Wednesday, April 16, 2008

What Goes Up, Um, Stays Up?

I was brought to laughter on Tuesday afternoon, and I had to share the moment with other members of the thinking class. Driving along Elysian Fields, in the heart of New Orleans, I ran across a price posting at a less-than-prominent gas station. Apparently, at this station, regular gasoline was now running at a stunning $3.35. I thought to myself, " What the hell!" With that, I could not help but to snicker, and then continued, "What is this world coming to?" An insane $3.35--and that was just for regular and unleaded petrol! Is someone, somewhere, perfectly off his or her rocker? Or perhaps I should not have been too surprised, as I reminded myself that it was not so long ago that I was calling just this event "a tragic inevitability."

On Tuesday, on the NYMEX, oil prices tickled the toes of $114 per barrel of Light Sweet Crude, and now, as markets opened today (Wednesday), the prices were back there again. The argument for the latest climb seems to center around the consequences of supply-side disturbances, like pipeline troubles in Eurasia and Africa, in addition to some distribution hang-ups in Mexico. But, put into perspective, oil prices just one year ago were in the mid-sixties, and today's prices are now so far above those levels that many question the possibility of a return to those comparatively tranquil days. The real question for most is, instead, where is the new ceiling? $125, anyone? Or will we begin to find a new floor near $100 per barrel?

Couple this radical momentum in energy prices with the fact that other sectors of the U.S. economy are in slumps, and also with the fact that the dollar has been hobbled so greatly--and you begin to believe the unofficial experts who confidently, and albeit prematurely, proclaim that we are in a recession.

That said, though, this is not necessarily burdensome for the whole nation. That is because life in the Houston-New Orleans mega-region is downright good, these days, and oilmen like my own father, as well as a few of my Axiom S.A. clients, don't seem too bothered by the prospects of heady, long-term oil prices. After all, the oil patch is where they make their coins, and right now, this region is benefiting from a countercyclical economy driven in large part by the demand for what the oilmen pull from the ground. Indeed, from a linear perspective, "Dad & Co." are right to predict that little is going to change in the coming months, particularly over the summer, and with forecasts like those from the International Energy Agency, which call for global consumption to reach 87 million-plus barrels per day, we are likely to see elevated energy costs for some time...Nevertheless, even the oilmen must take heed, for life has its share of "inevitabilities".

The acknowledgement of such "inevitabilities" remind me of something written by my dear buddy, Jonathan Melancon, just last week:

...[C]onsider a colony of mice trapped in a wheat field. Well the early generations of mice will be living the good life, eating and breeding with no end in sight. This could go on for generations until there are too many mice and not enough wheat produced fast enough to feed all the mice and sustain the population...[T]he population of mice will have to constrict to accumulate the situation. In general [it] will be the resourceful, smart, strong and lucky who will continue to survive. So is it with an economy relying on finite resources. Booms and bust are the natural order of our modern economy, it is the individuals job to survive the bust so that they may thrive during the booms.

Right now the oil business is booming, not because oil people work harder but because we are in a commodity boom. So individuals such as myself and those tied to the oil business and other commodities are still thriving while others are just trying to survive. But make no mistake about it, our bust will come and it is our responsibility to be prepared.

Like it or not, the young businessman is absolutely right. We are in a commodity boom that could be problematic even for the oil patch. In fact, more than a few analysts are declaring that this is more than a boom; to them, this is almost a bubble. There are no appreciable multiples in the growth rates of aggregate demand for commodities like oil, and according to these analysts, much of the run-up in prices is primarily due to speculative interests. When Big Money needed to hedge against the falling dollar and flat equities, they poured into the commodities markets, inadvertently helping to drive up the prices of everything from milk to wheat to, yes, oil. And now, as many American families struggle to maintain, particularly in the face of all of these higher prices, those analysts correctly contend that the heady commodity boom will come to an unceremonious conclusion.

Yes, it is the one of the most elementary rules of economics that I can think of: what goes up must go down, and that is whether we want it to or now. Unfortunately, when it seems that myopia is the order of the day, even the brightest and most hardworking people among us don't necessarily want to hear that. They focus too narrowly on the present, and take less interest than necessary in the future, or even the strategies necessary for profiting in that future. For that reason, it will be the smart and the lucky of tomorrow--those who are can properly identify the current reality--who unseat the strong of today. Sure, "Dad & Co." might quietly revel today, as they profess that "business is too good", and as America acquiesces to higher energy and commodity prices. But, sooner than later, their revelry will be virtually silenced...That, you can count on.

Booms and busts are natural and cyclical events in economies. When the price of X rises too greatly, consumers curtail their spending on X, and that slack in the demand for X deflates the price of X. We students of capitalism have seen this truism play out many times in every sector of the global economy since the dawn of the Industrial Age--but in no sector, or for no region, should this lesson be more salient than for the oil sector in the Houston-New Orleans mega-region. We need only to remember the dismal days of the mid-1980's to recall just how easily national recessionary pressure, built up in the late 70's and early 80's, led consumers make choices that woefully impacted the oil patch. The same is true today, insofar as, if the country does face a long and deep recession, then the American consumer will eventually change their buying habits again, and the reduced demand will drive down prices, prompting investors the to seek out new hedges, and ultimately impacting this region.

Booms can easily become bubbles, particularly when irrationality sets into a market. And as I think about the $3.35-per-gallon signs at fuel stations, I am even more convinced that irrationality, if not just lunacy, has its grubby hands all over the commodities markets. But I take a cold comfort in knowing that even this is unsustainable. For, as this economy faces more and more recessionary pressure in its other sectors--real estate, manufacturing, and financial services--and as the American family shifts into a defensive spending mood, such high prices will only hasten an full-blown economic correction.

Not to worry, though, oilmen. Sure, your profits will take a hit, but correction periods are good times for building efficient business models, pruning the laggards from the industry, and exploring consolidations opportunities. If you are smart today, you are probably plowing your large profits into reservers, and patiently waiting for those opportunities to come...That's when you guys need to remember your wise consultants, especially the ones like Axiom Strategy Advisors, LLC.



Kel Silverman said...

It costed seventy dollars to fuel up my truck today. You are right. People can't just pour that kind of money into their gas tanks with out without consequences. My kids have to eat, so I am thinking of just selling the truck now. It ain't worth it anymore.

John Alex said...

Preach, boy, PREACH!!!

The gas pump is burning a hole in my wallet. Someone needs to get a handle on this mess.

Anonymous said...

I can confidently say that we understand the frustration people feel right now with high energy costs. It affects all of us too. To do our part, my company has not raised the fees for our towing services in step with the greater demand for such services. Part of the reason for that is competition, but the other part is that we believe its our way of keeping prices down. We are also taking your advice, Gary: we are investing our net profits elsewhere. In fact, this year more of that money is going into community and service projects. It is another way for us to give back and be good business citizens.


Taylor Lambert said...

Where did you get this idea of a "Houston-New Orleans mega-region"?

Digger in LV said...

Try $3.59 here in LV, guys. Some of the cheap pumps are $3.35. I don't have to tell you that it hurts just to go to work everyday. And food prices are even more insane. $4.20 for milk! How are people going to make it? Especially the poor people? Man, if we are not careful, we are going to run the wheels right of capitalism, and the shit going on in Haiti will be happening right here in our own cities.

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