$80 Oil…
David R. Kotok co-founded Cumberland Advisors in 1973 and has been its Chief Investment Officer since inception. He holds a B.S. in Economics from The Wharton School of the University of Pennsylvania, an M.S. in Organizational Dynamics from The School of Arts and Sciences at the University of Pennsylvania, and a Masters in Philosophy from the University of Pennsylvania. Mr. Kotok is also a member of the National Business Economics Issues Council (NBEIC), the National Association for Business Economics (NABE), the Philadelphia Council for Business Economics (PCBE), and the Philadelphia Financial Economists Group (PFEG).
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October 23, 2009
The $80 oil price is starting to worry me a little. Translate it into gasoline and you get somewhere around $2.50 per gallon or a little higher, depending on where in the US you fill up your tank. Add to that a little cold weather and expanding crack spreads in refineries, and the price will edge toward $3.
History-derived economic models show that the US consumer starts to change behavior as the price of gas approaches $3, and then goes into a more pronounced state of shock when it ranges higher, in the $3 to $4 corridor. The reaction is to cut spending and retrench if the consumer thinks the price is going to stay at the new higher level for a while. When the consumer thinks the price will not stay higher, he keeps on spending and buying on credit.
BUT –
That history is derived, and has been modeled, from a time period when household balance sheets were relatively solid and when credit was flowing easily and when the unemployment rate was close to 5%, not 10%. So that is why I am starting to worry.
There are no solid models of rising gas prices that I can find which give good estimates of what happens to consumers when the unemployment rate is 10% instead of 5% and when many household balance sheets are wrecked, and when the credit mechanism is damaged.
SO –
The issue now is what gasoline price change it takes to impact consumer’s behavior. Does the price have to go as high as previously to hurt? Some retail experts I consulted say yes and that there will be no change in the relationship. Others disagree and say there is a new lower level, but they have insufficient experience to estimate what it is.
SO –
We asked some fellow economists if they thought the relationship was linear or something else. There was consistent disagreement. Five two-handed economists had ten opinions. Some said yes to linear and others said no. Most thought that the impact of a change in gas price is much more severe in the current environment. No one said it was milder.
SO –
If a rising gas price is going to crunch the consumer more than normally, the fragile economic recovery may be about to be derailed. Remember that every penny on the gasoline price acts as a $1-billion direct tax on the consumer. This rule-of-thumb estimate is used to guess at the normal effect. But if this time is not normal and if the effect is magnified and more severe, who knows what the new rule of thumb should be? We don’t.
AND –
We worry that this issue is not being discussed by the policy makers, who are still wringing their hands over inflation fear. And we see an energy policy coming from the Obama administration that will only serve to raise the price of gasoline and tax the extraction industries. That explains why the drill rig count is down even as the oil price is going up.
Energy and oil may be the next “sleeper” to awaken and jolt markets. However, we think it is more likely to slow down the fragile recovery. When it does, oil and gasoline demand will shrink, not grow. That will put downward pressure on the oil price, even if the dollar is weak. This will be even more pronounced if the dollar rallies
Oil is now $80. We may just see $60 sooner than we see $100. I will take the “under” on this trade as long as there is no outbreak of war in the Middle East, no rumbling from Russia, and I will hope there is no tax policy in the US that hits the energy consumer in the middle of a recession that features a 10% unemployment rate. We already have a no-exploration policy in all but four of these United States.
The first two risks are geopolitical. The last one is just political, no “geo” needed. As my friend Loren Scott likes to say in his speeches, “All the oil in America is in four states: Texas, Louisiana, Mississippi and Alabama, and the dipsticks are in Washington.”
David R. Kotok, Chairman and Chief Investment Officer, email: david.kotok@cumber.com
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Copyright 2009, Cumberland Advisors. All rights reserved.
Archived Commentaries: http://www.cumber.com/comments/archiveindex.htm
October 25th, 2009 at 6:20 pm
I usually like Kotok’s stuff, but this current thing is specious. To say that the reason why rig counts aren’t where they were a year ago is because of worries about Obama’s changes to energy policy/taxes is inane.
Prices are down by almost 50%, and much of the global credit market was vaporized for a good chunk of the period between now and then.
Blaming the lower rig count all on Obama is partisan hackery.
October 25th, 2009 at 9:46 pm
Remember that it was gas at about $4 that tripped the trigger on the mortgage problem.
