Monday, November 10, 2014

Is crude price decline good or bad? – Energy Economics 102!!

Crude prices have declined by more than 20% since June this year, creating turbulences/confusion across various governments.
So, the question: Is it good or bad?
The answer is: If you are a net oil exporting nation then it is bad for you and if you are a net oil importing nation then it is good for you.
Going away from Macro Economics into Micro Economics,
All oil producing companies are having a tough time trying to sell their product. Going by the analogy of countries all oil consuming companies should start feeling good.
But on the contrary, every one is suddenly concerned whether they are oil producing company or oil consuming company. Why?
Many oil/energy consuming companies which are heavily dependent on oil & natural gas as their input have seen a decline of more than 20% in their input costs. So, technically their margins should have gone up. Yes, the margins would go up only for those companies whose sale price hasn't come down as much as the input cost. For those companies, whose selling price is directly dependent on the input price, eg: utilities, fertilizers and other regulated industries etc., they have seen a sudden decline in their selling price and thereby their revenue. This lead to a huge decline in the market capitalization and accordingly their ratings in the markets. This has decreased their ability to raise debt and hence so much more downward pressure on their valuation and stock prices.
Now, let us dwelve a bit further. What is causing this decline?
Price of primary sources of thermal energy (coal, gas, crude oil) depends on various factors including cost of production and more importantly on the supply/demand factors. Right now, with US continuing to increase more and more crude oil and the OPEC nations not decreasing their production, the supply side has continued to be remain stable. But on the demand side, there is continuous pressure due to the expected decline in growth rates of various countries (whatever!!).
The other factor is the "stability in the instability in Middle East region" and the other politically volatile regions of the world. (Yes, I did say that).  Oh yeah, the other most convoluted and hardly understood factor is the interest rate. The oil demand is low inspite of such low interest rates across the world. So any increase in interest rates is only going to decrease the growth rate thereby reducing the demand for oil much more and hence leading to lesser crude prices.
So, now the question is: Is it the right time to invest in energy savvy companies?
The un-political answer is. Yes invest in energy consuming companies for they will do better as long as the prices continue to remain low. And, yes invest in energy producing companies as well since their stock prices are so low and are going to re-bound soon.
Now to answer another question: What about future generations, is it good for them?
Answer is: Do future generations really know what is happening now. But yes, we should be concerned about their well being because we continue to burn more fossil fuel and hence more emissions... And the story goes on!