This is somewhat related to Monsieur Keep It Simple Survival’s recent cold spell. But it is not just a story about fuel price swings, but also a story about the continuing deleveraging of our economy.
A number of posts here have been about price increases in fuel, food, etc. But at the same time we have had a continuing collapse in housing prices, and also in other prices as well.
So what do we have, inflation or deflation?
We have both.
We have a financial (elite) side of the economy that creates money through leverage (loans). To the extent that their loans far outstrip their equity backstop, they are able to inflate the value of items with the borrowed dollars. However, since they have very little equity (their own real money) in these deals, even a minor downturn causes a collapse of their position and creates a fire sale situation. This is the source of our deflation.
The cause of our inflation is demand for scarce resources (food and oil). To the extent that there are still financial players with borrowed money out there, they can also jump into these markets and exasperate the price increases. Thus all the talk of the oil price surge being speculator driven.
However, when you have a scarcity driven rise in prices, these prices tend to be very volatile. Even the smallest interruptions of supply can cause radical price swings. Notice the difference between the oil price surge and the earlier housing bubble. The housing bubble was a sell side inflation driven by easy credit chasing its own tale. There was very little real shortage of housing. Thus the supply of product good be maintained at a relatively stable level, and slowly increased to the point of bursting.
Food and fuel are much more erratic. You can pump up the price, but the ups and downs of pricing always threaten to wipe out the highly leveraged positions. The wipeout was in natural gas. And this lead us to this Wall Street Journal piece:
A hedge fund's allegations of a default by the Texas power producer formerly known as TXU Corp. roiled credit markets last week and intensified scrutiny by investors of the $45 billion deal. Even owners Kohlberg Kravis Roberts & Co. and TPG acknowledge the deal has become an albatross. KKR already has written down the $8 billion equity investment by 80%.
The company's unsecured bonds tumbled 13% to about 55 cents on the dollar last week, while the price of one-year credit-default protection tripled on TXU, now called Energy Future Holdings Corp. That reflects increasing market fears that the company could default on its debts, dashing the private-equity firms' hopes to hang on until a recovery in natural-gas prices.
The bond losses have implications for almost every high-yield bond fund in the country, as TXU's unsecured bonds make up about 1% of the overall market and are the ninth-largest out of more than 1,000 credits in the Merrill Lynch high-yield bond index. The bonds stand to be wiped out in a potential restructuring and retain value largely because of the interest that holders expect to collect before debts are reworked.
The chief financial officer of Texas's largest power company said it isn't insolvent and isn't considering a restructuring, but said leverage is onerous...
The same leverage that could prove so lucrative for KKR with hospital operator HCA Holdings Inc, has been disastrous for TXU because the company’s exposure to cyclical commodity pricing. Matt Wirz and Greggory Zuckerman, Texas Size Woes for KKR, The Wall Street Journal, page C1, March 8, 2011.