When I was in grade 3, we went on a field trip to the Science Centre and I distinctly remember being mesmerized by this glass oval contraption which was filled with a mixture of oil and pink-dyed water that you could spin around to illustrate the foundation of a heterogeneous mixture.
A heterogeneous mixture is made of different substances that remain physically separate – even though they may be mixed together. So, let’s apply that to what’s been happening lately …
Yesterday, the Organization of Petroleum Exporting Countries (OPEC) decided to maintain its output target at 30 million barrels per day. The effect of this decision was immediate as the Toronto stock market tumbled more than 100 points – lead by energy stocks being sold off and crude prices plunging to multiyear lows — below $70 US a barrel.
There had been hopes that oil ministers with OPEC (who met in Vienna this week) would cut production in order to put a floor under prices that have fallen about 30% since mid-summer, when prices were elevated by geopolitical qualms. Prices have steadily fallen since then because of a strengthening U.S. dollar (the Canadian dollar slid even further today) and now the basic fundamentals of too much supply relative to demand.
The decision against intervening in global markets by cutting production levels sends a clear signal that the 12-member oil cartel will no longer bear the burden of market adjustment alone and means that the oil complex will have to balance itself over the course of the coming months. There is certainly less doubt in our minds that Saudi Arabia is steering OPEC in a direction that will preserve the organization’s market share, with non-OPEC bearing the supply-adjustment burden for the time being. Which begs the question, have we seen the bottom yet? Who knows – likely not. I was chatting with our Chief Economist this morning and when I asked him what he was up to, he said, “trying to figure out oil prices” … so if he can figure it out, I’ll pass it along.
So, while this sounds like bad news, oil wasn’t the only element in that glass contraption I spun around as a child – much like it isn’t the only industry one would invest in. The pink water in this case is the positive effect that sustained lower energy prices will provide for consumers and businesses that are heavily reliant on energy.
For businesses, lower oil prices mean lower fuel and energy costs (one of the largest expenditures in any other resource industry, i.e. mining & automotives) and also means more profits, which in turn equals more taxes to the feds/provinces and ideally the creation of more jobs.
For consumers, it means more money our pockets - cheap energy has already been cited for lifting the spirits on ‘Main Street’ as people spend less at the pump and put more goodies into their shopping bags. The importance of consumer spending can’t be stressed enough as a driver of US economic prospects given personal consumption accounts for roughly 70% of the U.S. economy. Nearly half of Americans earn less than $50,000 annually, translating into an average after-tax income of ~$22,600, with roughly 10% of that after-tax income allocated to fuel expenses. Should U.S. gasoline prices remain near current levels for the balance of the year, our analysts estimate that it could result in an added $20 billion in consumer pockets. The timing of these gas price declines couldn’t be better, delivering added firepower to the all-important holiday shopping season.