Category Archives: Chinese economy

China Update – The Beatings Will Continue Until Morale Improves

It’s essentially illegal to short a stock in China today.

This developed in response to the more than 40  percent drop in market value  of most stocks– as in the chart for Shenzhen Index B shown below.

shenzhen

B shares (Chinese: B股, officially Domestically Listed Foreign Investment Shares) on the Shanghai and Shenzhen stock exchanges refers to those that are traded in foreign currencies. Shares that are traded on the two mainland Chinese stock exchanges in Renminbi, the currency in mainland China, are called A shares.

China Seen Delaying Shenzhen Stock Link Until 2016 Amid Turmoil

Chinese authorities have gone to extreme lengths to prop up the stock market as both the Shanghai Composite Index and the Shenzhen Composite Index lost more than 40 percent from their June highs. They’ve banned major shareholders from selling stakes, armed a state-run margin trader with billions of dollars to buy equities, allowed hundreds of companies to halt their shares and placed curbs on bearish bets in the futures market.

One casualty has been the World’s Biggest Stock-Index Futures Market

Volumes in the country’s CSI 300 Index and CSI 500 Index futures sank to record lows on Wednesday after falling 99 percent from their June highs. Ranked by the World Federation of Exchanges as the most active market for index futures as recently as July, liquidity in China has dried up as authorities raised margin requirements, tightened position limits and started a police probe into bearish wagers.

China’s Response to Stock Plunge Rattles Traders

A business journalist has been detained and shown apologizing on national television for writing an article that could have hurt the market.

Caijin

Apparently, the beatings will continue until morale improves.

The spectacle of Wang Xiaolu, reporter at a Chinese business publication, enacting Monday what authorities called a confession of spreading “panic and disorder” in the stock market through his reporting should scare investors.

The announcement Sunday by China’s Ministry of Public Security that 197 people had been punished for spreading rumors about stocks and other issues should scare investors.

That the head of hedge fund manager Man Group Plc’s China unit has been taken into custody, as reported by Bloomberg on Monday, should scare global investors.

This is not to say that China isn’t capable of browbeating and arm-twisting and public money spending its way to a higher stock market. China asked brokerages to increase their support of a market rescue fund by 100 billion yuan last week, according to reports, a move perhaps tied to a desire for a rally, or at least stability, ahead of Thursday’s parade commemorating victory over Japan…….

They do know that a huge country is scared so badly of something that they will not, cannot, allow things to be said that cause stocks to fall.

Reflections

These strong-arm tactics go beyond anything seen in the West, in terms of damage control. Transparency,  an key feature in financial analysis, has been thrown out the window. With Goons going around bullying people to hold stocks that have lost 40 percent of their value, pressing journalists to keep quiet about problems in the market, it is a strange world in Chinese finance and stocks. People “disappear” – no record of arrest being announced.

There is no question but that Chinese macroeconomic statistics must also be viewed in a more skeptical light.

This makes assessment of the Chinese slowdown more difficult.

Recent Events in the US Stock Market

The recent drop in US stocks is dramatic, as the steep falloff of the SPY exchange traded fund (ETF) Monday, August 24th– almost the most recent action in the chart – shows.

SPYAUG26

At the same time, this is by no means the steepest drop in closing prices, as the following chart of daily returns highlights.

SPYDailyReturns

TV commentators and others point to China and the prospective liftoff of US short term interest rates, with the Federal Reserve finally raising rates off the zero bound in – it was thought – September.

I have been impressed at the accuracy of Michael Pettis’ predictions in his China Financial Markets. Pettis has warned about a debt bubble in China for two years and consistently makes other correct calls. I have some first-hand experience doing business in China, and plan a longer post of the collapse of Chinese stock markets and the economic slowdown there.

You can imagine, if you will, a sort of global input-output table with a corresponding table of import/export flows. China has gotten a lot bigger since 2008-2009, absorbing significant amounts of the global output of iron and steel, oil, and other commodities.

Also, in 2008-2009 and in the earlier recession of 2001, China led the way to greater spending, buoying the global economy which, otherwise, was in sad shape. That’s not going to happen this time, if a real recession takes hold.

All very scary, but while the latest stuff took place, this is what I was doing.

CliveChair

In other words, I was the father of the groom at a splendid wedding for my younger son at the Pearl Buck estate just outside Philadelphia.

