January 1999 Vol. 220 No. 1  Editorial

Thomas R. Wright, Jr.,  Editorial Director

Hopeful signs

With oil prices around the world hovering at 12-year lows, it’s difficult to embrace the new year with any degree of optimism. A cursory look at what industry’s leading pundits are forecasting reveals a consensus that things won’t get better for at least a year, maybe as long as three. And just about everybody agrees that the "Asian flu" is the prime culprit causing oil supply to exceed oil demand, thus depressing prices.

However, J. Marshal Adkins (along with Research Associate John K. Tysseland) of Raymond James & Associates Inc. has published a study that is more upbeat. Basically, they looked at the Asian economies to see if anything was on the horizon that would improve them and, as a result, boost the consumption and price of oil.

Adkins, et al., began by comparing the decline of the Mexican stock market, which followed peso devaluations in 1994, with recent declines in Asian stock markets and currencies. In the Mexican situation, they found that severe currency devaluations led to severe stock market declines, and these were soon followed (in about 6 months) by GDP contractions. More important, the GDP contractions led to equal percentage declines in oil consumption.

To this point, comparisons of the Mexican and Asian debacles were "frighteningly similar." That is, severe currency and market declines occurring in Asia during late 1997 and early 1998 led to both GDP contractions and reductions in Asian oil consumption. And since the Mexican comparison proved to be an excellent forecaster of the Asian oil consumption decline, the analysts decided to expand their study to see what might be in store for Asian economies and oil consumption over the next year.

Mexico had experienced a relatively stable currency and strong average annual GDP growth from early 1990 through September of 1994. But beginning in September of 1994, the peso suffered a devaluation of more than 50%, which was followed about 6 months later by a 15% decline in GDP.

Following a significant bailout by the International Monetary Fund, the peso stabilized, and some 6 months later, the GDP rebounded sharply. As the peso was stabilizing in mid-1995, the Mexican stock market began to look forward to a potential economic recovery. The INMEX (an index of leading stocks) began to move up as the currency stabilized and preceded the Mexican economic rebound by about 6 months. Even though GDP declined 15% from peak to bottom, the decline lasted only about 6 months. On an annualized basis, GDP fell only 7.5% on a year-to-year basis.

What was surprising was the tight correlation between Mexican GDP and oil consumption. In 1995, oil consumption dropped by almost the same percentage as GDP (around 7.5%). In addition to the tight correlation going down, GDP and oil consumption both bounced back strongly in the year following the devaluation. Mexican GDP declined 7.5% in 1995, but rose by nearly 7.5% in 1996. Similarly, oil consumption fell about 7.5% in 1995, but posted a 4% increase in 1996.

While Adkins, et al., note that there are many differences between the Mexican and current Asian economic situations, the Mexican experience suggests that a stabilization in currencies and a rebound in stock markets should eventually lead to a recovery in Asian GDP growth.

Between September 1994 and March 1995, the Mexican peso was devalued by more than 50%. By comparison, South Korea, Taiwan, Indonesia and other Southeast Asian countries experienced similar devaluations between June 1997 and January 1998. These Asian currencies have been steadily improving since the summer of 1998.

When Mexican currencies devalued, the stock market reacted almost immediately and GDP followed by about 6 months. Asian currency and stock market changes also have tracked closely and led the GDP changes by about 6 months. Now that there has been a meaningful uptick in currency and stock market performance, this would seem to suggest, but not guarantee, that an Asian economic recovery is in the offing.

Another important point is that the Asian GDP also has correlated very well with Asian oil consumption. Like Mexico, Asian oil consumption tracks extremely closely with GDP, despite differing energy taxes and consumption profiles in the countries that potentially could skew the relationship of GDP to oil consumption.

The apparent conclusion is that a stabilization in Asian currencies, combined with a stock market rebound, may be signaling an end to the free-falling Asian economies and that Asian GDP should turn the corner shortly. If the 6-month correlation holds, this could begin by May.

Could this really happen? The Raymond James analysts think the answer is yes, because stock markets tend to be good predictors of future GDP changes, and energy consumption tends to track GDP. Thus far, Asian stock markets have been good predictors of declining oil demand, and it’s believed they also will be good predictors of future demand increases.

Although the problems in Asia are wider and deeper than the Mexican problems of 1995, numerous parallels can be drawn between the two economic debacles. Specifically, Adkins, et al., see the following scenario playing in both areas:

• Severe currency devaluations mark the onset of economic problems.
• Regional stock market declines closely track currency devaluations.
• GDP in affected areas trails the stock market move by about 6 months.
• Oil consumption changes closely mirror GDP changes.
• Once currencies stabilize, the stock market begins to respond.
• About 6 months after the stock market begins to improve, GDP and oil consumption begin to move up.

Thus far, the Asian situation has closely mirrored that of Mexico during 1994 through all but the last of the above points. Accordingly, given the rebound in Asian stocks, one would expect the logical conclusion to be a rebound in Asian energy consumption in the near future.

Given the other pessimistic views for 1999, we sure hope they’re right.

Copyright © 1999 World Oil
Copyright © 1999 Gulf Publishing Company