Thursday, April 29, 2010

Why the Greek Debt Crisis Matters

The big global economic news this week is that Standard and Poor's downgraded Greece's debt to junk status, which will make it very difficult for Greece to borrow money.

Some economists say that Greece has entered an economic death spiral and that it's only a matter of time before officials declare insolvency.

Greece is just the tip of the iceberg — or the canary in the coal mine — for the broader sovereign debt problems around the world.

The number of nations with deep debt problems is extensive, as I wrote about recently.

The Greek debt issue has become a European issue, and sooner or later could become a global issue.

As Harvard economist Kenneth Rogoff noted, "This is a very, very delicate situation that could spin out of control."

An eventual Greek default could spark a rapidly spreading contagion, which may have already begun. Portugal and Spain were both downgraded in recent days.

Though the EU has promised bailout money to Greece, it does not want to establish a precedent for bailing out the likes of Portugal, Spain, Italy, Ireland and Iceland, other European nations with burdensome debts.

The debt crisis could spread rapidly if Greece does indeed default.

It was just two weeks ago that the $40 billion EU bailout plan was announced, with the IMF promising additional billions in funding. Greek officials declared victory, saying that they didn't actually need the bailout funds, but that their availability would reassure investors and allow them to continue to borrow on the world markets.

But in the short interim, Greece's fortunes seem to have gone up in flames. This shows how quickly debt problems can become crises, and how quickly crises can become cataclysms.

The Greek bailout is not popular with German voters, who go to the polls next month. As Europe's largest economy, Germany would shoulder the largest proportion of any bailout. This has become a political issue and could sway the election. Germans are leery about bailing out entire nations, having absorbed the much poorer East Germany over the past two decades. German taxpayers are still paying for that huge expense.

The falling euro is a mixed blessing for the dollar, which should also be falling due to high budget deficits and long term US debt problems. The $12.9 trillion national debt is expected to be of 88% of the $14.6 trillion US gross domestic product by year's end.

As bad as the dollar's problems are, relative to other prominent world currencies, it appears stable. That's how bad the global debt problem is.

However, a strengthening dollar will hurt US exports, and since Western Europe receives 20% of US exports, an ongoing financial crisis there will also hurt the US economy.

Greek citizens are taking action in the face of the crisis. In the past two months, they have begun moving their money across the border to safer havens. Some 10 Billion Euros worth of cash and assets have made the exodus to escape a potential collapse.

Some economists think that Greece may have no choice but to leave the euro. And, despite all the repercussions that would ensue, the rest of the 16-nation Euro Zone may gladly let it.

Yet, that could be a cataclysmic moment for the relatively nascent currency.

As billionaire investor George Soros noted, "The consequences of Greece leaving the euro would be the disintegration of the euro. The disintegration of the euro would take [us] a very long way toward the disintegration of the European Union."

That's the ugly possibility European officials are grappling with right now.

Tuesday, April 27, 2010

Mega Banks' Power and Privilege a Threat to Our Nation and Economy

"History records that the money changers have used every form of abuse, intrigue, deceit and violent means possible, to maintain their control over governments, by controlling money and its issuance." – James Madison

Most people understand that commercial banks make money by taking deposits at low rates of interest (or often no interest at all) and then making loans at higher rates.

But investment banks rely on trading, issuing bonds, and borrowing money from other banks to raise capital. That's because they typically lack the deposits of commercial banks.

Investment banks also rely on arcane financial instruments such as derivatives, credit swaps, collateralized debt obligations, and the like, to increase profits. But those risky schemes are now facing scrutiny as Washington debates reform legislation.

Naturally, anything that upsets the banking industry's profits, or the way it customarily does business and makes money, is none too welcome. In fact, even the suggestion of reform is being met with stiff resistance.

The big banks love the status quo, which has allowed them to grown so wildly rich. However, under the spell of greed, they've forgotten how good they have it and take their incredible privilege for granted.

It can't be forgotten that the big banks are in the supreme and enviable position of getting virtually free money from the Federal Reserve, which they can then loan out at interest. This makes it easy to repay the Fed and still walk away with handsome profits.

What's particularly amazing is that the big banks are using this interest-free Fed money to buy billions worth of Treasury bonds, essentially returning this money right back to the federal government. Those bonds will eventually be paid back, at interest, with taxpayer money. And once again, the big banks will easily repay their Fed loans and enjoy massive returns.