Well, that wonderful thing being done, I plan to return to more frequent posting on BusinessForecastblog.

I also apologize for having the tools to predict the current downturn, at least after developments later last week, and not signaling readers.

But frankly, I’m not sure the extreme value prediction algorithms (EVPA) reliably predict major turning points. In fact, there seem to be outside influences at key junctures. However, once a correction is underway, predictability returns. Thus, the algorithms do more than simply forecast the growth in stock prices. The EVPA also works to predict the extent of downturns.

Here’s a tip. Start watching ratios such as those between  differences between the  opening price in a trading day and the previous day’s high or low price, divided by the previous day’s high or low price, respectively. Very significant predictors of the change in daily highs and lows, and with significance for changes in closing prices, if you bring some data analytics to bear.

Chinese Stock Market Collapse

Chinese stocks are more volatile, in terms of percent swings, than stocks on other global markets, as this Bloomberg chart highlights.

ChinaStockVolatileGlobal

So the implication is maybe that the current bursting of the Chinese stock bubble is not such a big deal for the global economy, or perhaps it can be contained – despite signs of correlations between the Global Stocks and Shanghai Composite series.

Facts and Figures

Panic selling hit the major Chinese exchanges in Shanghai and Shenzeng, spreading now to the Hong Kong exchange.

Trades on most companies are limited or frozen, and major indexes continue to drop, despite support from the Chinese government.

Chinese Trading Suspensions Freeze $1.4 Trillion of Shares Amid Rout

The rout in Chinese shares has erased at least $3.2 trillion in value, or twice the size of India’s entire stock market. The Shenzhen Composite Index has led declines with a 38 percent plunge since its June 12 peak, as margin traders unwound bullish bets.

China: The Stock Market Meltdown Continues

Briefly put, there are few alternatives for saving in China. The formal banking system provides negative returns (low deposit yields, lower than inflation typically). Housing is no longer returning positive capital gains — partly as a consequence of deliberate policy actions to moderate a perceived housing bubble. So, what’s left (given you can’t easily save in overseas assets)? Equities. We have a typical boom-bust phenomenon, amplified by underdeveloped financial markets, opacity in valuations, and uncertainty regarding the government’s intentions (and will-power).

Stock Sell-Off Is Unabated in China (New York Times)

Most of the trades on Chinese exchanges are made by “retail traders,” basically individuals speculating on the market. These individuals often are highly leveraged or operating with borrowed money.

The Chinese markets moved into bubble territory several months back, and when a correction hit and as it accelerated recently, the Chinese government has tried all sorts of stuff, some charted below.

Chinameasures

Public/private funds to buy stocks and slow the fall in their prices have been created, also.

Risks of Contagion

It’s hard for foreign investors to gain access to the Chinese markets, where there are different classes of stocks for Chinese and foreign traders. So, by that light, only a few percent of Chinese stocks are held by foreign interests, and direct linkages between the sharp turn in values in China and elsewhere should be limited.

There may indirect linkages going from the Chinese stock market to the Chinese economy, and then to foreign supplies.

Here’s why the crash in Chinese stocks matters so much to Australia, i.e.  Australian property markets and reduced Chinese demand for iron.

Iron ore demand by China and the drop in Chinese stocks actually seems more related to somewhat independent linkage with the longer term cascade down by Chinese GDP growth, illustrated here (See Ongoing Developments in China).

ChinaGDPgr

But maybe the most dangerous and unpredictable linkage is psychological.

Thus, the Financial Express of India reports Shanghai blues trigger panic selling on Dalal Street, metals feel the heat

Video Friday

Here are some short takes on topics of the day related to the economic outlook for the rest of 2015, nationally and globally.

First a couple of videos on the poor performance of the US economy in the first quarter 2015, when real GDP contracted slightly. This also happened last year, and so there may be a rebound, and, of course, the estimates are released at a significant lag – so we won’t know for a while.

US economy shrank in the first quarter of 2015

U.S. Economy Shrank in First Quarter

Then, a couple of videos on the Chinese stock market crash and condition of the Chinese economy – worrisome since China plays a bigger and bigger role in global business. Bear with the halting English in the first video; there is a payoff in terms of a look from the inside. The second is from a couple of months ago, but is extremely informative vis a vis the big picture.

