Rule No. 1: Most things will prove to be cyclical.
Rule No 2: Some of the greatest opportunities for gain and loss come when other people forget Rule No. 1.
Sounds like a Bond movie to me, cloak and dagger and much intrigue. Over the last year, the ministers of OPEC have had closed door meetings to discuss America’s upsurge in oil production. In its December 13 edition, The Wall Street Journal reported that U.S. oil output has grown from 4.8 million barrels a day in 2008 to 8.9 million as recently as this past summer. The Saudis in particular were worried that in a slowly rising demand environment, the U.S. wildcatters drilling in the Bakken and Eagle Ford shale deposits, would produce a global glut of supply. They were right; not only is production up and all reservoirs filled, but in late summer, global demand from emerging market economies began to fall sharply.
When commodity supply/demand ratios become unbalanced, even by a small amount, immediate price adjustments follow. When circumstances lead to these ratios becoming widely unbalanced – such as now with too much supply and little demand – the price adjustments are precipitous. You are seeing this play out at your local pump!
Now I have had more than a few clients ask what could possibly be wrong when gas prices are almost half of what they were six months ago. For those economies that are not petroleum producers, and are also predominately consumer driven, this is a fantastic economic boost, like a giant wind at our backs. Airline and trucking companies have seen an immediate boost to their bottom lines and their stock values. And who could possibly argue with having a few more dollars in your pocket during the holidays? Eventually, the price of oil will rise and stabilize somewhere between $50 and $100. It’s impossible to know the eventual price, but a range of between $60 and $80 per barrel might be a safe guess.
But what seems to be a tailwind to us as petroleum consumers is a headwind to the oil industry and those countries who are commodity exporters. There is a dark cloud on the horizon, always an evil villain in a Bond film. The villain here is a “lack of demand” in many parts of the world. And not just lack of demand for oil and other commodities, but the lack of demand that leads to slow growth, no growth, or negative growth that leads to deflation and eventual recession. The U.S. has been a global business bright spot, but we are not self-contained. We need strong demand from abroad for our exports and without it; our strong level of growth (relatively speaking) may quickly wither.
OPEC is playing a dangerous game of chicken with American producers by not agreeing to cut their own oil production. They probably have the financial resources (and in the case of the Saudis, according to The Economist, a much lower cost of production) to outlast us and retain their global market share. There will much economic pain and suffering in the global energy sector!
Many smaller companies will go out of business, while others will be absorbed into larger, stronger companies. But as oil production begins to fall, that magic supply/demand ratio begins to come back into balance, stabilizing and then slowly increasing oil prices.
Normality will eventually return to both the commodity and currency markets. Because oil is valued in U.S. dollars, large foreign oil exporters have taken a double financial hit and the recent currency crisis in Russia is a good example. Such a large global dislocation as the drop in the price of oil may create abnormally high market volatility before it eventually evens out. But here’s hoping for smooth sailing through the Holidays.
Enjoy your eggnog! Shaken, not stirred.
Jeffrey Cedarholm is the Chief Investment Officer at Longview Financial Advisors, Inc. He is a CERTIFIED FINANCIAL PLANNER™ practitioner with a passion for investment and wealth management. Jeff can be reached via e-mail at firstname.lastname@example.org.
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