Think about that; billions of dollars are being loaned to the biggest banks, essentially for free. And those banks are using that free money in exchange for Treasuries that pay 3%-4% interest, which results in huge gains for the big banks.

Who doesn't love zero percent loans?

The government loves this arrangement too since it provides them a buyer for hundreds of billions of dollars in government bonds. It's a pretty cozy relationship, don't you think? It's kind of like your dad loaning you money so that you can then spend it in his store and boost his sales.

It's also called insanity.

Our big banks have grown markedly larger in recent decades. Some would rightly argue dangerously larger.

In 1983, Citibank, America’s largest bank, had $114 billion in assets, or 3.2 percent of U.S. gross domestic product. By 2007, nine financial institutions were bigger relative to the U.S. economy than Citibank had been in 1983. By March 2009, Bank of America’s assets were 16.4 percent of GDP, followed by JPMorgan Chase at 14.7 percent and Citigroup at 12.9 percent.

The assets of the four biggest banks equal 50% of GDP. The top three equal 44% of GDP. That's way too much concentration of power and capital.

This concentration of capital has also lead to a concentration of power. Wall St. and Washington are incestuously interconnected. The banking industry is the most powerful, most politically connected industry in America. Its influence is unmatched. Money buys access.

A revolving door exists between Washington and Wall St., in which former politicians take lucrative positions as banking lobbyists, and where banking lobbyists take positions in government. The big banks aren't just connected, they're protected.

The Wall Street banks have become an oligarchy, gaining political power through their economic power, then using that political power for their own benefit.

Since last year, the Wall St. banking behemoths have spent more than $500 million to derail financial reform; that's $1.4 million per day.

More than 2,500 banking lobbyists are swarming the halls of Congress each week, fighting reform. This means that the big banks now have five lobbyists for every member of Congress.

According to the Center for Media and Democracy, the total cost to taxpayers of the Wall Street bailout was $4.6 trillion. Of that, $2 trillion is still outstanding. To out this in perspective, the entire federal budget is $3.6 trillion.

The biggest banks must be broken up and reduced a to a series of smaller banks. In the last century, the government used antitrust laws to trim the power and influence of banks and other industries. Banks so massive are rigidly anti-competitive because they control an outsized market share. They simply buy up their competitors, becoming continually larger.

And the big banks take on absurd and dangerous risks with the implicit understanding that the government will bail them out with taxpayer money when disaster strikes.

Far from being regulated by the government, it now seems that the big banks regulate the government. Politicians become bank lobbyists, and bank lobbyists assume lofty positions in our government. It's all to cozy and amounts to a dangerous conflict of interest.

In the face of the financial meltdown and subsequent economic crisis – when reform seemed vitally necessary and inevitable – the biggest banks only grew bigger, concentrating ever more power and wealth.

Too big to fail means too big to exist. Free from regulation, over-the-counter derivatives grew to over $680 trillion in face value and over $20 trillion in market value by 2008. The consequences to our economy and the taxpayers could be devastating.

The big banks endanger our economy and our democracy. Our government is representative of banks and other moneyed interests, not the ordinary citizens. This is not what our democratic republic was founded on. The Founding Fathers would be horrified. They warned of the abusive power and corrupting influence of big banks, and their warnings have not been heeded.

We ignore them at our own peril.

"I sincerely believe that banking institutions are more dangerous than standing armies; and that the principle of spending money to be paid by posterity is but swindling futurity on a large scale."

"The end of democracy, and the defeat of the American revolution will occur when government falls into the hands of the lending institutions and moneyed incorporations." – Thomas Jefferson

Friday, April 23, 2010

What Good is the SEC?

The Securities and Exchange Commission should be relabeled "Sycophants Exhibiting Cronyism."

We now know that before it collapsed, Lehman Brothers was manipulating its books through a mechanism called Repo 105.

Using this scam, assets were shifted off Leman's books at the end of each quarter in exchange for cash. This was done via a clever accounting maneuver that made its leverage levels look lower than they really were. Then Lehman would bring the assets back onto its balance sheet days after issuing its earnings report.

Lehman was determined to make its quarterly reports look more appealing by any means necessary.

To create the appearance that its leverage levels were within reason, Lehman would “sell” assets (typically highly liquid government securities) to another firm in exchange for cash, which it would then use to pay down its debt. The assets were typically worth 105 percent of the cash Lehman received. Several days later, after reporting its earnings, it would subsequently repurchase the assets.