Stock market of China Falls 16, June 2015

China’s Economy: The Numbers Look Scary

And finally Greece.

Greek crisis in 90 seconds | FT Markets

In closing, I have a comments on technical forecasting issues suggested by the above.

First, “nowcasting” with mixed frequency data should always be applied to these prognostications of what will happen to past economic growth, e.g. the 2nd quarter of 2015. My sense is this is not being done widely, but it’s easy to show its efficacy. There is no reason to drawl on about imponderables, when you can just apply available weekly and monthly data, maybe using MIDAS, to get a better idea of what number we are likely see for the 2nd quarter 2015.

Secondly, I doubt data analytics can provide much light on the situation in China, precisely because there is a lot of evidence the data being announced are suspect. You can go too far in claiming this, but there are warning signs about Chinese data these days. It’s probably comparable to assessing the integrity of Chinese company financials – which see very creative accounting. in certain cases.

As far as Greece goes, I think the outcome is completely unpredictable. Greece is a small economy. If turning Greece away means catastrophic consequences, assistance should be forthcoming, and there are resources available for the size of the problem.  Events, however, may have moved beyond rationality.

The crux of the matter seems to be that there needs to be a way to recirculate funds from the surplus exporters (Germany, largely) to the deficit importers (peripheral Europe).

One proposal is for Germany to create a kind of “New Deal” to invest in the European periphery, so that down the line, their economies can become more balanced and competitive. Another approach, which seems to be that of the Christian Democratic Union (CDU) of Germany, is the neoliberal “solution.” Essentially, force wages and living standards down in debtor countries to the point where they again become globally competitive.

Links – February 2015

I buy into the “hedgehog/fox” story, when it comes to forecasting. So you have to be dedicated to the numbers, but still cast a wide net. Here are some fun stories, relevant facts, positive developments, and concerns – first Links post for 2015.

Cool Facts and Projections

How the world’s population has changed – we all need to keep track of this, 9.6 billion souls by 2050, Nigeria’s population outstrips US.

worldpop

What does the world eat for breakfast?

Follow a Real New York Taxi’s Daily Slog 30 Days, 30 random cabbie journeys based on actual location data

Information Technology

Could Microsoft’s HoloLens Be The Real Deal?

MSHolo

I’ll Be Back: The Return of Artificial Intelligence

BloomAI

Issues

Why tomorrow’s technology needs a regulatory revolution Fascinating article. References genome sequencing and frontier biotech, such as,

Jennifer Doudna, for instance, is at the forefront of one of the most exciting biomedical advances in living memory: engineering the genomes not of plants, but of people. Her cheap and easy Crispr technology holds out the promise that anybody with a gene defect could get that problem fixed, on an individual, bespoke basis. No more one-size-fits all disease cures: everything can now be personalized. The dystopian potential here, of course, is obvious: while Doudna’s name isn’t Frankenstein, you can be sure that if and when her science gains widespread adoption, the parallels will be hammered home ad nauseam.

Doudna is particularly interesting because she doesn’t dismiss fearmongers as anti-science trolls. While she has a certain amount of control over what her own labs do, her scientific breakthrough is in the public domain, now, and already more than 700 papers have been published in the past two years on various aspects of genome engineering. In one high-profile example, a team of researchers found a way of using Doudna’s breakthrough to efficiently and predictably cause lung cancer in mice.

There is more on Doudna’ Innovative Genomics Initiative here, but the initially linked article on the need for regulatory breakthrough goes on to make some interesting observations about Uber and Airbnb, both of which have thrived by ignoring regulations in various cities, or even flagrantly breaking the law.

China

Is China Preparing for Currency War? Provocative header for Bloomberg piece with some real nuggets, such as,

Any significant drop in the yuan would prompt Japan to unleash another quantitative-easing blitz. The same goes for South Korea, whose exports are already hurting. Singapore might feel compelled to expand upon last week’s move to weaken its dollar. Before long, officials in Bangkok, Hanoi, Jakarta, Manila, Taipei and even Latin America might act to protect their economies’ competitiveness…

There’s obvious danger in so many economies engaging in this race to the bottom. It will create unprecedented levels of volatility in markets and set in motion flows of hot money that overwhelm developing economies, inflating asset bubbles and pushing down bond rates irrationally low. Consider that Germany’s 10-year debt yields briefly fell below Japan’s (they’re both now in the 0.35 percent to 0.36 percent range). In a world in which the Bank of Japan, the European Central Bank and the Federal Reserve are running competing QE programs, the task of pricing risk can get mighty fuzzy.

