Jan
7
The Effect Of $100 Crude Oil
January 7, 2008 | 10 Comments
The spot price for crude oil hovering close to $100 has gone on long enough that the consequences are going to come in more strongly and widespread than many had expected. It’s a big shift in cost to enroll into budgets whether you’re running a business or household. In just 48 months, the price has increased fourfold, 400% if you like scary terms. It should have been a more serious warning than most have been willing to engage.
The crude oil price directly passes on to increase the price of gasoline, diesel, jet fuel and home heating oil. Everyone using these products has already caught on to the effects and those whose budgets cannot adapt are suffering. The casualties are mounting quietly, but a breakthrough in damage reports cannot be far off.
Natural gas has also climbed as its price is often tied to the crude oil price. Depending on where on the planet the buyer is relative to the supply and its’ abundance the price can be quite high or still comparatively low. However, with continuing investment in liquefying natural gas, more buyers will become equalized in a world price.
These oil price trends come into other prices due to the pervasive nature of modern economies needs for transport of nearly everyone and everything. This drives food costs up, adds the cost of home ownership through utility expenses and the expense to get to work and do work in businesses and in government. Meanwhile, government tries mightily to obfuscate by avoiding including the crude oil price premium in many ways into the inflation that is gathering steam particularly in the U.S. and soon throughout the rest of the world. Many will be surprised and many not to reflect on the fact that a 1980 dollar requires $2.20 of 2008 dollars to get the same goods and services.
Predictions run the gamut for 2008 crude oil prices. From Goldman Sachs estimating $105 for a 2008 peak to rival Morgan Stanley predicting a yearly average of $80, the fact will lie in how much demand is made and answered by what supply. With a long list of players in the pricing of crude oil, ranging from U.S. oil companies vigorously working to find more and enhance the recovery of fields to the Axis of Oil busily stirring up trouble, the market has become something far removed from the easily recognized business of answering demand with the lowest cost provider. It’s a market rife with influences that hide the price and replace it with the emotions and machinations of those who seek to maximize the price rather than compete on quality and quantity.
Soon we’ll see a much broader application of “fuel” surcharges. Its happening now in air travel and will become more of an epidemic through out economies soon. These added costs, while cancelled by governments to hide inflation, remain real enough to see in the largest expense that many in the west carry, the housing expense. While the “subprime mortgage” debacle and on rushing adjustable rate mortgage debacle due over the course of 2008 and beyond, the choices are not easy.
In the West, central banks are in theory supposed to protect the currency and the buying power of the citizens. Many wish that the central banks act to prop up economic sectors, commercial banks in particular. This is ongoing now, but only serves to force the citizens to absorb a changing cost structure and higher prices.
The alternative is to do what will happen anyway, move to protect the buying power of the citizens. This too is an awful remedy, as weaker financial businesses and closely budgeted people will be compelled to make very difficult adaptations. While postponed for now, the drivers, the costs of owing money and the price of oil products will not find equilibrium in the economy until later when the harm is deeper and more widespread.
It is likely too late to avoid a reckoning with the price of oil and the costs of owing money. The choice by the U.S. Federal Reserve to put the interests of a few commercial banks ahead of the world economy can be seen as the turning point where the opportunity was lost. The USFR choice to lower rates added dollars that went into the banks where it hasn’t generated any efficiency other than to prop up the banks, and to add to the fuel for cheaper dollars relative to other currencies that just drives the price of oil higher.
Had the USFR chosen to raise rates and squeezed the economy to higher efficiency some banks may have had to merge or fail, some of the citizens would have had to drastically alter their lifestyles, but the devaluing of the dollar and a large driver for increasing oil prices would have been stopped cold. Choices for capital expenditures would have a much broader range and the opportunities for conservation and new technologies a clearer field and sounder footing for investment and product pricing.
While the cleaner and more honest policy by central banks might seem fraught with risks, the continuation of easy money to finance consumer and business purchases only makes the problem larger and more difficult to handle. It may seem kind to encourage even more easy money, more spending and consumption, but the total of debt versus the income to serve it grows ever wider. It would have been easier and quicker to answer the fact that oil has reached a market point where the demand nears supply with an early, short and quick economic contraction that would drive investment and consumption choices to conservation, efficiency, alternative sources.
The choices will get clearer. As the cost to use oil circulates through more of the economy and likely rises further, food and basic necessity prices will rise and homes and other static assets will decline. The choice has always been to reduce the value of the financial values or crush the economy as a whole. As an example, a home that will lose the low introductory rate and be reset will likely not be worth what the loan was made for. Thus, the choice can be to write down the value of the loan and rewrite it at terms that reflect the facts of the home and customers circumstances or to take the property into a declining market and hope to salvage some capital. If enough lenders choose to keep the customer, even to lose a portion of the capital, it would still have a customer paying on a portion and would serve to keep a floor under the home’s value as an asset. Its hard work, and it isn’t easy. The other hand holds the prospect that many more homes come into the market of poor and declining financial value, which exposes an increasing and larger share of the home loan portfolio to larger risks for a longer period of time. A haircut on performing loans that support the value of the assets are much better over time than a loss that drives asset values lower and more loans into trouble.
The cost to answer the rise in crude oil prices is going to be a huge amount of capital. Destruction of the West’s main asset, citizen’s homes, would strangle the capital base and the growth needed to needed to answer the increasing price of oil. All of the world’s citizens need more energy used more efficiently, conserving what we have, and innovating and inventing alternatives to fossil fuels. Everyone needs personal transportation, goods, and services that are affordable. To get there we need to put our economy in order and defend our purchasing power. That is much more important than the rush to chase troubled homeowners out of their homes and drive more owners into trouble. It doesn’t help the lenders in the long run and hurts all of our efforts to work our way to a higher, fully fueled and energized standard of living for everyone.
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[…] unknown wrote an interesting post today onHere’s a quick excerptIts hard work, and it isn’t easy. The other hand holds the prospect that many more homes come into the market of poor and declining financial value, which exposes an increasing and larger share of the home loan portfolio to larger risks … […]
[…] Original post by New Energy and Fuel […]
[…] unknown wrote an interesting post today onHere’s a quick excerptAs an example, a home that will lose the low introductory rate and be reset will likely not be worth what the loan was made for. Thus, the choice can be to write down the value of the loan and rewrite it at terms that reflect the facts … […]
Gr8 very nice post !!
sometimes it is hard to find a good company that offers auto loans;*”
the auto loan that i got this year have a higher interest rate ~