Normally, this would be considered a loan, or repurchase agreement, but instead it was booked as a sale.

Massive sums of money were flowing in and out of Lehman in successive quarters.

According to the examiner’s report, “Lehman reduced its net balance sheet at quarter-end through its Repo 105 practice by approximately $38.6 billion in fourth quarter 2007, $49.1 billion in first quarter 2008, and $50.38 billion in second quarter 2008.”

The latter were the final two quarters before the investment bank's inevitable collapse.

What's even more disturbing is that a team of officials from the Securities and Exchange Commission and the Federal Reserve Bank of New York had moved into Lehman Brothers' headquarters while this scam was being perpetuated. And they were either so inept as not to notice, or they willingly looked the other way.

But that's not the only evidence of the ineptitude or complicity of the SEC, which is ostensibly a regulatory agency.

The litany of the SEC's failures is lengthy and includes missing Bernie Madoff's huge Ponzi fraud for many years.

And, according to the Wall St. Journal, the SEC suspected Texas financier R. Allen Stanford of running a Ponzi scheme as early as 1997 but took more than a decade to pursue him seriously.

A report by the SEC's inspector general says SEC examiners concluded four times between 1997 and 2004 that Stanford's businesses were fraudulent, but each time decided not to go further. The report singles out the former head of the SEC's enforcement office in Fort Worth, Texas, accusing him of repeatedly quashing Stanford probes and then trying to represent Stanford as a lawyer in private practice.

And finally, two years after the financial collapse, the SEC recently charged Goldman Sachs with fraud. The investment bank steered investors into exceptionally risky and unstable mortgage-backed securities put together by a hedge fund that was betting on their failure. Despite Goldman's conflict of interest, the SEC did nothing.

But the SEC is finally paying attention and has suddenly taken an interest in the case. Thank goodness. We can all sleep better now.

Even after being charged with fraud, Goldman announced that it is handing out another $5 billion in bonuses this month. That comes on the heels of $16.2 billion in bonuses granted to employees in January.

The reality is that there is no regulation. The SEC is either inept or complicit. Wall St. has a strangle hold on our government. They have bought and paid for it. After spending so much money, they feel entitled.

Since last year, the Wall St. banking behemoths have spent more than $500 million to derail financial reform; that's $1.4 million per day.

More than 2,500 banking lobbyists were swarming the halls of Congress this week, fighting reform. The sad truth is that the big banks now have five lobbyists for every member of Congress.

The American taxpayers have been, and continue to be, shafted. We foot the bills for failure and receive no protection.

According to the Center for Media and Democracy, the total cost to taxpayers of the Wall Street bailout was $4.6 trillion. Of that, $2 trillion is still outstanding.

And the American taxpayers remain on the hook.

Why anyone would still invest their money with Wall St. banks is a mystery. They are unscrupulous, lying, cheating, scheming and manipulative. They undermine our democracy and our economy.

The next time the crisis occurs, and you can bet it will – count on it – Wall St. should be allowed to go up in flames, whatever the alleged cost.

Wednesday, April 21, 2010

Big Banks Love Status Quo, Will Resist Change

Over the past couple of years, we've all been exposed to news reports using arcane financial terms such as derivatives and credit swaps, which are confusing to many people. But they can be pretty easily explained.

Derivatives are simply bets on what will happen in the future. For example, interest rate swaps are bets that rates will either rise or fall. And, for a few hundred years, farmers safely used transparent derivatives contracts to sell their crops in advance.

Derivatives were regulated until 2000, at which point parties were allowed to buy and sell derivatives on bonds without actually owning the bonds. This is analogous to buying insurance on someone else's house, which provides the perverse incentive to then burn down that house.

Through deregulation, banks and hedge funds were no longer compelled to trade derivatives on public exchanges. Suddenly, banks could set derivatives prices and keep them private, without anyone knowing how much risk they were exposed to.

But now proposals are being put forward to clear up the opaque nature of derivatives so that everyone knows what they're based on, who owns them, which ones are being traded, how many are being traded, and what their value really is.

Under one such proposal, derivatives would once again have to be traded on an exchange, just like stocks and bonds. Swaps would have to be reported to regulators and go through a clearinghouse, or brokerage, to make sure that all parties have enough money to cover their deals.

