What If . . . ?

Over the weekend, I penned a corny piece “Giving Thanks” for the technical improvements we have been blessed with (broken downtrend, above 50 & 200 day MAs, etc.) But a chance encounter yesterday with a peer from a competitor led to a rather intriguing economic discussion. That chat thankfully spared you of my holiday hokum, sending me back to my keyboard instead, to ask:

“What If . . .?”

Third quarter GDP came in at a robust 3.9%; What if Oil was at $30 instead of $50 per barrel? Let’s acknowledge that related factors impact both energy and growth, so as avoid a disingenuous query. Oil is higher because of the weak U.S. dollar, as well as due to increased global demand, both of which get reflected in improving GDP numbers. The War in Iraq has also contributed to rising Oil prices, while increased military spending and government hiring has been a significant part of that GDP growth. That said, what might the world look like if Oil were at $30/brl?

From a macro perspective, back out higher energy prices’ drag on GDP (estimated at 1.2%), and growth is a robust 5.1%. Other commodities priced in Dollars (Gold, etc.) would be significantly below their recent highs. Consumer sentiment would improve, sending discretionary spending higher. Manufacturing activity would also expand, with some positive impact on employment numbers. Perhaps corporate margins might progress to the point where some Hiring and Capex spending became all but inevitable. Unfortunately, Oil prices have no impact on Productivity or Outsourcing, so the hiring gains would be rather muted.

Drilling down to specifics, many sectors would see relief. Retail numbers, especially at the big discounters, would be significantly better. Dining, travel and entertainment would also perk up. Airlines would see reduced margin pressure; Domestic automakers – long overly dependent on gas-guzzling SUVs for the bulk of their profits – would find immediate sales and margin improvements.

But let’s not paint this scenario too rosy. The economy’s heartiest sector – refinance/refurbish/new homes – are also the most rate sensitive. $30 oil would have long ago forced Fed Chair Greenspan to raise rates considerably. The fallout of a less accommodative Fed: Homebuilders top lines would drop, as would those of real estate agents, mortgage and home equity loan originators. Big box retailers and durable goods manufacturers would suffer also.

Policymakers may lament high-energy prices, but should also consider the ramifications of the alternative in our complex economy. $50 oil may make investing challenging, but we should bear in mind that there are no silver fiscal bullets. Investors must play the hand they have been dealt.

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An Energy Illusion of the Highest Order


"We are living with an energy illusion of the highest order,"

So warns oil banker Matt Simmons, 61, whose "bold and often prescient pronouncements have won him followers — and detractors — in the course of his 30-year career."

According to Simmons, whether the Saudis have overestimated their crude reserves or not is the key question for energy prices the next decade or so.

In an interview with Barron’s, Simmons lays out the Bull case for Oil:

"With global demand for oil on the rise, and prices hovering near $50 a barrel, the Saudis’ production profile is more than academic. The No. 1 oil producer, Saudi Arabia pumps 13% of the world’s oil and boasts 23% of its oil reserves. Moreover, the Saudis alone claim to have excess production capacity and the ability to increase output if demand continues to rise.

Barrons_oil_11262004_1 Simmons’ conclusions are based largely on his analysis of the high water content and other signs of aging of Saudi oil fields. Not surprisingly, they have caught the attention of Saudi Aramco, the kingdom’s national oil company, which has dismissed his views and remains committed to previously published numbers of the size of Saudi reserves.

Because the Saudi oil industry is state-run, and there is no independent auditor of national reserves, it is impossible to determine just how large — or small — the Saudis’ are.

If the Saudis’ numbers are correct, the kingdom could continue to produce at current levels of about 10 billion barrels a day for the next 50 years, or more. That would give the industrial world time to develop alternative energy sources and prepare for a graceful transition.
If Simmons is right, however, the world could face a dangerous imbalance between rising oil demand and diminishing supply, perhaps within the next 10 years. Oil prices could soar, economies could suffer, and oil-dependent nations, such as the U.S., China and Japan, would be forced to scramble for additional energy sources."

Consistent with my long term view on this sector, Simmons may not be that far off.

Field Theories
Barron’s, NOVEMBER 29, 2004

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