Early Look: Deflation Clouds Loom Over China’s Economy

The [Chinese] consumer-price index, a main gauge of inflation, likely rose only 0.9% from a year earlier, according to a median forecast of 13 economists surveyed by the Wall Street Journal

China’s Air Pollution: The Tipping Point

Chinapollution

Energy and Renewables

Good News About How America Uses Energy A lot more solar and renewables, increasing energy efficiency – all probably contributors to the Saudi move to push oil prices back to historic lows, wean consumers from green energy and conservation.

Nuclear will die. Solar will live Companion piece to the above. Noah Smith curates Noahpinion, one of the best and quirkiest economics blogs out there. Here’s Smith on the reason nuclear is toast (in his opinion) –

There are three basic reasons conventional nuclear is dead: cost, safety risk, and obsolescence risk. These factors all interact.            

First, cost. Unlike solar, which can be installed in small or large batches, a nuclear plant requires an absolutely huge investment. A single nuclear plant can cost on the order of $10 billion U.S. That is a big chunk of change to plunk down on one plant. Only very large companies, like General Electric or Hitachi, can afford to make that kind of investment, and it often relies on huge loans from governments or from giant megabanks. Where solar is being installed by nimble, gritty entrepreneurs, nuclear is still forced to follow the gigantic corporatist model of the 1950s.

Second, safety risk. In 1945, the U.S. military used nuclear weapons to destroy Hiroshima and Nagasaki, but a decade later, these were thriving, bustling cities again. Contrast that with Fukushima, site of the 2011 Japanese nuclear meltdown, where whole towns are still abandoned. Or look at Chernobyl, almost three decades after its meltdown. It will be many decades before anyone lives in those places again. Nuclear accidents are very rare, but they are also very catastrophic – if one happens, you lose an entire geographical region to human habitation.

Finally, there is the risk of obsolescence. Uranium fission is a mature technology – its costs are not going to change much in the future. Alternatives, like solar, are young technologies – the continued staggering drops in the cost of solar prove it. So if you plunk down $10 billion to build a nuclear plant, thinking that solar is too expensive to compete, the situation can easily reverse in a couple of years, before you’ve recouped your massive fixed costs.

Owners of the wind Greenpeace blog post on Denmark’s extraordinary and successful embrace of wind power.

What’s driving the price of oil down? Econbrowser is always a good read on energy topics, and this post is no exception. Demand factors tend to be downplayed in favor of stories about Saudi production quotas.

Links – End of 2014

Well, Happy New Year coming up, and here are some great links!

Here are 38 maps that explain the global economy An outstanding collection, including amazing favorites, such as Open Defecation in India and alcohol consumption

globalalcoholconsumption

Speaking of India, though – India launches biggest ever rocket into space

thegeostatio

The new rocket, weighing 630 tonnes and capable of carrying a payload of 4 tonnes, is a boost for India’s attempts to grab a greater slice of the $300-billion global space market.

Keeping the focus on Asia –

China is Planning to Purge Foreign Technology and Replace With Homegrown Suppliers Bloomberg – this could be big if it can be implemented.

China is aiming to purge most foreign technology from banks, the military, state-owned enterprises and key government agencies by 2020, stepping up efforts to shift to Chinese suppliers, according to people familiar with the effort.

The push comes after a test of domestic alternatives in the northeastern city of Siping that was deemed a success, said the people, who asked not to be named because the details aren’t public. Workers there replaced Microsoft Corp.’s (MSFT) Windows with a homegrown operating system called NeoKylin and swapped foreign servers for ones made by China’s Inspur Group Ltd., they said.

The plan for changes in four segments of the economy is driven by national security concerns and marks an increasingly determined move away from foreign suppliers under President Xi Jinping, the people said. The campaign could have lasting consequences for U.S. companies including Cisco Systems Inc. (CSCO), International Business Machines Corp. (IBM), Intel Corp. (INTC) and Hewlett-Packard Co.

Why Christmas Is Huge in China

Christmas is “an excuse to party” whereas Chinese festivals are comparatively “solemn, serious, and spiritual,”

4e19ba881

2015 looks like it is going to be a big year for economic news, with many forecasting opportunities.