Some groups, such as farmers, airlines, and manufacturers would be exempt, allowing them to continue using derivatives to protect themselves from the wild price swings of commodities.

Another proposal goes even further by requiring banks to spin off their derivatives-trading business or lose their FDIC insurance and access to Federal Reserve credit.

The idea is to prevent banks from engaging in the kind of risky trading that brought the financial sector, and subsequently the US economy, to its knees. Depositors and taxpayers were unfairly put at risk by this sort of gambling.

Re-regulation, the reduction of unsound risk-taking and the protection of taxpayers sounds reasonable, right?

Not to Republicans, who see this proposal as "overly regressive and bureaucratic," in the words of Senator Judd Gregg. They worry that putting derivatives on exchanges would simply move off-shore the type of gambling that nearly destroyed AIG and put taxpayers on the hook to save it.

Banks and other financial institutions fear transparency and want US taxpayers to continue backing their unsound bets. The banker's threats to move off-shore if re-regulated are nothing more than idle threats.

And if some banks refuse to be regulated and do move off-shore, that would be a good thing. If they no longer have FDIC insurance, they will no longer endanger depositors and taxpayers.

Naturally, financial firms are fighting these proposals. They don't like regulation and want the ability to continue doing whatever they choose.

Naturally, the biggest banks, like Goldman Sachs and JP Morgan, don't want to revert to the days when their clients could compare prices for services — the days when trades were transparent. That's not the sort of free market Big Banks like.

Absent transparent pricing, the Big Five derivatives dealers can charge whatever they want for these derivatives products, substantially boosting profits. For example, JP Morgan makes at least $700 million a year through derivatives trading.

This affects more than just farmers. Speculating in the unregulated derivatives market has increased the cost of home heating oil by about a $1 per gallon, according to some estimates.

However, the banking industry is trying to make the case that derivatives are actually good for the economy and that regulating them would somehow decrease lending and credit to consumers and businesses.

Such a suggestion is patently absurd and is designed to scare the ignorant.

Hopefully, not too many of our members of Congress are among them.

Perhaps that's too optimistic.

Friday, April 16, 2010

Is China's Real Estate Bubble A Global Economic Threat?

Charlie Rose recently conducted an revealing interview with James Chanos, the founder and president of the hedge fund Kynikos, which manages roughly $6 billion. Kynikos specializes in short selling, or betting against investments that it considers overvalued.

Ten years ago, Chanos bet against Enron, predicting that it was on the brink of ruin. He was right, and his bet paid off handsomely.

Chanos now predicts that the Chinese real estate market is overheated, overvalued, and headed towards a similar fate. In fact, he calls it a "world-class property bubble."

The problem, as Chanos sees it, exists primarily with high-rise buildings of offices and condos.

As Chanos defines it, "A bubble is any kind of debt-fueled asset inflation where people are borrowing money to buy the asset, where the cash flow generation from the asset itself — a rental property, office building — does not cover the debt service and the debt incurred to buy the asset.

"So you depend on a greater fool, if you will. I think Hyman Minsky called it the 'Ponzi finance', meaning you need the greater fool to come in and buy it at a higher price because, as an income-producing property, it’s not going to do it. And that’s certainly case in China right now."

In 2009, Chinese real estate went up 50 percent. But the amazing thing is that a lot of those apartments are empty.

According to Chanos, when you buy a high-end apartment in China, you get an empty shell that doesn't even come with internal walls or floors. And the investors who buy more than one property typically keep them empty because it’s much easier to sell an unoccupied apartment to the next speculator, who will, in turn, flip it.

Chinese developers are planning extravagant projects like indoor ski resorts and a new Times Square in suburban Beijing that will include 32 Broadway theaters.

The stunning reality is that 50-60% of China's GDP is construction, so the government — determined to promote vigorous growth — is letting this bubble expand. According to Chanos, too much construction has been geared toward real estate development and not enough toward infrastructure, such as airports and high-speed rail.

And the problem is that the real estate being built is not for the masses. It is not affordable housing for the middle-class; it's all high-end condos and office buildings.

The typical new Chinese condo is 1,100 square feet and costs between $100,000-$150,000. However, the typical two-income Chinese couple in their 30s makes approximately $7,000 or $8,000 a year. That just doesn't add up, notes Chanos.

