Skip to main content

Lessons From The Current Oil Shock

I came across one of the smartest article in Newsweek (31/10/05) written by Ruchir Sharma (co-head of global emerging markets for Morgan Stanley Investment Management) on the present oil shock. Many are confounded by the lack of calamity owing to the recent surge in oil prices. Sharma cited some clever insights and I would like to add to them:

a) The present oil price bull market is due to demand-surge factors and supply growth that could not cope. This is very different from previous oil price rallies which were more likely due to supply shocks (e.g. wars, embargos, cartel behaviour). What this means is that a very strong global economy is pushing demand for oil, and the usage of oil is more for production of goods which has an end market demand. Hence oil consumption is largely for "productive means". The higher cost of oil is more easily absorbed or passed on along the production and consumption processes.

b) It used to be that higher oil prices meant that we are lining the pockets of OPEC nations at the expense of non-OPEC nations. Back in the mid 70s, the additional revenue from jumps in oil prices stayed mainly with OPEC nations and was not recirculated back to the global economy. Sharma cited UBS economic research as saying that back in 1974 only 27% of petrodollars was recycled back into the global economy. Now OPEC nations are more involved with the global economy by consuming as much as 83% of oil revenues. An example would be the aggressive purchasing of US Treasuries by OPEC nations which lowers the global cost of capital, thus allowing the major economies to chug along without higher interest rates cutting off economic activity.

c) The present oil shock has also magnified countries that have been subsidising the cost of oil in their country (namely Malaysia, Indonesia). These oil price surges have reinforced the growing amount of subsidy, which could have been better spent to revitalise other areas of their economies. Malaysia, correctly surmised that they should reduce the level of subsidy. In fact, one can safely say that countries engaging in subsidising oil prices are gradually lowering their subsidy from here on. It is not prudent to artificially sustain a country's competitiveness and purchasing power via the subsidy method. The political will to act on the subsidy is stronger this time around because many are recovering well from the 1997 financial implosion, and is more acutely aware of bad economic policies. It is better to reduce the subsidy from a position of strength.

d) Consumption patterns have also changed owing to the present oil price rally, but isn't that the case every time there is an oil price shock? Drops in sales of SUVs (four wheel drives) and increase in purchase of hybrid cars are evident. The only difference is that the consumer is generally pretty pissed off with the magnitude and arrogance of the oil price rally over the last 12 months. There is a growing sense of the consumer not wanting to be an idiot victim of future oil price hikes, and also a warming appreciation of global warming and conservation issues.

e) Oil companies and refineries are also taken aback by the present oil price rally. Though they are all recording supernormal profits, many felt that they were caught unawre by the rally. These companies and governments have stepped up efforts to speed up on oil exploration and refineries have charged along to increase capacity.

The above factors would indicate that the price of oil will stay stubbornly high over the next 12 months at least as demand is still genuine, and supply is still not able to catch up that fast. Extra capacity and supply will come along only after a couple of years.

What is important here is that governments have generally wised up to the need to adapt quickly, either by reducing subsidy on oil prices or change in consumption patterns or increase activity in exploration - this should reduce the price volatility in the next oil price shock, and also indicate that future oil price shocks is more likely to be determined by demand factors again rather than supply constraints.

The final lesson here is that it used to be the trade surplus countries are subsidising the ballooning US budget deficit. Though naysayers have been plenty and more vocal over the last 10 years on the need to bring down the US budget deficit (and they should), the end for the US dollar is still a bit further away as there is sufficient petrodollars providing extra support for the deficit. Hence I would only really start to worry about a collapse in the US dollar and US economy if Japan and China stops registering trade surpluses or OPEC nations NOT making real money anymore, as it is not in anyone's interest to allow the US dollar and US economy to collapse. Having said that, I would think that certain US government officials are not too perturbed by the present oil price shock. In fact, it could work out better to further sustain the US budget deficit.


Popular posts from this blog

My Master, A National Treasure

REPOST:  Its been more than two years since I posted on my sifu. This is probably the most significant posting I had done thus far that does not involve business or politics. My circle of close friends and business colleagues have benefited significantly from his treatment.

My Master, Dr. Law Chin Han (from my iPhone)

Where shall I start? OK, just based on real life experiences of those who are close to me. The entire Tong family (Bukit Kiara Properties) absolutely swear that he is the master of masters when it comes to acupuncture (and dentistry as well). To me, you can probably find many great dentists, but to find a real Master in acupuncture, thats a whole different ballgame.

I am not big aficionado of Chinese medicine or acupuncture initially. I guess you have to go through the whole shebang to appreciate the real life changing effects from a master.

My business partner and very close friend went to him after 15 years of persistent gout problem, he will get his heavy attacks at least…

PUC - An Assessment

PUC has tried to reinvent itself following the untimely passing of its founder last year. His younger brother, who was highly successful in his own right, was running Pictureworks in a number of countries in Asia.

The Shares Price Rise & Possible Catalysts

Share price has broken its all time high comfortably. The rise has been steady and not at all volatile, accompanied by steady volume, which would indicate longer term investors and some funds already accumulating nd not selling back to the market.

Potential Catalyst #1

The just launched Presto app. Tried it and went to the briefing. Its a game changer for PUC for sure. They have already indicated that the e-wallet will be launched only in 1Q2018. Now what is Presto, why Presto. Its very much like Lazada or eBay or Alibaba. Lazada is a platform for retailers to sell, full stop. eBay is more for the personal one man operations. Alibaba is more for wholesalers and distributors.

Presto links retailers/f&b/services originators with en…

How Long Will The Bull Lasts For Malaysia

Are we in a bull run? Of course we are. Not to labour the point but I highlighted the start of the bull run back in January this year... and got a lot of naysayers but never mind:

p/s: needless to say, this is Jing Tian ... beautiful face and a certain kind of freshness in her looks and acting career thus far

I would like to extend my prediction that the bull run for Bursa stocks should continue to run well till the end of the year. What we are seeing for the past 3 weeks was a general lull where volume suddenly shrunk but the general trend is still intact. My reasons for saying so:

a) the overall equity markets globally will be supported by a benign recovery complemented by a timid approach to raising rates by most central banks

b) thanks to a drastic bear run for most commodities, and to a lesser extent some oil & gas players, the undertone for "cost of materials" have been weak and has pr…