Peter Jones: Oil slump brings black times indeed

THE price of commodities is falling, yet there is no sign of any boost from a resulting increase in spending power, writes Peter Jones

Yet more evidence has emerged to give the lie to the SNP claim that oil is a bonus and not the basis of the Scottish economy. Tell that to the Federation of Small Businesses or Scottish Chambers of Commerce, both of which partly blame oil industry woes for the depression settling on Scottish businesses, small, medium, and large, as shown in latest confidence surveys.

Worrying though this is for the Scottish economy, which will struggle to show any growth in the months ahead, it is but a microcosm of much bigger difficulties afflicting many economies around the world and which is raising the spectre of a new financial crisis.

It isn’t just oil which has plunged in value, yesterday dipping yet further to below $30/barrel and getting on for just a quarter of the value we were assured by Alex Salmond it would be when independence day was due to dawn in, ahem, three months’ time. Thanks to the indyref No vote, we have been spared public spending cuts that would have been at least twice as harsh as anything we face now in the Union.

Nevertheless, we still have to deal with the blight being spread across the economy by depressed oil prices. True, the increased spending power given to consumers and the relief afforded to transport and energy-dependent businesses by lower fuel costs should provide an off-setting boost, but that doesn’t seem to be showing up in the surveys mentioned above.

We are not alone in facing these problems. The selling price of virtually anything that grows out of, or is extracted from, the ground has nearly halved in the last five years, hammering everyone from farmers to multi-national mining companies.

Iron ore prices have just dipped below $40/tonne, down from a peak of $187/tonne in February 2011, a price crash even more precipitous than that experienced by oil. Over the same period, the IMF’s commodity metals price index, which covers aluminium, nickel, tin, copper, uranium, zinc, lead, and iron, has slumped from 256 to 105.

The World Bank records the price of barley peaking at $259/tonne in August 2012, but now down at $122/tonne. The price of sugar has also almost exactly halved over the same period.

With the exception of precious metals, you name the commodity, I’ll show you a price crash. The graphs are dramatic, but the impacts on producers are less severe because of hedging. Basically, both the producers and the buyers of commodities know that prices are volatile. They, on the other hand, would prefer some certainty. So they trade on the futures markets, agreeing to sell and buy commodities a month, six months, even two years ahead at prices which may be a bit higher or lower than the price on the day when the trade is agreed.

Right now, for example, today’s price of oil is a lot lower than it was expected to be this time last year so any hedging done by an oil company is very valuable. Reading the 2013-14 accounts of one North Sea producer recently, I noted that it was boasting of having fixed an average price of $68/barrel for about 90 per cent of its expected 2016 production.

This financial safety cushion, however, will start deflating later this year and by next year it will be emptier than an SNP independence prospectus. Oil companies, even though they will be hoping for a price revival over the next two years, know that they have to prepare for a long period of low prices. The last time they were as low as now, they stayed this low in real terms for 17 years between 1986-2003.

The same goes for virtually every commodity. It is now evident that, driven by seemingly never-ending growth in China, the world has been through a five-year commodity price boom which has now turned to bust caused by a rush to increase supply coinciding with a downturn in demand as China has slowed.

Among the countries worst affected is Brazil which, a few years ago, was the B in the happy BRIC family that was expected to lead the world. This year it hosts the Olympics, awarded to it in the boom times. Since 2011, however, the prices of commodities on which the Brazilian economy relies – oil, iron ore, soya, sugar, and indeed coffee – have fallen by 41 per cent.

Now Brazil is only setting unhappy and unwanted records – experiencing the longest recession in a century which may yet turn out to be the deepest. Even with the boost an Olympics brings, output by the end of the year is expected to be 8 per cent lower than at the start of 2014 when recession began and GDP per capita may be a fifth lower than in 2010.

This is almost as bad as Greece which, you may recall, was the catalyst for a European sovereign debt crisis. Brazil may be headed the same way – its credit rating has been downgraded to junk status by two ratings agencies. Russia faces similar problems as does Chile, Peru, Bolivia, Venezuela, Indonesia, the Philippines, Nigeria, Algeria, and South Africa.

Even developed commodity-producers such as Canada, Australia (and remarkably Saudi Arabia), while unlikely to have sovereign debt problems, are having to raise taxes and cut public spending. The basic underlying problem, however, is the same as in the extreme case of Brazil – large amounts of debt, both private and public, were raised in the good times to finance the expansion of commodity production, but now there doesn’t look to be the earnings to pay back the debt.

This time financial instruments such as hedging may be our saviour rather than nemesis, or at least postpone the day of reckoning. But it still points to a problem which has been unresolved since the 2009 financial crisis – that there is simply too much debt overhanging a too slow-growing world.

Some, such as RBS analysts in their recent extraordinary “sell everything” advice note to investors, think the outcome could be extremely messy. At least we can be thankful that Scotland won’t be where the mess is worst – independence would have turned out to have been an even crazier proposition than I thought at the time.