Coddling big oil

The USA top equity index, the DOW JONES INDUSTRIAL AVERAGE (DJIA), surged up 138.88 (1.2%) last Friday to 11,577.74, its highest level in six years. The DOW stopped just 145 points shy of its record, set on January 14, 2000, when it ended at 11,722.98, the then all-time high. The rally was broad- based with all three major gauges logging gains for the week. The DOW gained nearly 1.8% for the week, the S and P added around 1.1% and the NASDAQ was up nearly 0.9%. Europe and Japan also booked gains of between 1% and 2% for the week.

On a year to date basis, the equity markets have delivered some very good returns, mostly between six percent and eight percent. Both the German DAX and the French CAC have put in near 11% ytd figures. The recent strength in the markets was based in an understanding that the US economy is going well, that other major economies are following suit, the conclusion of another good earnings season and weaker-than-expected April jobs report in the US. All this news has left investors feeling that things are going good, but not too good and that hopefully, the US Federal Reserve’s interest-rate hiking campaign will end soon.

Often in our articles, we try to apply reason in looking forward with a view to giving our readers a better understanding (and hence stronger belief) as to the long term direction various economies and industries are taking.

For example, we discussed real estate at length because the recent boom in Trinidad and Tobago, as well as other parts of the world, left some obvious conclusions. Interest rates and construction costs are rising, making housing less affordable, which will flow through to higher occupancy on rental units and of course increased rents as well.

This week, we have elected to discuss resources and commodities. Looking down the road for a three to five year strategic planning exercise, it is difficult to see commodity prices falling much. The only one that might correct with any kind of significance would be oil price, but we don’t anticipate much softening here either.

First off, remember that oil price declined from US$40 a barrel in 1980 to 1985 and then the global price stayed effectively flat for the next 20 years. Energy is still cheaper today at US$ 70.00 a barrel, when measured as a percentage of your annual income than it was 20 years ago. Sure many people are complaining, and there has been a bevy of people lining up in the news to beat up on the oil companies for “making too much money.”

But take note, the upstream petroleum producers have often not made money and did you see people lining up at the gas pumps to pay a higher than market price to help them out. So why now, when earnings are up to 8.8% in the sector, just above the overall market average of 8.5% ? Do people want to get after them for “price gouging?”

You will likely hear a lot of political rhetoric, because that is what people want to hear, but you will not likely see anything actually come of it.

Fact is, the world is consuming about 85 million barrels a day, 25% of that consumption is by the USA (with only 6% of the world’s population) and the Arabs control all the spare crude oil production at this time.

Another major point to consider is that supply of commodities, not just oil, is mostly coming from more unstable regions of the world. Thus, more things are likely to go wrong than right with supply.

And as for consumption, the figures continue to be strong.

We believe that India and China will continue to grow, and the worlds consumer consumption will continue to grow. At its current pace, increased volumes of raw materials will be required to feed this manufacturing trend.

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