Saturday, December 6, 2014

Schrodinger's Oil is both Good / Bad for the Economy

I like Zerohedge. As bearish and doomsday as they are, they very good humoured and more often than not, proven right in the long run. Another piece by theirs rightly points out the media's crazy flip-flopping of ideas, proving that MSM is a load a crap that strokes you wherever you feel like being stroked. The number of straight talking guys out there are like beautiful supermodel with Ph.D's.

Oil in Dec 2013 rising = Good for the economy, signs of recovery
Oil in Dec 2014 falling = Good for the economy, since most countries are net importers

You really can't make this shit up.

Now, the real question you should be asking yourself is, what makes it bad?

Increased oil prices naturally sounds bad since energy is a fixed cost component to most businesses. To me, it simply means that with a fixed amount of capital, you will produce less / consume less. It's a natural brake when things get too overheated. But I don't think there's an arbituary number that says, "above $XX, oil is expensive". No. I think as oil gets more scare, naturally we will have to be paying more to use energy, be it from oil or its alternatives. We will slowly move up the cost curve as we use up all the cheap stuff.

Lower oil prices sounds like the flipside of the previous argument, no? If high oil prices means higher operating costs, lower oil prices means lower operating costs! Well, sort of. As the price of oil drops, the supply of oil drops as well. Oil companies find it not worth it to extract oil anymore. This is exactly the same rationale for gold mining companies. At a particular price point down the road, all remaining producers of the commodity will exactly meet the supply required of the global economy. That is the lowest point we go, in theory. This is the econs 101 most people agree with. Not the voodoo Keynesian stuff. So I guess, this is kind of like evolution. Most people agree with it, except the really, really, really stupid ones. Yes, stupid, not stubborn. Stupid. Just my opinion. Anyway...

Low oil is caused by 1 of 3 situations. Lower demand for oil, increased supply of oil and finally the sexy combination of both. I believe we are in the last situation. However, my personal belief doesn't move the market. We are having lower oil prices. So 1 of the 3 must be happening.

Lower demand for oil is not too hard to imagine. Most of the world is constantly revising down their GDP forecasts across the board.

Increased supply of oil? From's BP's June 2014 Oil report. (they also show consumption higher than production at that point of time, which makes sense since oil went from $90 to about $110 from Dec 2013 to June 2014.)

So, lower oil prices might be here to stay for a while. Oil producing names might also be depressed for a while. *GASP* why would I wish for such a thing, especially when Singapore has big oil names like Keppel and SembCorp? I'm not saying that it will happen, but it jolly well might happen. Just look at precious metals and their miners over the past few years. Anyone trying to catch that falling knife has been impaled in half. Oil and oil-related trades might be the next "barbaric relic" industry moving forward. Who needs oil anyway, since we are in the new-era with solar and wind energy? /sarc

Okay, so whatever. Who cares about the reason behind low oil. It is interesting, but really, whatever. Lower oil prices is then good for the economy, yes? Actually, I am in the camp that it is might spark a credit crisis. Since 2011 when Oil consistently stayed above $80 and even went over $100 a few times, there has been a rush back to the Oil sector because of shale oil. Companies borrow money on credit to fund their businesses. It was a good and fast way to set up a business that was profiting from the increased prices of oil. That is, if oil still stays high. Below $60, most producers don't even need to play anymore.

This is exactly like the Chinese commodity companies, like the steel mills. When businesses borrowed heavily, banking on a sustainable price in the underlying commodity, the businesses suddenly becomes super high risk when the underlying commodity drops below their breakeven price. 

ICYMI, the yield curve is one of the best recession indicators EVER. And under ZIRP policy, it is impossible for the yield curve to invert and give a signal. In ZIRP, flattening is inversion.

So there you have it, that is my take on all this oil mambo-jambo-shambo that has been happening recently.

Why is the price of oil dropping? Global fundamentals.
Can Oil continue going lower? Refer to gold and 90% of other commodities the past few years.
It this good for the economy? I still haven't the slightest clue.
It this good for the stock market? Yes, anything and everything is always bullish for the US stock market. /sarc

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