Time To Play, Not Politicize

Some people are just impossible to please. With oil prices headed towards the $50 threshold (and that’s just the start off this massive decline which will probably bottom out around $35), private equity booming, IPO markets up across the world and tech staging a massive comeback, there are still those who aren’t satisfied right now.

Hugo Chavez’s “socialist revolution”, the threat of North Korea, more troops headed out to Iraq, even – unbelievably – a declining oil price: the list goes on of negative indicators market bears are conjuring up as reasons to be pessimistic about the outlook for 2007. It’s time to dispel the myths and the bears which tout them like second-hand concert tickets.

First of all, Chavez’s socialist Venezuela is nothing new, and although high on the U.S. republican administration’s worry-list, that’s about all it is – political propaganda. In fact, in the cases of surrounding Latin American countries, whether the Bush administration wants to admit to it or not, Chavez’s heavy-handed administering of the country’s oil market has provided the much-needed economic reprise for these countries to get their finances in order. Argentina fared dismally when exposed to the distinctly one-sided battle with powerful American market capitalism only a decade ago - trade with Chavez’s Venezuela over the past year has put some money back into the cavity made by traders from New York and London back then; Cuba finally has a trading partner rich enough to strike something resembling a good deal with; and Bolivia, Ecuador and Brazil are all beneficiaries.

This is not to support Chavez whatsoever, but economic reality is often vastly different from its political interpretation. Richer countries are less of a geo-political threat than poorer ones, and that old adage goes for Latin America as much as anywhere else. Politically sanctimonious foreign policy from the republican administration is obsolete now the global economy is in better shape, and should be ignored.

And what about North Korea? “North Korea will not cause too much trouble for the region,” one hedge fund manager in Hong Kong told me last week. That seems to sum up the general consensus over there well. If North Korea isn’t even an issue in South East Asia, it shouldn’t be one for anyone else, either, Washington included.

In short, the political agenda which sent oil prices surging upwards for five years finally seems to be fading away as oil speculators realize that the game of crying wolf in order to justify big profits from commodities has finally come to an end.

This is not to disparage republican policy per se: most of it, such as early-century tax breaks and responsible rate handling has been economically intelligent and has brought about the liquidity the economy has needed to get to this stage of powerful growth. But it’s time to accept that the cache of war on terrorism has had its day, and like it or not, it’s become terribly passé.

The massive hit the price of oil has taken is evidence of this and it’s almost impossible to see how this is a negative thing for the economy. Sure, oil exporters like Russia, Venezuela, Malaysia and Norway will feel the negative effects, but this will only help industry there which uses oil as a cost stream rather than a revenue stream to grow over the long term. High oil prices generally mean good news for one industry, and one industry only: oil companies. By contrast, low oil prices mean good news for multiple industries. This is a good time for U.S. companies.

A low price of oil does not gel logically with the idea that countries like Iran and Iraq will become more dangerous, either. The irony was that as the “war on terror” ensued, oil prices were being pushed up as a result, empowering the military in those places who relied on a big price in the black liquid to fund their expensive guerilla wars. Low oil prices can only mean less power to those perceived as global threats.

Most of all however, the extra capital most major corporations who see oil as a cost will now have more money to play with, which means more money to invest, which means a stronger economy and a stronger market. 2007 is set to rock and roll for U.S. markets, and it’s high time this was made the focus of the republican administration.

Otherwise, just as with his father before him, President Bush risks handing all the republicans’ economic success over to the democrats. And, just as with investors in the 1990’s, investors this time round will wait until the point where another bubble is about to burst before joining in the big gains of a surging market.

Comments

[Amit]

I'd agree that some of the main issues include oil, and geopolitical concerns. However, another rather large problem, which leverages itself more as time goes by, is the US trade deficit and the incredible debt held by countries like China in US Treasury bills. Any slight deviation from an optimistic outlook could cause a ripple effect that would go down like a set of dominoes. The US currency has already devalued massively. Beacon investors like Warren Buffett have refused to buy US assets for several years now, and I think you've ignored this in your post.

Regards

Amit

[CJ]

"But it’s time to accept that the cachet of war on terrorism has had its day, and like it or not, it’s become terribly passé."

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He was a terrible economist and worse person, but it's time to paraphrase Vladimir Lenin: You may not be interested in terrorism, but terrorism is interested in you. The jihad problem is not much affected by financial conditions, and it is not going to go away any time soon.

BTW, I agree with everything else in your post. The present administration has actually done a good job with the economy, and it's remarkable how well business performed during the recent cycle of very high oil prices.

[ATM]

I wouldn't concern myself with Warren Buffet too much. He did miss much of the legitimate technology boom.

[Mark in Texas]

"High oil prices generally mean good news for one industry, and one industry only: oil companies."

High oil prices also seem to be doing good things for agriculture and the biofuels industry. In the past, the Saudis were able to keep the price of oil low enough to where ethanol and biodiesel could not compete economically except with massive subsidies. The gasoline prices since 2005 combined with the elimination of MTBE as a fuel additive have created an enormous expansion of the ethanol infrastructure in the US to more than 5 billion gallons of annual production. Just the additional plants already under construction will add another 6 billion gallons of production capacity over then next two years. The cost to produce a gallon of ethanol from corn in the US is currently averaging ~$1.00. The new plants coming on line are more efficient and will be able to lower that cost.

Can enough oil be brought to market to bring the wholesale price of gasoline down below that number? Maybe, but they will have to act fast because as ethanol producers climb the learning curve, their cost of production is going to keep dropping.

Anyway, the point of this long winded comment is that high oil prices are not really in the long term interest of the oil industry. They are, however, good news for the alternate fuel industry which looks like it might actually get firmly established this time.

From a global perspective, consider what this means for those countries that can produce ethanol from sugar cane like Brazil for the same cost as Brazil, i.e. $0.50 per gallon. What do you think the chances are of wholesale gasoline prices reaching that level?