Monday, March 17, 2008


What do we make of the steep drop in oil per barrel and in cents per gallon today? Oil is down $5.50 per barrel and the wholesale price of gasoline is down $.21!

For a number of months, I have suggested that commodities have been in a bubble. I suggested that at some point a flood of money would pull out of commodities and that this money would make its way into high tech stocks. One problem has been that oil has been propped up by the geopolitical risk that the feud between Iran and the US might result in a cut off of oil flow from Iran or even from the middle east. As a result of this fear, China, the USA and other countries have been actively filling strategic oil reserves even at the cost of $110 per barrel.

Last week, we saw a significant move that suggest that Iran wants to come to the bargaining table with the USA. The price of oil hardly budged. This week, there is great fear that a significant recession is at hand, the price of oil is falling hard.

While I still believe that the geopolitical question has a strong influence, the actual demand for oil is trumping the demand for "protection against events". The total amounts being added to strategic reserves are small relative to usage. Never-the-less, the total amounts in reserve have become significant. An oil embargo would be no fun but, during a recession, total demand could decline enough to significantly reduce the risk from embargo. It is estimated that there is about 3 million barrels per day of excess capacity now. This is less than the net amount of oil exported by Iran. An economic slow down could easily push excess capacity up to 8 or even 10 million barrels per day. As of last week, gasoline inventories in the USA sat at a 16 year high, going back to just after the recession of 1990-91. The big decline today suggests that the market believes there will be an additional jump in gasoline inventories announced Wednesday.

The most recent retail sales report showed a steep decline in gasoline sales. It is clear that the current price is destructing demand.


I think it is significant that Vietnam has launched its own communications satellite, long before traditional infrastructure has been built. The developing world is learning quickly that the way to grow an economy in today's market is to grow the communications (Internet) network. Around the world, lessons are being taught and meetings are being held via communications terminals. At current prices, all companies and all individuals must ask the question, "Do I really need to be there"?

The irony has been and will continue to be that global communications make it all the more necessary for international travel to occur. The demand for international travel continues to show up in the revenue and earnings report of international airlines. At the same time, the fuel price crunch has dictated that planes must be flown at full capacity.


The sentiment indicates that we are already in the middle of a tough recession and the swoon in stocks supports that belief. On the other hand, the economic numbers still show world wide growth and even growth in the USA. The majority of market observers now believe that we are in a recession but I believe John Maynard Keynes was correct that in economic matters the majority is always wrong.


As expressed many times, I see signs of the big turn all around. The problem in seeing the turn is that it begins as a turn of relative performance. If big pharma goes down in price, the turn has started if wage intensive health care providers goes down in price more. If small banks go down in price, the turn has already started if investment bankers go down more. If tech stocks go down in price, the turn is already here if energy stocks go down more. The turn is here is if US stocks go down less than international stocks.

The most obvious example of the "reverse turn" I can give is when tech stocks were hitting outrageous prices in 1999 while oil stocks were dragged along the bottom. When the market fell sharply in 2000, oil stocks went down but nothing at all like the high tech stocks. By the time the public, who sold out in droves, came back to the market, the oil stocks were already soaring and they looked too expensive to buy.


Some folk believe the FOMC will cut as much as 100 points tomorrow. This is another one of those no one knows questions. What is easy to surmise is that what ever the size of the cut, interest rate will have come a long way down from the 5.25% level of just a few months ago. A cut from 3% to 2% is a huge cut. It is enough to encourage a lot of small businessmen to take a chance. Small business is where the "rubber meets the road". A lot of people are in a depressed state of mind right now. However, there are a large number of small business owners who are enjoying the benefits of the low dollar. NC is one of the states that has come full circle. A state in which textiles and furniture production was hit hard by competition. NC is back high on the list of exporting states. Our export growth is very strong. I can't find my notes at this moment but as I recall, NC exports more value than all but 4 other states. The price of a home in NC is cheap compared with prices in many northern states and NC is enjoying strong migration. Business is expanding in NC.

Since 1960, the growth in number of employees engaged in manufacturing in the USA is almost zero. During this time, the production of goods has increase 450%. In this new world, automation allows us to do more with less. The USA has decreased its use of fuel in manufacturing. Our use of oil in the manufacturing process has gone down for 35 years or more. The example of Vietnam shows how other countries are not just following our lead but are jumping ahead. The successful person of the next generation will in all likelihood be a person who has embraced the Internet. The growing church will be the church that uses Internet technology. The successful business will also be likely to have embraced technology. In the case of a country, Internet communication will be a critical component of economic freedom and success.


We have long know that the demand for oil is "inflexible" in the short run and "flexible" in the long run. The answer to the question, will the price of an airline ticket be raised enough to offset the price increase of oil is a resounding yes over time. Knowing that a few monster oil fields are expected to come on line over the next several years, it is my belief that today's big fall in oil prices is the start of a long decline, but who can call short term moves?

By the way, in my area, retail gasoline is already depressed relative to the wholesale price. Should the normal spreads prevail, the 21 cent decline in wholesale prices will only convert to a 12 cents decline in retail prices. In other words, the wholesale price at $2.47 should give us an average retail price of $3.07, not good but since I just put $72 worth in my car at $3.18 per gallon, I am thankful for the decline and can only hope that it will continue.