Links – Beginning of the Holiday Season

Economy and Trade

Asia and Global Production Networks—Implications for Trade, Incomes and Economic Vulnerability Important new book –

The publication has two broad themes. The first is national economies’ heightened exposure to adverse shocks (natural disasters, political disputes, recessions) elsewhere in the world as a result of greater integration and interdependence. The second theme is focused on the evolution of global value chains at the firm level and how this will affect competitiveness in Asia. It also traces the past and future development of production sharing in Asia.

Chapter 1 features the following dynamite graphic – (click to enlarge)

GVC2009

The Return of Currency Wars

Nouriel Roubini –

Central banks in China, South Korea, Taiwan, Singapore, and Thailand, fearful of losing competitiveness relative to Japan, are easing their own monetary policies – or will soon ease more. The European Central Bank and the central banks of Switzerland, Sweden, Norway, and a few Central European countries are likely to embrace quantitative easing or use other unconventional policies to prevent their currencies from appreciating.

All of this will lead to a strengthening of the US dollar, as growth in the United States is picking up and the Federal Reserve has signaled that it will begin raising interest rates next year. But, if global growth remains weak and the dollar becomes too strong, even the Fed may decide to raise interest rates later and more slowly to avoid excessive dollar appreciation.

The cause of the latest currency turmoil is clear: In an environment of private and public deleveraging from high debts, monetary policy has become the only available tool to boost demand and growth. Fiscal austerity has exacerbated the impact of deleveraging by exerting a direct and indirect drag on growth. Lower public spending reduces aggregate demand, while declining transfers and higher taxes reduce disposable income and thus private consumption.

Financial Markets

The 15 Most Valuable Startups in the World

Uber is among the top, raising $2.5 billion in direct investment funds since 2009. Airbnb, Dropbox, and many others.

The Stock Market Bull Who Got 2014 Right Just Published This Fantastic Presentation I especially like the “Mayan Temple” effect, viz

MayanTemple

Why Gold & Oil Are Trading So Differently supply and demand – worth watching to keep primed on the key issues.

Technology

10 Astonishing Technologies On The Horizon – Some of these are pretty far-out, like teleportation which is now just gleam in the eye of quantum physicists, but some in the list are in prototype – like flying cars. Read more at Digital Journal entry on Business Insider.

  1. Flexible and bendable smartphones
  2. Smart jewelry
  3. “Invisible” computers
  4. Virtual shopping
  5. Teleportation
  6. Interplanetary Internet
  7. Flying cars
  8. Grow human organs
  9. Prosthetic eyes
  10. Electronic tattoos

Albert Einstein’s Entire Collection of Papers, Letters is Now Online

Princeton University Press makes this available.

AEinstein

Practice Your French Comprehension

Olivier Grisel, Software Engineer, Inria – broad overview of machine learning technologies. Helps me that the slides are in English.

China – Trade Colossus or Assembly Site?

There is a fascinating paper – How the iPhone Widens the United States Trade Deficit with the People’s Republic of China. In this Asian Bank Development Institute (ADBI) white paper, Yuqing Ying and his coauthor document the value chain for an Apple iPhone:

IPhone

The source for this breakout, incidentally, is a “teardown” performed by the IT market research company iSupply, still accessible at –https://technology.ihs.com/389273/iphone-3g-s-carries-17896-bom-and-manufacturing-cost-isuppli-teardown-reveals. In other words, iSupply physically took apart an iPhone to identify the manufacturers of the components.

The Paradox

After estimating that, in

2009 iPhones contributed US$1.9 billion to the trade deficit, equivalent to about 0.8% of the total US trade deficit with the PRC,

the authors go on to point out that

..most of the export value and the deficit due to the iPhone are attributed to imported parts and components from third countries and have nothing to do with the PRC. Chinese workers simply put all these parts and components together and contribute only US$6.5 to each iPhone, about 3.6% of the total manufacturing cost (e.g., the shipping price). The traditional way of measuring trade credits all of the US$178.96 to the PRC when an iPhone is shipped to the US, thus exaggerating the export volume as well as the imbalance. Decomposing the value added along the value chain of iPhone manufacturing suggests that, of the US$2.0 billion worth of iPhones exported from the PRC, 96.4% in fact amounts to transfers from Germany (US$326 million), Japan (US$670 million), Korea (US$259 million), the US (US$108 million), and other countries (US$ 542 million). All of these countries are involved in the iPhone production chain.

