The Oil Market Today & In The Future

Introduction: 

If I had told analysts a year ago that oil prices would've dropped over 30% during 2015, then they would have laughed at me hysterically. But, would-ya know? The past year and a half has been the worst bear oil market since the financial recession of 2008. Brent/WTI crude is hovering around $35 dollars and is leaving huge question marks going into the new year. Prices were at all-time highs at $100+ during 2014, and has dropped to a ridiculous amount during all of 2015. Analysts and economists have consistently spoken about oil reaching a "bottom", but every-time this has been said, prices seem to keep declining.

Well, Whats going on?:

Very simple, the supply and demand curves are HURTING, tremendously with the supply side bringing on the most burden.

Supply side:

Ever since US drillers have entered the oil market, OPEC has increased its production tremendously with the intent to not give up market share to the West. This has caused a huge glut in oil within the markets. OPEC recently met during November and tensions rose as the ministers for the members within OPEC debated on whether or not to cut supply in order to increase prices. They came out with no solution and have been continuing to pump in supply into the market much more. OPEC would like to compete with North Americans producers to the point where the North American producers can no longer profit and risk financial turmoil if production continued. In addition to this aspect, the addition to Iran into the oil market will cause a surplus in supply as well. Iran expects to pump over 500,000 more barrels into this oversupplied market. This should also continue to wage prices lower if the market continues as it is.

Demand side: 

 
Although demand for oil is expected to increase going into 2016, fears of an economic slowdown in China has also waged on the demand side. China, who is a huge importer of oil, has slowed down its demand for many of the materials it demanded during its boom period over the past few decades. Now that the world is certain of this slowdown, any news of economic slowdown within China will surely lower prices. Although I do mention China is a huge part on the demand side, I want to be clear that demand for oil within China is still growing ( ~7% GDP growth), but the "fear-factor" of China's economic slowdown is what is ultimately affecting the demand side. Low oil prices ultimately is spurring more oil demand within China, but not in the usual places. Because China is shifting its economic structure from an infrastructure/export based economy to more of a consumer-based economy, there has been a slowdown in demand for oil from the infrastructure side. The consumer side, however, is growing at large rates, which is directly correlating with an increase in demand for oil.




Macro-economic factors:

This graph clearly shows an inverse relationship between the price of oil and the value of the dollar. After the Federal Reserve rose interest rates by 25 basis points, and is almost certain to increase interest rates 2-4 times during 2016, the value of the dollar is certain to rise much more going into the future. The expansionary policies of other major central backs such as the BOJ, ECB, and the Chinese Central Bank will cause higher divergences between the dollar and other major currencies around the world. As the chart shows, the higher the dollar gets compared to other world-wide currencies, the lower these dollar-backed commodities get. This occurs because as these commodities get more expensive because of the increase in dollar (compared to other currencies), there will be less demand which will ultimately lower prices.

My prediction:

Going into the future, I truly do believe OPEC will be able to find its way to victory. Countries like Saudi Arabia are creating huge deficits but are insistent on bringing down non-OPEC producers such as Canada, USA, and Russia to assert and control their power of the oil market. They will be restless in attempting to bring down producers within the Western hemisphere, because, lets be honest, it matters to them more. Countries within OPEC highly depend on the price of oil and oil itself for its economy. 80-90% of Saudi's exports are purely oil related and so is a majority of their GDP.

As OPEC will continue to strive for market share, many US exploration projects will come to a close, and eventually lead to lower oil being produced (exactly what OPEC wants). Many companies within the US have been heavily pressured by the oil price plunge and have been forced to cut workers and cut production in the market in order to stop the bleeding of their balance sheets. As the chart shows, capital spending and gas exploration has been decreasing recently due to the unprofitability and the high losses that drilling under these oil prices can bring. Many NA firms have already called for bankruptcy, or have been severely damaged by these low prices because of oil being way below their break-even prices.

In addition to that, the sanctions lifted off of Iran and continuing political turmoil within the Middle East due to ISIS will be underlying factors in the oil market during 2016. Iran will definitely have a factor in keeping prices low, but one factor that might reverse the tracks unintentionally will be the shortage of supply that ISIS might be able to cause. After the Paris attacks, we saw a spike in oil prices due to the "geo-political factors" that ISIS can cause to the supply market within the Middle East. I definitely do believe a large-scale attack or war in 2016 can have the possibility of effecting the markets in a large way.

