Catalysts for change: part one - oil

I currently have my eye on three catalysts that I see changing the global market in the second quarter:

Oil
Source: Bloomberg
  1. The oil conundrum
  2. Earnings ‘growth’
  3. Volatility complacency

The catalysts are not new, however the time of their influence is quickly approaching, with the oil conundrum being the closest.

OPEC’s Doha meeting is now 12 days away and oil is clearly repricing on the idea that ‘no deal’ will be inked, showing that OPEC is just a cartel by name and not by action.

Oil is such an influencer of global markets because cheap prices are a double edge sword.

When cheap is too cheap

  • As the cheap oil cycle began in mid-2014, the windfall was soaked up by household consumption. Cheap fuel boosts spending and in turn filters into growth –  this is simple economic theory.  
  • However, there is an ‘equilibrium point’ to cheap oil. The increase in household spending due to the cheap end-user price is offset by the collapse in capex and opex spending from producers, creating a drag on growth.
  • Energy producers both in Australia and globally are showing that in the current low oil price environment, growth and economic inputs have suffered and are more than offsetting household spend.
  • The collapse in capex globally (just look at the cuts by Shell, BP, Exxon-Mobil and Woodside to programmed projects) is clearly outweighing the consumption boost, the impact on employment, confidence and investment weighing on growth.
  • Oil needs to migrate to US$50 a barrel to have a mildly positive effect. Consumption would still be elevated as end-price would still be well below the ten-year average, but US$50 a barrel would be conducive enough to stimulate production capex as internal rates-of-return would pop back above investment thresholds at major oil firms.

Oil is therefore the first catalyst to watch in the second quarter, if Doha fails as is expected, oil is likely to slide back to mid-to-low US$30 a barrel and markets will respond to oil being ‘too cheap’ similar to the January-February trade period.

Oil fell 1.5% yesterday and saw seven out of the bottom ten ASX 200 companies being oil exposed.

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