Yuqing Xing builds on the paradox in his more recent China’s High-Tech Exports: The Myth and Reality published in 2014 in MIT’s Asian Economic Papers.

Prevailing trade statistics are inconsistent with trade based on global supply chains and mistakenly credit entire values of assembled high-tech products to China. China’s real contribution to the reported 82 percent high-tech exports is labor not technology. High-tech products, mainly made of imported parts and components, should be called “Assembled High-tech.” To accurately measure high-tech exports, the value-added approach should be utilized with detailed analysis on the value chains distributions across countries. Furthermore, if assembly is the only source of value-added by Chinese workers, in terms of technological contribution these assembled high-tech exports are indifferent to labor-intensive products, and so they should be excluded from the high-tech classification.

MNEs, in particular Taiwanese IT firms in China, have performed an important role in the rapid expansion of high-tech exports. The trend of production fragmentation and outsourcing activities of MNEs in information and communication technology has benefitted China significantly, because of its huge labor endowment. The small share of indigenous firms in high-tech exports implies that China has yet to become a real competitor of the United States, EU, and Japan. That China is the number one high-tech exporter is thus a myth rather than a reality.

Ying and Yang

This perspective – that it is really “value-added” that we should focus on, rather than the total dollar volume of trade coming in or going out of a country – is interesting, but I can’t help but think there is a disconnect when you consider actual Chinese foreign exchange reserves, shown below (source – http://www.stats.gov.cn/tjsj/ndsj/2013/indexeh.htm).

ChinaFER

So currently China holds nearly 3.5 trillion dollars in foreign exchange reserves – most of which, but not all, is comprised of US dollars.

This is a huge amount of money, on the order of five percent of total global GDP.

How could China have accumulated this merely by being an assembly site for high tech and other products (see Five Facts about Value-Added Exports and Implications for Macroeconomics and Trade Research)? How can this be attributable just to mistakes in counting the origin of the many components in goods coming from China? Don’t those products have to come in and be counted as imports?

There is a mystery here, which it would be good to resolve.

Assembly photo at top from Apple Insider

China Passes US in Terms of Purchasing Power Parity

The International Monetary Fund (IMF) announced recently that Chinese GDP passed that of the United States – in terms of purchasing power parity (PPP).

Business Insider charts the relative sizes of the Chinese and US economies in terms of total global output, where, again, production is measured in terms of purchasing power output.

ChinaUS

According to the World Bank,

Purchasing power parity conversion factor is the number of units of a country’s currency required to buy the same amount of goods and services in the domestic market as a U.S. dollar would buy in the United States.

In a less serious vein, the Economist magazine maintains the Big Mac Index. This is informative, however, inasmuch as MacDonalds outlets range across the globe.

In July of this year, the Economist lists the US price of a Big Mac hamburger as $4.80.

China is among the cheapest places to buy a Big Mac, as shown in this table from Economist data.

BIGMAClist

The China Big Mac Index, therefore, is 0.57, suggesting Chinese yuan purchase almost twice the actual goods and services in China, as their dollar exchange rate would suggest.

Or to do this calculation based on the current exchange rate, 1 US dollar buys 6.41 Chinese 1 yuan.

So, if the local price has not changed, 16.9 yuan buy a Big Mac, indicating that a Big Mac now has a dollar price of $2.63. Then, if today’s Big Mac still costs $4.80, the renmimbi buys 4.8/2.63 or 1.83 times as much as its market exchange rate indicates. Hence, according to a Big Mac type index evaluation, the renmimbi is undervalued.

This is a pretty good calculation, according to the World Bank, which lists the conversion factor as 0.7.

Of course, there are four to five times as many residents of the People’s Republic of China, as there are US residents. Per capita Chinese incomes, accordingly, are four to five times lower, even in terms of purchasing power parity.

And in terms of market exchange values, the IMF estimates 2014 Chinese GDP at 10,355 billion dollars, compared with $17,416 billion for the US.

The rise of Chinese production has been truly spectacular, as this chart of Chinese GDP shows, based on official Chinese statistics.

ChinaGDPgraph

There are a lot of other remarkable charts that can be pulled together about China, and I am planning several future posts along these lines.

