Wednesday, October 15, 2008

Oil, Auto, Main Street, Global Economy

I have been trying to bring in the price of oil to my arguments to show how the world is changing, and how the media can be over-focused on certain issues when it blows up, to the detriment of other broader issues, just as important.

We have seen massive de-leveraging from all assets classes over the last few weeks. Three of the top US investment banks now no longer exist. Demand destruction in commodities everywhere. Real estate collapsing not just in the US but parts of Europe, in particular UK and Spain. Hedge funds saw massive redemptions. The Icelandic internet banking fiasco. Credit frozen, nobody wants to lend. Emerging markets all down nearly 40%-50% already this year. All taking about recession for sure and maybe even depression...
why then is the price of oil today still about US$10 higher than what it was a year ago???

1) It tells you that the inherent demand, though weakened, is still very firm, especially from China and other emerging markets. It also tells you that the global economy is not as small as it was 10 years ago. Since 2000 till now, the global economy has grown by 70% in size - guess where the bulk of the growth in trade came from? Even though you may see absolute devastation in US property market, much of the wealth destruction hit investment banks and mortgage lenders capital base. Yes many of the broader property owners are feeling the pinch as well, it is not debilitating so.

2) Watch for the auto sector - this is where the pain will shift to. Big companies will fail or be merged and job losses will be massive - the auto sector consolidation has been brought forward by the events over the last couple of weeks. The auto sector combustion will cause the media to focus away from the carnage on Wall Street to carnage on Main Street. Expect markets to be wobbled by this. Keep cash at least 50%, trade out on weak signs - the worst may be over, but the general conditions still shifty. Jobs is where we should really look at. We can expect more job losses in the coming weeks and even months. I forsee some industries will see MASSIVE failure - the first to go will be the US auto makers.... pension problems, no credit or loans for people to buy cars, consumers delaying changing of cars now, problems with unions... very difficult to refinance their lines of credit moving forward... watch for at least two of them being merged or absorbed by a foreign competitor at cut throat prices. The auto industry are big employers, and that will hurt employment, and drag property prices weakness in those states where auto industry is strong.

3) The price of oil is higher today than a year ago because th cost of bringing oil to the market is now "very high". Forget about the easy low hanging fruits where the cost is less than US$20 per barrel. The average cost of a barrel to the market is now in the US$65-70 per barrel. If the price of oil drops below US$70, OPEC would just prefer not to produce. In fact many of the smaller producers may even produce less. Better to leave them in the ground. If that being the case, we can safely say the price of oil will not dip below US$75. I would also like to go very long on oil contracts again at US$80-81, rolling till March next year.
From that alone, we can safely say that things are bad, but not as bad as the Western media makes them out to be. Focusing maniacally on one issue can desensitise us to other issues.

p/s photo: Uli Auliani


yj said...

didn't goldman sach lowered their projection for oils next year to reach $50 per barrel citing demand destruction ?

Datuk said...

Agreed with your points highlited in this article. However, my opinion do differ in the following area:

i) In a highly competitive business of today, it's quite common for prices to below marginal production cost, particularly in the periods when the bases of prices and marginal costs were derive from peak cycle but demand destruction had raise its ugly face. Take for example:

Nickel - marginal cost/MT is US$ 18000, but today selling price =US$ 13000; but the marginal cost 2years ago at US$ 8000/MT.

Scrap Iron = marginal cost/MT = US$400 but selling price = US$320/MT
;but marginal cost 2 year ago at US$ 150/MT.

Hence, assuming yr production costs of oil quoated is correct, i think when the force of demand destruction raise its ugly face, oil prices will be naturally below its marginal cost. Bear in mind...the forces of inflation will be evaporated at the rate faster than our general feeling.

The above analysis is purely confined to the price and marginal costs only. That is hypothetical for our comprehension. Far from reality.

If you factor in other business aspect like inventory position, order cancellation, bad debt, extended collection period etc with each company having a different scenario.....this may resulted in a cut throat competition when the demand and good customers becoming a scarcity animal.

Good day.

Gamelion said...

The world economy had been self-destruct with the never before seen of ultimate super duper everlasting highest of the most inflationary in this era with this nonsense forever injection of liquidity for bailout with unlimited
amount of printed money and the forever unlimited demand for the bubble of commodities mania !!!!!!!

Anonymous said...

Petrol price decrease 3rd time by 15 sen. I think petrol price may decrease further by end of this month. However, with series of decrease in petrol price, suprisingly gov still keep petrol rebate RM 625 unchanged. I worry gov deficit will keep worsening as CPO, crude oil continue on downtreand. A lot of project under 9 Msia plan could not executed and corridor development also may not continue in view of new PM in next year.

Philip Lee said...

Markets are never efficient. To achieve that, we either need to squash competitions to 0 or encourage competitions till there are no monopolies. Either seems impossible and hence one cannot correlate the price of oil with everything else..

Here is a more simple thought that makes more sense ....