Since China doesn't have property taxes, state and local governments make almost all their money from land developments. Chanos says many of them simply recycle bank loans to do more land speculation and raise more government revenues. So these governments have taken on a lot of debt. And when these debts go bad, Chanos says China will have to nationalize a lot of them.

This already happened in China during the mid-’90s, when there was a banking crisis. Property prices collapsed. The government nationalized the bad debts and the private equity investors got burned.

In Chanos' estimation, the bubble will likely burst and run its course in late 2010 or in 2011. And when that happens, all the foreign investment money will want to escape intact. But will it? Will the government allow this? Will the government simply inflate the currency to bail out everyone, including foreign investors?

China is facing a lot of pressure to revalue its currency higher relative to the dollar. But if China has to nationalize lots and lots of bad real estate debts, its currency — the renminbi — may be devalued. That could potentially spark a trade war.

The Chinese government has a lot riding on this. They are determined to – they need to – maintain the country's exceptional GDP growth. Their $500 billion stimulus package last year proves this. And Chanos says a lot of that money ended up in real estate.

As Harvard economist Kenneth Rogoff has noted, "In my work on the history of financial crises, we find that debt-fueled real estate price explosions are a frequent precursor to financial crisis."

Imagine if the Chinese government has to use its US currency reserves to solve its own financial and economic crises. Imagine if it has to sell off its US Treasuries to fill the void?

Why does all of this matter to America? The concern is that there are similarities between the Chinese bubble and the American housing bubble, which led to the global economic meltdown.

If the Chinese bubble bursts, it would affect all US companies that sell commodities to China, particularly the variety that go into construction, such as steel, most of which goes to China at present.

What the Chinese may soon come realize in their experiment with capitalism is that, without capital, there is no capitalism.

Tuesday, April 13, 2010

Greek Bailout Plan May Be Template for the PIIGS

Last weekend, European leaders agreed to provide Greece with up to $41 billion in aid – if requested - to meet its giant debt obligations.

Under the plan, Greece would receive three-year loans at about 5% interest. Though Athens had wanted an even lower rate, beggars can't be choosers.

However, the rate is still significantly lower than what the markets were demanding last week.

The yield on 2-year Greek bonds had recently soared from 5.2% to 7.5% in a single week, to an 11-year high.

In addition to the $40 billion in European Union aid, the IMF will offer up to $20 billion in additional funds, probably at an even lower interest rate.

The hope is that the huge financial commitment, which exceeded market expectations, will at least postpone the need for aid by reassuring investors. Greece needs to refinance $20 billion (11.5 billion euros) of debt that comes due by the end of next month.

Greece has not yet made a formal request for aid, and hopes to avoid drawing on the EU and IMF money. Instead, it continues to turn to the capital markets, which may work for a while.

The future cost of government borrowing fell sharply in Athens today, and the danger of default receded, if only temporarily.

Greece was able to auction 1.56 billion euros worth of six and 12-month treasury bills today. However, the markets didn't seem entirely reassured.

The interest rate was punishingly high compared to Greece's previous short-term debt auction; the yield on the six-month bond was 4.55%, while the 12-month bond was 4.85%. Both yields are more than twice what they were in January.

However, they were still lower than the 5% offered under the EU bailout offer. And the demand for both was very heavy.

Due to the perceived risk of it defaulting on its debts, Greek borrowing costs are much higher than its eurozone partners.

Greece had been hoping that the rescue package offer would restore market confidence and drive rates down. The government has said it cannot go on paying elevated market interest rates as it seeks to roll over its debt obligations and avoid default or a bailout.

The Mediterranean nation still has to borrow around 11 billion euro ($14.9 billion) next month, and around 54 billion euro ($73 billion) for the year.

Analysts are concerned that the country's weak growth prospects may prevent it from paying off its enormous debt burden in coming years.

However, no one seems to be asking how taking on even more debt will help the Greeks solve their debt problem.

After adopting the euro nine years ago, Greece saw its interest rates drop to German levels. Subsequently, the Greek government – and Greek consumers – responded by going on a borrowing binge.

Sound familiar, America?

All 16 eurozone nations would take part in any rescue, with contributions based on the proportion they pay into the European Central Bank's capital reserves, which are roughly based on the size of their economies.

That means Germany would shoulder the biggest share of any rescue package and could be asked to contribute more than 6 billion euros.

However, even countries such as Portugal, Ireland and Spain – who are all facing their own economic difficulties resulting from massive debts – have agreed to participate in any potential Greek bailout.

