More on Oil Under $50
Following up on yesterday's post, some additional thoughts on this all-important collapse in the oil price. I also want to tell you about a conference I recently attended, part of which concerned energy investments, specifically how the "experts" at the conference completely misjudged what's really going on.
First of all, it really is "all-important." The drop has been swift and precipitous. It's not a correction or a typical reversal in trend. It's telling us something. At first, that something was touted to be "good news": the lower oil price was due to the increased production from the U.S. fracking operations and would not only end America's dependence on foreign oil, but would also translate into a tremendous boost for the economy: people would save on the gas they use for their cars, and use those savings to buy more stuff, giving the economy a good goose.
That story persisted until the price dropped below $70. Very few expected the price to get any lower. Now that it has, we're starting to see at least the beginning of a reassessment of the initial happy story of oil's price drop. In addition to the suspicion that the "glut" behind the drop in price isn't simply due to over-production but rather a result of reduced demand due to slowing economic activity world-wide, the idea that consumers will run out and spend what they saved at the gas pump isn't yet showing up. In fact, we might consider whether it ever will. Perhaps people will pay down debt or - heaven forbid - save this windfall.
The "all-important" part also has to do with the simple fact that oil is the most important commodity in the world's economy. Any price drop will effect economic activity, and a precipitous drop such as we are now in the midst of, is going to leave its mark worldwide, for better and for worse. (And there are usually two sides to every story like this.)
Now for that conference I recently attended, part of which had to do with energy investments, specifically investing in oil and gas. At the time, the price of oil had dropped into the low 90s and was heading down. The experts were surprised by this. But to a person, they all declared that "if" the price dropped to $70, they'd be even more surprised, but that would likely be the extent of the drop. I especially note the expert in investing in oil and gas pipeline companies, and companies engaged in fracking to extract oil and gas. We were told that as long as the price held at $70, these activities would continue to prove profitable enough for the companies to keep pumping and transporting oil and gas. America would indeed cease to be energy dependent. Then came the question from the audience that was likely on many of the attendees minds: What if the price dropped below $70? Wouldn't some of these companies find that their profits would disappear? Wouldn't the result be a ceasing of exploration, a slowing or elimination of production? Wouldn't that counter the thesis that America would soon be free of its reliance on foreign, more specifically Middle East, oil?
The answer didn't surprise me, and there's a lesson to be learned. Basically that answer boiled down to this: If the price dropped below $70, it was doubtful it could go much below that, and would subsequently head back up again. But if it did drop into the $60s, most of the current production would continue. The reason is - and this does make sense - that many of the companies producing oil using fracking techniques has already made their initial investment and their costs were low enough to absorb the reduced revenue from a lower price. Of course, some of the newer entries into the production of fracked oil might suffer and perhaps even be driven out of business. But the effect on the fracking "miracle" would be minimal.
So far, so good. Until the next logical question popped out of the audience: What if the price dropped below $60? To the credit of the experts, none insisted this was impossible, although all believed it highly unlikely. But when pressed, they did agree that the models they used to determine profitability would have to be revisited, the implication being that even companies who had been successfully and profitably fracking for oil and gas might also be affected, such that they too would have to curtail or cease production. That's where things left off.
So here we are not only below $60, but below (gulp!) $50. Will the price hold here? Maybe. But that's what we thought at $70, then at $60. In fact, there's no special reason to believe the price will hold. Even the thesis that the price has dropped "too far too fast" may not save the day. If we are indeed in the initial stages of slowing economic activity worldwide, production activity will eventually have to adjust, meaning both exploration and drilling will slow until the price stabilizes. That could take a while, which is why we're not so sure that the price is bottoming or even close to a bottom. Only time will tell.
As for the lesson we can learn from this, it's simply that a) expert opinion is not infallible, something you should already know if you're in the habit of using your reason and commons sense; and, b) many experts are invested in the areas of their expertise, which calls for additional skepticism when considering their prognostications. That's not to say they're always wrong, or always being misleading or deceptive, of course. But when you're living depends on the continued success of an enterprise, it's hard to be completely objective.
