Will Oil Lead Us Down?

12/8/15  – Oil has dominated headlines recently. The single most important commodity on the planet has been under significant pressure lately. If this doesn’t tell you that something is wrong with the global economy, then I don’t know what can. This drop can be attributed to a stronger US dollar, slowing global demand, and ever-increasing supply from OPEC.

wti crude

  • Stronger Dollar – Around the world, oil is denominated in US dollars. That means the supply/demand of US Dollars significantly impacts the price of oil. With the Fed likely to raise interest rates next week, it will be an unprecedented reversal from the easy monetary policy the rest of the world is currently undertaking. If this trend continues, the dollar will likely to continue to strengthen versus the other major currencies.And as the US Dollar strengthens, the price of oil tends to weaken.

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  • Slowing Global Demand – The slowing global economy has led to lower levels of production, international trade, and easy money. While the United States is said to lead the nation in growth, the Federal Reserve Bank of Atlanta GDP Now predictor indicates otherwise. As any ECON 101 student can point out, falling demand = falling prices.

gdpnow-forecast-evolution

  • Increasing Supply – This leads us to the ever-increasing supply by OPEC. In an attempt to kill off US Shale, OPEC recently announced it’s decision not to cut supply ahead of the Fed’s important decision. This sent WTI prices stumbling this week down to $37 per barrel.

Quite frankly I don’t know when oil, or the other major commodities for that matter, will recover. But what is certain is that the decrease in the price of oil is putting tremendous strain on energy-related companies. A significant number of oil companies have been able to sidestep the free-fall by placing hedges a few years back. However, this is only a temporary fix as these hedges will expire soon. Financial strain will surely increase within this sector. A lot of these companies issued debt to help sustain their day-to-day operations. Most of it is classified as junk. That means as oil stays depressed, these companies will burn through cash, miss debt payments, and begin defaulting.

Many pundits believe that this fall in oil prices will not adversely impact the rest of the US economy. It is, after all, just one sector among many. However, keep in mind that the 2001-02 recession was caused by a single sector: technology. And remember that oil is the most important commodity in the world. While cheaper gasoline prices is a nice to have, the reason why gasoline is so cheap is what should be on everybody’s mind.

 

Ryan Hughes
Bull Oak Capital
Bull Oak Newsletter
12/8/2015


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