Dr. Marc Faber concluded his monthly bulletin (June 2008) with the following: ”The federal government is sending each of us a $600 rebate.
If we spend that money at Wal-Mart, the money goes to China . If we spend it on gasoline, it goes to the Arabs. If we buy a computer,it will go to India.

If we purchase fruit and vegetables, it will go to Mexico, Honduras and Guatemala. If we purchase a good car it will go to Germany . If we purchase useless crap, it will go to Taiwan and none of it will help the American economy.

The only way to keep that money here at home is to spend it on prostitutes and beer, since these are the only products still produced in US.

Ivan said...


Gov already say it. they must implement it espesially with Msia politic risk now :D
if not, sure many plp blame liao lo . .perhaps , gov will implement another "tax" in social to offset the burden -RM625.

2) that is a "cost" for gov to pay due their "investment" are fail. I am sure, they do expect the oil price is keep going on and they will earn a sexy income due earning in petronas :D

solomon said...

Hopefully, after this economic readjustment, auto and banking companies will become stronger.

In reality, if a country purchase in bulk for commodities, normally the prices they obtained is 5%-10% below the quoted market price. Most of them have their price remained fixed for at least a year and also depends on the negotiators.

Taking another spectrum of issues, with the slowing demands in US retails, one of the actions US Congressmen should consider is to curb outsourcing in lower cost countries by enacting laws. This will bring back jobs to US. Some may argue this make no economic sense. On the hindsight, this will help to re-generate income in this region and a stronger spending at the end of days.

I also disagree of some sayings that Asia will overtake US as the next consumption locomotive. If you look at it, the Asia consumer spending pattern is careful, and this will remain as their habits and it cann't change overnight.

The more important thing now, other than boosting the credit circulation, is also to stabilize the forex fluctuations. This will in turn reduces imported inflation and better biz prifit forecast, hence more certainty in job market.

Chauncey Gardener said...

Yes, you are right.

Nobody is talking about going green now.

DarkWan said...


Am not a financial person, but I am an avid reader of ur blog lately since the AIG thing.

Just want to say that u made a wrong assumption here, but I think everyone love to be wrong about that. Haha.

"If that being the case, we can safely say the price of oil will not dip below US$75. I would also like to go very long on oil contracts again at US$80-81, rolling till March next year. "

At the moment, crude oil price is USD $73.22.

Salvatore_Dali said...

dark wan,

what is wrong with yr posting... it is stating an obvious... yes I still call a buy at 81... yes its now 73... so??? Why you dont go and write to Buffett that GE or Goldman dropped 15% after he bought shares in them recently... I am not saying I am Buffett, but u r giving a bs posting that adds no value... I did not retract my posting, so whats yr problem... its like me saying your mummy is a woman.. (that may be true, but u sure did not need to hear that right?)...grow up la... dont go making passing investment judging comments on a daily basis

Anonymous said...

Dear Ivan
Our gov never strictly keep their promise. In fact, it is justifiable to reduce if not abolish petrol rebate. Perhaps our ministers need to attend assest management course to equip themselve on how to effectively make use of resourse. Take for example, one reason CPO price trade at big discount compare to corn/soya oil is our ever growing stockpile and lack of alternative use of CPO. Msia should start mandatory use of blend petrol or fuel to generate electricity. Policy change must adapt fast, flexible and active rather than passively and over dependent on Petronas.

Ivan said...

Dear Hng,

I agree with ur point... to send minister to go to study on asset management class. . but will u think that is funding at RM x million per each of minister if we want send them for study?

They will charge us another 10X normal bills . Dont u think so?

Biodiesel is a good idea but so far, not much car use it.

NGV gas is a good due the price is cheap .. but again, due gov restricted policy, only Petronas have the NGV supply. walaeuh. . cab driver has time to wait to fill in petrol. will we have ?

Highway too - use smart tag shall give discount ? perhaps can implement -5% discount to avoid trafic jam (espesially the festival season) & increase the smoothy of traffic. Doesn't it good? (try think 10% plp use smart tag, the car move more fast, not heavy car jam in toll )...

happy sharing..

TsuChong said...

Looks like OPEC is gonna cut production.

Price increase soon? Such volatality doesnt sound good.

But despite the changes in oil prices, the car rebate thing still remained the same. I bet there'll be another flip-flop decision soon.

DarkWan said...

"I am not saying I am Buffett, but u r giving a bs posting that adds no value...
I did not retract my posting, so whats yr problem...
grow up la"


As I said earlier, I am new in this financial/investment/money thing. I don't see a problem in my posting, but as you pointed out, clearly I need to learn more.

Having said that, I'm sorry as it seems I said things that shouldn't be said (?). You can delete my previous comment and this comment too because it add no value.

"dont go making passing investment judging comments on a daily basis"

Thank you for the insight. Really appreciate it.

PS: I am having no basic in financial/money except when learning Kemahiran Hidup, well in seconday school about 12 years ago hehe.


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