Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

As hikes go, the Fed's latest is more of a gentle stroll, at least for financial markets. Stocks rallied on the news, including high yielders like utilities and master limited partnerships. Even gold went up, though it lost its poise on Thursday morning.

And then there's oil. Having been walloped by news of swelling inventories earlier on Wednesday, crude stirred briefly on the Fed's announcement before thumping its head back onto the canvas. 

Janet Who?
Brent crude oil prices didn't really react to the Fed's lift-off news
Source: Bloomberg
Note: Intraday pricing

The Fed's move matters for oil, though. Not because of the usual linkage between oil and the dollar, which has frayed these past few years.

Bucking the Trend
The usual relationship whereby oil prices tend to rise when the dollar weakens (and vice-versa) has largely disappeared in recent years
Source: Bloomberg

The real linkage concerns oil demand and, more specifically, where that demand is expected to come from. The chart below breaks it down by major region for this year and next, based on the International Energy Agency's latest projections.

Situation Developing
Oil demand growth will rely overwhelmingly on developing markets in 2016
Source: International Energy Agency

Global demand is expected to rise by 1.2 million barrels a day in 2016, down from this year's supercharged 1.8 million. Within those numbers, though, a profound shift is taking place toward emerging markets. This year, the U.S. and even sluggish Europe burned more oil, in large part because it was cheaper. So emerging markets, as represented by the non-OECD countries, accounted for slightly less than three-quarters of the world's appetite for more oil. Next year, they're expected to account for 96 percent.

Until recently, that wouldn't have mattered. Emerging markets have been central to projections of growing oil demand for a decade or more and have delivered. Moreover, the IEA's numbers already factor in some weakness: Overall, non-OECD demand growth eases from 1.31 million barrels a day this year to 1.18 million in 2016. Powerhouse China is expected to take an extra 390,000 barrels a day in 2016, a drop of 40 percent relative to this year's increase. Both Brazil and Russia are expected to notch up another year of outright declines.

Yet for anyone long oil heading into 2016, there is no escaping the risks of being almost wholly reliant on emerging markets for new demand just as the Fed is raising interest rates.

On the positive side, rising rates will come as no surprise, as a quick glance at some emerging market currencies demonstrates.

Saw It Coming
Emerging market currencies have been weakening ahead of Fed lift-off
Source: Bloomberg
Note: Currencies vs. U.S. dollar, indexed to 100

Given this, and general agreement that the Fed has mapped out a slow and steady schedule for increasing rates, some argue that emerging economies could do better than expected next year. At least two big uncertainties cloud this view, though.

First, rising Fed rates at a time of loose monetary policy in most other major economies raises the risk of that old bugbear for emerging markets -- namely, capital outflows toward the U.S. This could be exacerbated by the long period of zero rates, which pushed capital toward riskier assets. For example, capital flows from developed markets to emerging market bonds jumped above trend between 2010 and 2014, rising from the equivalent of 3.6 percent of developed markets' GDP to 5.3 percent, according to Citigroup. The recent ripples of anxiety in high-yield credit funds show what can happen when sentiment suddenly shifts against a riskier asset class.

Secondly, the last time the Fed started tightening rates, all the way back in 2004, global trade was on an upswing. That was partly because China was sucking in commodities to build infrastructure and partly due to developed markets sucking in imports of merchandise amid a boom in credit.

The Shipping News
Growth in the volume of world merchandise exports has slumped since the financial crisis
Source: World Trade Organization

As the last few bars on the chart above show, trade ain't what it was. The favorable backdrop that kept emerging markets humming through the last upswing in U.S. rates has disappeared. China, even if its slowdown is kept at a managed pace, is trying to shift its economy toward services and is also making efforts to cut pollution, which hits all industrial commodities.

And that is the added twist: A fair chunk of projected growth for oil demand next year relates to economies that also depend to a large degree on producing and selling the stuff, as well as other raw materials.

Russia's president Vladimir Putin insisted in his annual televised news conference on Thursday that his country was through the worst of its recession. But like his endorsement of FIFA president Sepp Blatter for the Nobel Peace Prize, we'll have to wait and see on that one.

Similarly, there is no telling right now where Brazil will bottom out. Meanwhile, the Middle East's projected contribution to global oil demand growth next year rises to 14 percent, from 7 percent this year; Africa's rises above 11 percent from 6 percent. Both of those regions rely heavily on exports of oil, metals and ores.

If nothing else, the Fed's move should remind oil bulls trying to time the recovery that supply is only half of the equation.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in San Francisco at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net