Oil is The Most Important Market Right Now

oil line 220
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It’s possible you’re getting bored with all the oil talk.

But I make no apologies for it. It’s the single most important commodity that you need to watch today.

If you’re not looking for the latest crude oil price each morning, you’re doing yourself and your investments a disservice.

Forget iron ore (for now). And definitely forget gold (for now, and probably for the next year or more too).

Oil is the only market worth watching.

This week, the price slumped. All the positive noises on oil after the big spike on Friday night last week have suddenly gone quiet.

The thing that strikes me as the strangest is the American commentary on the falling oil price. The gist of it is that the oil price collapse is good news for US oil producers.

That’s despite the fact that, according to a Bloomberg report this morning, the current oil price is close to many producers’ cost of production.

Without a profit margin, what are the chances that they’ll keep drilling? As the Bloomberg report notes:

Not all companies and oil fields will fare the same if oil prices sink below $70. On average, shale producers in North Dakota’s Bakken and Texas’s Permian Basin formations need prices around $67 and $65, respectively, to make drilling worthwhile, according to ITG Investment Research. And while oil-sands operators can continue producing at $75 a barrel, new projects may be put on hold as companies reassess the economics of lower prices.

Remember, OPEC’s national oil companies are in a completely different position to US oil producers. OPEC producers are state-owned.

They don’t have a profit motive. If revenue from oil production falls, the state will increase taxes or raise revenue from somewhere else.

If an oil producer’s revenue falls, it’s not as easy to generate revenue from elsewhere, such as by suddenly switching to drilling for gold, iron ore, or copper.

Even so, according to Bloomberg earlier this week, ‘No matter what OPEC countries decide tomorrow about cutting oil output, U.S. producers already know what they’re going to do: drill on.

Quite. But whether most of them will be able to keep drilling if the oil price sinks to US$60 per barrel is another story. Sound crazy? The price surely couldn’t go that low, could it? Again, according to Bloomberg:

No action from OPEC would probably pressure oil prices to as low as $60 a barrel, Paul Sankey, an analyst at Wolfe, said in a Nov. 24 note to clients. That would prove disastrous for countries such as Equatorial Guinea, Chad, Venezuela, Angola and Iran that are dependent on oil revenues to survive, said Mark Schaltuper, head of the Americas research team at Fitch Inc.’s Business Monitor International.

Hmmm. It’s an interesting take. US$60 oil would be disastrous for Equatorial Guinea, Chad, Venezuela, Angola, and Iran, but it would be good for the US producers?

I’ll admit that the picture for oil is confusing right now. But after yesterday’s decision by OPEC not to cut production, you can expect lower prices for some time to come.

Yet it’s important to separate the impact of lower oil prices on the oil producers from the impact on consumers.

The impact on producers will be bad. It will push prices lower and force many drillers out of business. That’s bad for the US economy and its plans to be a long-term major oil producer and exporter.

But there is a flipside to this story.

This is where things get complicated. Because while a lower price is bad for the US shale oil industry, it’s great news for the US consumer.

This is part of the reason I’m pegging the market to boom over the next three years (or longer).

If the oil price stays low — perhaps as low as US$60 — it will be a boon for the US economy. That’s because you’ll see the best (and worst) of consumerism.

Remember the heady days of the 1990s and the early 2000s? That’s what the US economy has in store if oil prices stay low. Sure, it will mean the US relies more on imported energy and goods.

But heck, folks are sure to borrow, borrow, borrow and spend, spend, spend.

Yes, that’s right, you’re looking at all the ingredients of another bubble and bust boom.

So, the mainstream commentary has it right in one way. A lower oil price will provide a short term boost to the US economy. But not in the way they think.

Like it or not, OPEC is back in the driving seat when it comes to oil…and based on what we’ve seen over the past few weeks, it intends to stay there. That’s bad news for US shale energy producers.

But it could be good news for conventional energy producers.

Remember ‘86

I remember 1986. I mostly remember it for Diego Maradona’s ‘Hand of God’ goal, when he deftly [cough] helped lift the ball over England goalkeeper Peter Shilton’s despairing lunge.

Others may remember 1986 for other reasons, such as the plunging oil price.

For the mainstream analysts who are cheering for lower oil prices, and hollering about why it’s bad news for Saudi Arabia, they may wish to think back to 1986.

As Bloomberg reports:

The last time that U.S. oil drillers got caught up in a price war orchestrated by Saudi Arabia, it ended badly for the Americans.

In 1986, the Saudis opened the spigot and sparked a four-month, 67 percent plunge that left oil just above $10 a barrel. The U.S. industry collapsed, triggering almost a quarter-century of production declines, and the Saudis regained their leading role in the world’s oil markets.

So while no one expects the Saudis to ramp up output now like they did then and U.S. shale oil companies are pledging to keep drilling regardless, the memory of that bust looms large for American industry executives on the eve of OPEC’s meeting tomorrow.

Really? ‘No one expects the Saudis to ramp up output’?

I certainly wouldn’t put it past them. If Saudi Arabia sees the US shale producers increasing production for fear of further oil price falls, I have absolutely no doubt that the Saudis would go for the ‘nuclear’ option by opening the spigot once more.

The interesting question is what would it do for stock prices? I’ve already made my position clear. The lower oil prices go, the worse it will be for US shale oil producers, the better it will be for the consumers, and the better it will be for stocks.

This chart of the Dow Jones Industrial Average from 1985 to 1987 appears to confirm that:




Source: Google Finance


Yes, the market crashed in 1987. But not before it gained 74% from the start of 1986 through to the October 1987 crash.

I’m not saying history will necessarily repeat, but I am saying that if you’re not watching the oil price, then you’re missing out on the stock market’s biggest influence of today.

By the way, we’re finally opening the door this weekend on my new investment advisory. Keep your eyes peeled for more details.

One of the markets I’m following closely is — as you can guess — oil. But it’s not the only market I’m watching. You’ll see what I mean this weekend…and it may surprise you.

Kris Sayce
Publisher, The Daily Reckoning Australia

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Kris Sayce
Kris Sayce, dubbed the ‘Jeremy Clarkson of Australian finance’, began as a London finance broker specialising in small-cap stock analysis on London’s Alternative Investment Market (AIM). Kris then spent several years at one of Australia's leading wealth management firms. A fully accredited advisor in shares, options, warrants and foreign-exchange investments, Kris was instrumental in helping to establish the Australian version of the Daily Reckoning e-newsletter in 2005. He is currently the Publisher, Investment Director and Editor in Chief of Australia's most outspoken financial news service — Money Morning.
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