The concern of the other eurozone nations is that this could create a template for the future bailouts of these debt-stricken European nations as well.

Perhaps that's why Jean-Claude Juncker, head of the eurozone finance ministers, described the weekend aid decision as "a loaded gun."

Sunday, April 11, 2010

The Government's Goal: Inflate Away The Debt

The Federal budget is $3.6 trillion. Federal revenues are $2.4 trillion. Even the math-challenged among us can see that this has lead to a budget deficit of $1.2 trillion.

In other words, one-third of the federal budget is deficit-driven spending, and it financed through the sale of US Treasuries.

However, the government not only needs to sell bonds to finance its deficit, it also needs to pay off the holders of presently maturing bonds.

Decades of accruing deficits have led to a national debt that will likely reach $14 trillion by year's end – roughly equal to GDP.

With the economy creeping along due only to the government's deficit spending, we will not grow our way out of our mounting debt troubles. In other words, economic growth will not offset our burdensome debt-to-GDP ratio.

The Federal Reserve and the government know this. So their only hope is to attempt to inflate their way out the burgeoning crisis. That's because inflation reduces the value of the dollar.

Since our debts are based on a specific dollar amount and not a specific value, the less our dollars are worth, the easier it will be for us to pay off our debts.

Neither the Fed nor the government will admit this, but that's the reality.

Inflation will hurt those who have avoided debt and instead saved money. And it is the very thing that so many economists — not to mention most Americans — fear. Yet, that is the objective of those in charge. So, all we can do is try to prepare ourselves.

This is not an environment for savers. Holding dollars is punitive in an inflationary environment since money can lose value rapidly.

The Fed will continue to print dollars backed by nothing, with no consideration of their relation to the goods or services in our economy. And they will then repay holders of US debt with devalued money.

Unfortunately, millions of those people are Americans.

Saturday, April 10, 2010

Unpaid Mortgages Fueling Consumer Spending

The latest report from Lender Processing Services shows that mortgage delinquencies have reached an all-time high.

More than 7.4 million home loans nationwide are in some stage of delinquency or foreclosure. And another one million properties are either bank-owned or have been sold out of foreclosure.

But what's truly stunning is that 10% of all U.S. loans are delinquent.

And that huge volume of delinquent loans virtually assures another wave of foreclosures.

In addition, as of last fall, 25% of all US mortgages were underwater. Things haven't improved since then.

It's hard to know exactly how many, but a huge number of Americans are no longer paying their mortgages. They are waiting for loan modifications, or for a judge to order them to vacate.

Not making that monthly payment has put a lot more spending money in the hands of many Americans, and that is fueling national spending.

Consumer spending increased 0.3% in February, marking the fifth straight month with an increase.

But unemployment remains uncomfortably high, and even those who haven't lost their job or their home know how challenging this economic environment is for millions of fellow Americans.

That concern, or worry, is why the Conference Board's Consumer Confidence Index stood at 52.5 in March. The economy is considered stable only when the reading surpasses 90.

Though Americans also dipped into their savings to help fuel spending in February, all the money not going into mortgage payments is surely boosting the overall spending numbers.

That's creating a bit of an illusion, albeit one that won't last indefinitely.

To date, most loan modifications haven't worked, and huge numbers of adjustable-rate mortgages that haven't even reset yet are already delinquent or in various stages of foreclosure. By September, $71 billion of interest-only loans will have reset over the preceding 12 months.

That indicates that there will be a lot more foreclosures. And when the sheriff shows up to order people to vacate their premises, the days of living for free will be over.

As that occurs, there be a lot less discretionary spending flowing into the US economy.

Wednesday, April 07, 2010

US Natural Gas Supplies Overestimated

The Energy Department says it has been overstating US natural-gas output for quite some time.

Each month, the Energy Information Administration releases gas-production data, known as the 914 report. The report is supposed to indicate how much natural gas the US produces, how much we have in stockpiles, and how much the nation is using.

Among other things, the data helps predict future natural-gas prices.

The problem is that the 914 report doesn't reflect the production swings of hundreds of small producers. And that has led to an overstatement of gas supplies of up to 10-12%, according to analysts.

That's a significant miscalculation, and the overestimate was responsible for pushing prices to seven-year lows in 2009.