First of all, it really is "all-important." The drop has been swift and precipitous. It's not a correction or a typical reversal in trend. It's telling us something. At first, that something was touted to be "good news": the lower oil price was due to the increased production from the U.S. fracking operations and would not only end America's dependence on foreign oil, but would also translate into a tremendous boost for the economy: people would save on the gas they use for their cars, and use those savings to buy more stuff, giving the economy a good goose.
That story persisted until the price dropped below $70. Very few expected the price to get any lower. Now that it has, we're starting to see at least the beginning of a reassessment of the initial happy story of oil's price drop. In addition to the suspicion that the "glut" behind the drop in price isn't simply due to over-production but rather a result of reduced demand due to slowing economic activity world-wide, the idea that consumers will run out and spend what they saved at the gas pump isn't yet showing up. In fact, we might consider whether it ever will. Perhaps people will pay down debt or - heaven forbid - save this windfall.
The "all-important" part also has to do with the simple fact that oil is the most important commodity in the world's economy. Any price drop will effect economic activity, and a precipitous drop such as we are now in the midst of, is going to leave its mark worldwide, for better and for worse. (And there are usually two sides to every story like this.)
Now for that conference I recently attended, part of which had to do with energy investments, specifically investing in oil and gas. At the time, the price of oil had dropped into the low 90s and was heading down. The experts were surprised by this. But to a person, they all declared that "if" the price dropped to $70, they'd be even more surprised, but that would likely be the extent of the drop. I especially note the expert in investing in oil and gas pipeline companies, and companies engaged in fracking to extract oil and gas. We were told that as long as the price held at $70, these activities would continue to prove profitable enough for the companies to keep pumping and transporting oil and gas. America would indeed cease to be energy dependent. Then came the question from the audience that was likely on many of the attendees minds: What if the price dropped below $70? Wouldn't some of these companies find that their profits would disappear? Wouldn't the result be a ceasing of exploration, a slowing or elimination of production? Wouldn't that counter the thesis that America would soon be free of its reliance on foreign, more specifically Middle East, oil?
The answer didn't surprise me, and there's a lesson to be learned. Basically that answer boiled down to this: If the price dropped below $70, it was doubtful it could go much below that, and would subsequently head back up again. But if it did drop into the $60s, most of the current production would continue. The reason is - and this does make sense - that many of the companies producing oil using fracking techniques has already made their initial investment and their costs were low enough to absorb the reduced revenue from a lower price. Of course, some of the newer entries into the production of fracked oil might suffer and perhaps even be driven out of business. But the effect on the fracking "miracle" would be minimal.
So far, so good. Until the next logical question popped out of the audience: What if the price dropped below $60? To the credit of the experts, none insisted this was impossible, although all believed it highly unlikely. But when pressed, they did agree that the models they used to determine profitability would have to be revisited, the implication being that even companies who had been successfully and profitably fracking for oil and gas might also be affected, such that they too would have to curtail or cease production. That's where things left off.
So here we are not only below $60, but below (gulp!) $50. Will the price hold here? Maybe. But that's what we thought at $70, then at $60. In fact, there's no special reason to believe the price will hold. Even the thesis that the price has dropped "too far too fast" may not save the day. If we are indeed in the initial stages of slowing economic activity worldwide, production activity will eventually have to adjust, meaning both exploration and drilling will slow until the price stabilizes. That could take a while, which is why we're not so sure that the price is bottoming or even close to a bottom. Only time will tell.
As for the lesson we can learn from this, it's simply that a) expert opinion is not infallible, something you should already know if you're in the habit of using your reason and commons sense; and, b) many experts are invested in the areas of their expertise, which calls for additional skepticism when considering their prognostications. That's not to say they're always wrong, or always being misleading or deceptive, of course. But when you're living depends on the continued success of an enterprise, it's hard to be completely objective.
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