels, but production is already outpacing demand.
Then there’s the problem of compliance. Russia has made similar undertakings to limit production in cooperation with OPEC in the past, and then went on to increase output.
As well, seven of t he world’s 10 largest oil producers aren’t participating. Iran, for one, won’t give up market share after being held out by sanctions for so long. Iraq needs the money, even if it means selling oil at bargain- basement prices. The same goes for a host of smaller oil- producing coun- tries, not to mention a lot of U. S. shale oil producers who have to meet their financial commitments.
Long story short, we can’t expect this deal to have much impact on oil prices, and so far it hasn’t. Meanwhile, U. S. oil and gasoline inventories have reached record levels, according to data released last week by the U.S. Energy Information Administration.
For oil investors, this is now a familiar story. Despite prices coming down more than 70 per cent since December 2014, produc- tion continues to outpace demand, as market participants are either a) scrambling for share or b) in desperate need of revenue at any cost, because they have bills to pay. In financing circles, the phrase “oil zombies” is being bandied about.
The more worrying thing is, this is not just an oil story, nor just a commodities story.
On the weekend, Chinese officials held a much- publicized conference at which they laid out their plans to clean up the economy and stimulate consumption, in an obvious attempt to re- store confidence in their ability to engineer growth.
Besides firing the head of the securities commission, Xiao Gang — who, after the debacle of circuit breakers and a series of failed stock market interventions, must have been relieved — the mandarins also reasserted their commitment to ridding the economy of so- called “zombie factories.”
No one really knows how many of these there are in China — the government is apparently counting them — but everyone knows what they are: factories that con- tinue to pump out goods t here i sn’ t demand f or, propped up by easy borrowing terms.
Beijing wants to cleanse the system of these things, and that’s good. Trouble is, as bad as they are, the zombies employ people, generate revenue and extend the pretence that the banks that loaned to them will get paid back some day.
Japan has been saddled with “zombie companies” for decades now, supported not just by banks but by government bailouts. The payoff for the government is jobs and economic “stability.” The costs, though, are high — in taxpayer dollars, market oversupply, and the suppression of competition.
Let’s not feel too comfy over here in Canada, either, as our federal government contemplates yet more corporate bailouts — Bombardier Inc., anyone? — and our mining sector struggles with low prices.
Investors might take comfort from the assumption that, in a rational economy, these zombies couldn’t survive forever. But as Japan demonstrates, getting rid of them while policy- makers are committed to jobs and stability ( not to mention votes) is a tall order. More to the point, the conditions that created them — years of easy money and government intervention — are still in play.
Zombies, it seems, are popping up everywhere. And while the world continues on the path of “not overproducing any less,” they just might be here to stay.