See you this coming week!

Chinese official courtesy of Wikipedia

The Limits of OPEC

There’s rampant speculation and zero consensus about the direction OPEC will take in their upcoming Vienna meeting, November 27.

Last Friday, for example. Bloomberg reported,

The 20 analysts surveyed this week by Bloomberg are perfectly divided, with half forecasting the Organization of Petroleum Exporting Countries will cut supply on Nov. 27 in Vienna to stem a plunge in prices while the other half expect no change. In the seven years since the surveys began, it’s the first time participants were evenly split. The only episode that created a similar debate was the OPEC meeting in late 2007, when crude was soaring to a record.

Many discussions pose the strategic choice as one between –

(a) cutting production to maintain prices, but at the cost of losing market share to the ascendant US producers, and

(b) sustaining current production levels, thus impacting higher-cost US producers (if the low prices last long enough), but risking even lower oil prices – through speculation and producers breaking ranks and trying to grab what they can.

Lybia, Ecuador, and Venezuela are pushing for cuts in production. Saudi Arabia is not tipping its hand, but is seen by many as on the fence about reducing production.

I’m kind of a contrarian here. I think the sound and fury about this Vienna meeting on Thanksgiving may signify very little in terms of oil prices – unless global (and especially Chinese) economic growth picks up. As the dominant OPEC producer, Saudi Arabia may have market power, but, otherwise, there is little evidence OPEC functions as a cartel. It’s hard to see, also, that the Saudi’s would unilaterally reduce their output only to see higher oil prices support US frackers continuing to increase their production levels at current rates.

OPEC Members, Production, and Oil Prices

The Organization of Petroleum Exporting Countries (OPEC) has twelve members, whose production over recent years is documented in the following table.

OPECprod

According to the OPEC Annual Report, global oil supply in 2013 ran about 90.2 mb/d, while, as the above table indicates, OPEC production was 30.2 mb/d. So OPEC provided 33.4 percent of global oil supplies in 2013 with Saudi Arabia being the largest producer – overwhelmingly.

Oil prices, of course, have spiraled down toward $75 a barrel since last summer.

WTIchart

Is OPEC an Effective Cartel?

There is a growing literature questioning whether OPEC is an effective cartel.

This includes the recent OPEC: Market failure or power failure? which argues OPEC is not a working cartel and that Saudi Arabia’s ideal long term policy involves moderate prices guaranteed to assure continuing markets for their vast reserves.

Other recent studies include Does OPEC still exist as a cartel? An empirical investigation which deploys time series tests for cointegration and Granger causality, finding that OPEC is generally a price taker, although cartel-like features may adhere to a subgroup of its members.

The research I especially like, however, is by Jeff Colgan, a political scientist – The Emperor Has No Clothes: The Limits of OPEC in the Global Oil Market.

Colgan poses four tests of whether OPEC functions as a cartel -.

new members of the cartel have a decreasing or decelerating production rate (test #1); members should generally produce quantities at or below their assigned quota (test #2); changes in quotas should lead to changes in production, creating a correlation (test #3); and members of the cartel should generally produce lower quantities (i.e., deplete their oil at a lower rate) on average than non-members of the cartel (test #4)

Each of these tests fail, putting, as he writes, the burden of proof on those who would claim that OPEC is a cartel.

Here’s Colgan’s statistical analysis of cheating on the quotas.

OPECquota

On average, he calculates that the nine principal members of OPEC produced 10 percent more oil than their quotas allowed – which is equivalent to 1.8 million barrels per day, on average, which is more than the total daily output of Libya in 2009.

Finally, there is the extremely wonkish evidence from academic studies of oil and gas markets more generally.

There are, for example, several long term studies of cointegration of oil and gas markets. These studies rely on tests for unit roots which, as I have observed, have low statistical power. Nevertheless, the popularity of this hypothesis seems to be consistent with very little specific influence of OPEC on oil production and prices in recent decades. The 1970’s may well be an exception, it should be noted.

We will see in coming weeks. Or maybe not, since it still will be necessary to sort out influences such as quickening of the pace of economic growth in China with recent moves by the Chinese central bank to reduce interest rates and keep the bubble going.

If I were betting on this, however, I would opt for a continuation of oil prices below $100 a barrel, and probably below $90 a barrel for some time to come. Possibly even staying around $70 a barrel.