October 25th, 2009 at 11:26 pm
ummmm, alaska?
October 25th, 2009 at 11:55 pm
Fantastic post. Oil is definitely a sleeper.
1) The oil price impact tips over at certain price – at least in India. This could be mainly because every item has a oil cost (transportation) embedded into it. Now these are enterprise set prices and move in steps.
2) Oil, coupled with currency pegs, could start spreading inflation fires across global markets. I fear a currency impact leading to further strain. Global economies will face slowdown v/s currency appreciation choice. Ultimately they will (or be forced to) choose currency appreciation. That might take a cycle or two though. So initially we might see Oil at $60 (if countries stick with their pegs).
3) The mechanism seems to be a self-reinforcing spiral.
Oil goes high, china faces huge inflation (because of pegs), money managers smell potential appreciation, capital flows out of USD into CNY/HKD, forces Oil higher …
OR
reverse Oil goes high, global economy slows (continues with pegs), commodity managers realise falling demand and investors realise there will be no un-pegging, leads to capital flows back to USD, strengthens USD, Oil falls on twin pressures (lack of demand and stronger USD).
October 26th, 2009 at 12:13 am
US$3/gallon worries you? That’s nearly half what we pay (equivalent) for petrol in Australia and that’s too cheap.
Petroleum is an addictive drug to economies, and biodiesal is just methadone therapy for those economies.
October 26th, 2009 at 12:23 am
Scientists have plans to cryogenically freeze samples from coral reefs in order to repopulate them in the future. Coral reefs are expected to be wiped out within 50 years due to acidification and temperature increase.
http://www.guardian.co.uk/environment/2009/oct/25/coral-arks-doomed-reefs
Drill, baby, drill.
October 26th, 2009 at 1:35 am
Until the Fed realizes that it’s just blowing another bubble and kills the carry trade by raising interest rates, you can expect oil to price well above what the demand side of the equation would dictate.
That’s why it’s all such a ridiculous game. The Fed is trying to stimulate economic growth with low rates, but what it’s getting is commodity speculation that only takes resources away (as a tax) from economic activity.
October 26th, 2009 at 1:53 am
Higher oil means more than just higher gas prices. Winter approaches , so heating bills will add to the impact. Some food prices are already rising. More bucks to fill the tank in the Yugo is just one more kick to the middle-class groin.
Consumers have little choice about consumption of essentials, but everything else will take a hit if oil continues rising.
I think you can safely throw out the old rulebooks from here on.
October 26th, 2009 at 1:53 am
Forget all consumer related issues regarding the economy because they are really beside the point. Policy is dictated by corporations and their lobbyists, period. Here is what worries me about $80 oil and really all commodities as well. What if Wall St. can borrow enough free money to effectively buy all the oil and drive the price up to $150 dollars again and then hedge and short the oil all the way down to wherever and make money both ways? What if they can do this with EVERY commodity? From the current corporate point of view if they can do it they should do it. Keep those shareholders happy…. and consumers? Consumers are last century’s news. Now we just have corporations and worker drones and peasants. Welcome to the 21st century.
October 27th, 2009 at 1:19 am
[...] $80 Oil… The $80 oil price is starting to worry me a little. Translate it into gasoline and you get somewhere around $2.50 per gallon or a little higher, depending on where in the US you fill up your tank. Add to that a little cold weather and expanding crack spreads in refineries, and the price will edge toward $3. History-derived economic models show that the US consumer starts to change behavior as the price of gas approaches $3, and then goes into a more pronounced state of shock when it ranges higher, in the $3 to $4 corridor. The reaction is to cut spending and retrench if the consumer thinks the price is going to stay at the new higher level for a while. When the consumer thinks the price will not stay higher, he keeps on spending and buying on credit. BUT – That history is derived, and has been modeled, from a time period when household balance sheets were relatively solid and when credit was flowing easily and when the unemployment rate was close to 5%, not 10%. So that is why I am starting to worry. [...]
October 27th, 2009 at 11:42 am
Actually high energy prices are just what is needed to get people ready for commodity depletion. Necessity is the mother of invention and when bubba finally realizes that driving his F350 to work is too expensive, supporting mass transit will be his new religion. Scientist can yell at his face about global warming, overpopulation, etc…. but nothing will change until his wallet becomes thinner and thinner. It’s the only thing the masses understand.
Local economies will grow because imports will be far too expensive due to transportation costs. It looks as if those dirty hippies were right….yet again.