The depressed prices may not last much longer. For its future reports, the agency will use new methods to estimate gas supplies. The January and February numbers will be revised later this month. The numbers for all of 2009 will also be updated, but those numbers won't be available until late fall.

Some commodities analysts have long suspected that the EIA was overstating domestic natural-gas output. For example, the EIA data showed that gas supply rose 4% in 2009, despite a 60% decline in onshore gas rigs.

However, the new methods of collecting data will likely lead to a downward revision of the nation's gas production. And that will ultimately affect gas prices.

Ben Dell, an analyst with Sanford C. Bernstein, believes production is actually falling. When that is fully realized, gas prices will be pushed "much higher," he says.

The monthly EIA reports contain what is known as the "Balancing Item", which represents the difference between the supply of natural gas and the demand for it. It is supposed to account for any discrepancies.

However, the numbers have not always added up, meaning that EIA data either overstates production or understates demand, or a combination if the two.

Either way, markets rely on accurate information to determine supply, demand and pricing. It's self-evident that if production has been overestimated, prices have been inaccurate for some time.

That's about to change.

Natural gas prices have already shot up 11% just this week.

Monday, April 05, 2010

World Energy Demand Unexpectedly Increases

One of the only benefits of a global recession was supposed to be a reduced demand for energy, particularly for transportation fuels, such as oil.

Surprisingly, that's not happening.

Despite the global recession, the International Energy Association has increased its forecast for global oil demand this year by 1.8%, to 86.6 million barrels a day.

It's a rather remarkable development since most previous estimates foresaw world usage dipping this year.

Though the IEA predicted that demand in developed countries would fall by 0.3%, it also predicts a rising demand from emerging markets, with half of all growth coming from Asia.

In fact, the IEA said that China's demand for oil jumped by an "astonishing" 28% in January compared with the same month a year earlier.

It appears that meeting this rising global demand will be a long term challenge.

On March 23, the Smith School of Enterprise and the Environment published a paper stating that the capacity to meet projected future oil demand is at a tipping point and that we need to accelerate the development of alternative energy fuel resources in order to ensure energy security and reduce emissions.

The Status of Conventional Oil Reserves – Hype or Cause for Concern?, published in the journal Energy Policy, concludes that the age of cheap oil has now ended and demand will start to outstrip supply as we head towards the middle of the decade.

The report also suggests that the current oil reserve estimates should be downgraded from between 1150-1350 billion barrels to between 850-900 billion barrels, based on recent research.

Overcoming such potential oil shortages will be a vexing challenge.

The world is currently consuming nearly 87 million barrels of oil daily, an annual total amounting to nearly 32 billion barrels. But with the developing world continually using ever greater quantities of oil, that amount will only grow in the coming years.

However, according to a research paper by Joyce Dargay of the University of Leeds and Dermot Gately of New York University, official forecasts by OPEC and the U.S. Department of Energy may be underestimating the future demand for oil by 30 million barrels a day.

If this is accurate, the next oil crisis is going to be life altering for all of us.

Dargay and Gately base their conclusion on the observation that the demand for oil no longer appears to respond to price. While price increases in the 1970s placed downward pressure on the worldwide demand for the fuel, the increased oil prices of the past decade had no such effect. Instead, worldwide demand for oil increased by 4% during that time.

Dargay and Gately project that per-capita oil demand will grow to 138 million barrels a day in 2030.

If that's accurate, the supply of oil won't even begin to keep up with increasing global demand. Peak Oil is upon us, and recent oil finds have been far too small to make an appreciable difference in overall supplies.

Oil companies are having to go into ever deeper waters, at ever-increasing expense, just retrieve the finest oil. That's because the cheaper, easier to access, land-based oil supplies are clearly in decline.

For example, the once-mighty Cantarell field was the third-largest oil field in the world. Today, it's one of the chief reasons why Mexico's oil exports are shriveling. That poses a critical problem for the U.S. since Mexico is the number two exporter to our nation, following Canada.

It's an example of why there is now such an interest in oil sands, which result in a heavier, lower-grade, harder-to-refine oil. Oil sands are also much more expensive to refine, resulting in higher prices for consumers.

Here's the reality; there's still plenty of oil left in the earth, just not cheap oil. Those days are over. Simple market forces are revealing that there is not enough oil to keep up with rising global demand, and as in any market, that means rising prices.

Eventually, and much sooner than most people realize, the margin of supply will shrink to the point that our lives, and our modern economy, will be irrevocably affected.