REAL PRESSURES IN THE OIL MARKETS 6/13/2008

We’re all amazed, stunned is more like it, at the current price level of oil and how that has translated to the price of fuel. There is no one culprit in this disaster, but several major factors, including the weakened US dollar, the financial appetites of oil producing nations, commodities speculators, increased demand from emerging economies, and the swelling profits of major oil companies (foreign and domestic).

The Federal Reserve and the US Treasury appear to have gotten the message that the US dollar must be strengthened and are beginning to take steps that should minimize inflationary pressures on oil and other commodities. Lawrence Kudlow, Chief Economist for Prudential Annuities and CNBC regular, recently wrote an article titled ‘Bernanke Backs King Dollar’ wherein he offers advice to US Treasury Secretary, Henry Paulson, and presidential hopeful, John McCain. Kudlow points out that the Fed, the Treasury and the Executive branch all need to shift to a dollar strengthening policy and that the Fed needs to restore ‘an inflation-targeting policy that has been badly undermined of late’. He’s right, of course, but strengthening the dollar includes more than just increasing interest rates. It includes decreasing corporate tax rates and absorbing some of the excess money supply the Fed injected into the economy in recent months via lending operations.

OPEC recently called for a summit of oil producing and consuming nations to determine how much of oil’s price increase is due to speculation versus supply and demand versus currency exchange issues. While this may be an encouraging sign from those that may be profiting the most from higher priced oil, it may also be an attempt to shift the attention elsewhere. What is clear is that OPEC sees that the US and Western Europe, traditionally their best customers, are beginning to push efficiency measures and demand is decreasing. While the domestic demand decreases may not be in OPEC’s best interest they are definitely in the best interest of US businesses and consumers, and their effects will bring about permanent economic and environmental benefits.

Our legislative representatives in the House and Senate have heard the national outcry to increase regulations on oil speculation and for major oil companies to reign in their profits. Even though the problems our legislators are working to address are real, additional domestic regulations on corporations that are trying to compete on a global basis and levying more tax on any industry are never good solutions and terrible long-term policies. Free market economies really do work and a certain way to deepen the economic slow-down our economy has experienced is to place more burdens on the basic engine of our economy. Fortunately, it appears that sound minds may prevail and the current house and senate are steering clear of a burdensome course of action and seeking more progressive alternatives; such as adding incentives for exploration and developing alternative energy strategies. It remains to be seen what the next batch of executive and legislative officials will do - this is not a time to respond to populist pressures.

The US demand for oil is decreasing, albeit slightly. Given the transportation and fuel efficiency shifts we’re beginning to see, the ‘greening’ of America brought about largely due to concerns over global climate changes, and a generational shift towards greater social and environmental responsibility, we are likely to see substantial decreases in energy consumption across the board. First quarter decreases in seasonally adjusted household energy consumption were down 8%, with even greater expectations for the second quarter. Even though this doesn’t make up for the increase in energy consumption in developing economies (China and India represent the largest increase in consumption), the added demand has created no obvious, near-term supply problem. Tankers are not sitting empty at docks awaiting new supply, factories and workers are not idle due to fuel shortages, and no one under the age of 30 can remember seeing a line of more than 3 or 4 cars at a fuel pump. Though reasonable minds can recognize that there is only so much oil in the ground, many discount the technologies being brought to bear that will create energy from resources previously thought to be unprofitable.

To be sure, speculators have driven the price of oil beyond reasonable levels. Some suggest that these levels are here to stay, others recognize that the current price levels may not be sustainable, others still have used the term ‘bubble’ to describe the current commodities market and suggest that just as the ‘dot com’ and housing bubbles burst, this too shall pass. History says they are correct. Some solidly state that this time it’s different, but experience has shown that it’s almost never different – whenever there is an imbalance in a free market economy something moves to correct it.

In 1980, during another era of increasing commodities prices and uncertain economics, a noted Utah business and ecclesiastic leader stated that ‘There is only one energy shortage existing today, and that is what exists between our own two ears.’ The remark was more a commentary on the resiliency of our economy and the resourcefulness of our innovators than it was anything else. Ultimately prices came back into line, supplies became more plentiful and innovation brought about greater efficiencies. In this case it will most likely be several influences that converge to lower commodities pricing. Our free market economy will prevail and adjustments in both supply and demand, currency valuation, and corporate responsibility will evolve to support ongoing economic growth. Because, this time is no different than last time and history is always correct.

Rick Haskell – Signature Wealth Management