Overall, prices will rise, its just a matter of when. It will take time people, but alas, prices will rise and OPEC will get their way.



Picture References: WSJ, Market Realist, Energy Research

My opinion on Tax Inversions.

Ever since the Pfizer, Allergan deal, there have been many talks about how "un-patriotic" it was for Pfizer to move its tax base to Ireland. Well, to those people, I have a question for you guys. If you were the CEO of a firm, and had an opportunity to pay 12.5% on all sales compared to 35%, would you take that opportunity? Of course you would. It is ridiculous to think that Pfizer was in the wrong of wanting to commit to an inversion acquisition that would lower its companies tax rate by more than 25%.

If inversion deals aren't the problem, what is? Well, the problem is the US Government. The US Government has established a 35% tax rate on all US companies revenue stream, including revenue stream abroad. Compared to an average tax rate of 26% worldwide, the US has one of the highest tax rates in the world. It's excuse? Some claim that it is a privilege to be domiciled in the US and paying the high tax rate domestically and for all income made abroad is the "tradeoff". That is COMPLETE insanity. In a world of globalization, the US is slowly looking a lot less attractive than it used to be.

Apple's Tim Cook, in an interview with 60 minutes, was asked why he had billions in revenue parked offshores. He replied, simply by saying that it was preposterous that he would have to pay over 35% to the government if it were brought back to the US. And I completely agree with him. Apple, a company that makes 2/3rds of its revenues offshore, should not be taxed 35% for the privilege of being domiciled in the US.

If the US wants to be a competitive and an attractive place to start a business, it must commit to a tax reform that does not TAX at such high rates domestically and abroad. My proposal is to lower the tax rate domestically near the average of 26%, and DRASTICALLY decrease offshore revenue to single digits. Some might argue that this would dramatically lower government revenue, which would result in less expansionary fiscal policy. But to those people, what do you think these high taxes are doing? Say you had 100 billion in revenue. With the US tax rate in place, this would result in about 35-40 billion in taxes going back to Uncle Sam, not including other state taxes, etc. This 35 billion to 40 billion could've been used in R&D, or company expansion which would create more jobs and a growing economy. What happens when an inversion occurs and a company is domiciled offshores? Well, that company will commit to R&D and expansion within that country, taking away jobs that could've been created in the US.

All I am saying to Repubs and Democrats is: DO THE US ECONOMY A FAVOR AND FIX THE TAX CODE. DO NOT DIS-INCENTIVIZE COMPANIES AND PENALIZE THEM FOR WANTING TO LOWER THEIR COMPANIES TAX RATE. A BUSINESS'S PRIME GOAL IS TO GIVE THE BEST VALUE TO ITS SHAREHOLDERS. FIX THIS NOW BEFORE THE INVERSION RATES GET HIGHER!

Why the Federal Reserve was correct

The Federal Reserve, for the past year, has been flirting with the idea of raising the interest rate benchmark from 0% up to .25%-.50%. Well, on December 16th, they have finally answered the wishes of finance experts everywhere. They rose rates very marginally, and are expected to continue to do so as inflation picks up.

Was this too late? In my opinion, no. I do not think the rise in interest rates was late at all. I think the Federal Reserve did the right thing and wait the interest rate hike out until it was adamantly clear that macroeconomic conditions were sufficient enough for them to do so. Although I also think the Fed's hike was also due to a credibility issue (promised rates would increase in 2015), I think that a small hike was definitely justified.

To go back through the year, we have had an unbelievable amount of volatility. The Greek debt crisis. The Chinese stock-market plunge. The Chinese yuan devaluation. Oil price drop and much more! These obstacles were all in the Fed's way to increase interest rates and these problems still exist today. While the hysteria surrounding these problems were at all time highs, the employment numbers for September and October were dismal. This caused a huge fear with investors and also the Fed that the global economic slowdown was slowly creeping into the US economy.

... Then, things started to calm down. Payroll numbers increased by an expected 200k+, global stock markets slowly got back to shape, and so on.

No doubt that the US Economy is at full employment and is ready for a small hike. Monetary policy for the past decade has remained at emergency-like policy for way to long. At about 5% unemployment and a moderate 2-3% GDP growth, an increase was fully justified.