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Kass: Cheaper Oil's Silver Lining

As you read this, keep in mind that I am not an oil economist (nor am I even a decent investor in oil-related equities). As a sometime consumer specialist, however, I have had to observe oil prices and understand their impact on consumer behavior.

Nothing impacts consumer spending faster than change in price at the gas pump.

In 1973, OPEC announced its oil embargo, and the price of crude tripled. For almost 40 years, oil prices have included an oligopoly rent from OPEC (also called political uncertainty), which has trumped the law of supply and demand.

The cartel's influence may now be finally breaking down.

Today, with WTI down to $88 a barrel, gas prices are below year-ago levels, serving to provide the consumer with a tax cut. Chinese demand is ebbing, perhaps due to concern about horrendous pollution. Cars are growing more fuel-efficient. Plus, there are other, larger factors at work:

  • New supply is developing due to the fracking boom that has increased supply of U.S. crude as well as natural gas. The collapse in price of tankers ($170,000 a day at peak to $7,000 a day now) confirms that less oil is being transported globally.
  • Several producers of oil are now in a mode of having to produce. This includes Russia, Saudi Arabia (which must support a growing welfare state for its youth), Iran (where a lot of its oil is embargoed), Iraq (which needs cash) and Venezuela (which also needs cash). Indeed, it is hard to find a member of OPEC that is not motivated to produce.
  • Commodity investors have had a boom in the last 15 years. That may be ending. Gold is in a bear market. Gold investors may be getting margin calls forcing them to liquidate other commodity pools (which have huge weightings to oil). This creates a vicious cycle, forcing oil and other commodities down. (In just the past two weeks, commodity indices used at The Economist are down by over 7%. That may not seem like a lot unless you have 5x margin, which you can in some of these contracts.)

Oil is still far above the point of zero marginal production price. The price of crude might have a lot further to go, and, in the short run, prices can go below the cost of production.

The law of supply and demand may start to apply to oil, and OPEC may be all over. Both, at least in the intermediate term, would be bullish for the U.S. economy -- the consumer sector will be delivered with a tax cut and corporations' profit margins could be buoyed. It could also be seen as a negative for the bond markets as lower commodities revive economic growth.

There is a silver lining.
At the time of publication, Kass and/or his funds were long TBT, PG, PEP and CL, although holdings can change at any time.

Doug Kass is the president of Seabreeze Partners Management Inc. Under no circumstances does this information represent a recommendation to buy, sell or hold any security.

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