When oil goes up, the stock market goes up. When oil goes down, the stock market goes down.
That was the basic tale of the tape in Wednesday trade. The release of the U.S. Energy Information Administration report on crude-oil inventories gave an early boost to the cost of a barrel of crude.
The EIA data showed that crude inventories fell 3.6 million barrels last week. That’s a big difference from the 500,000-barrel build that analysts were expecting.
That news caused oil to spike. Stocks climbed alongside it, as the Dow responded with a triple-digit gain early in the session.
Today’s Dow performance (black line) vs. the NYSE Arca Oil & Gas index (gold line)
The gains in oil were short-lived, however. A deeper dig into the EIA report also showed a build in distillates such as heating oil and diesel.
The build in these areas was larger than anticipated, and that helped to renew supply glut concerns.
The result was a reversal of fortune in crude price, followed by a corresponding plunge in the Dow.
The linkage between the price actions in crude (which sank below $37 in midday trade before fighting back above this key mark) now appears to be the biggest short-term influence on the broader equity market.
Oil prices are set to remain under pressure at least through 2016. Here in the short term, stocks will likely continue following oil’s lead for at least the next several trading sessions.
Of course, markets will almost certainly turn their attention to the Fed’s decision on interest rates. That is due out one week from today. Whatever the Fed decides (the smart money is pricing in an 80% chance of a 25-basis-point hike in the Federal Funds rate), stocks will assuredly respond.
The Fed will likely be the big determiner of how equities finish out the year. But there is no doubt that oil prices will also be a major consideration going forward.
Now, aside from the pressure on so many big-cap oil and energy companies, a continued plunge in crude oil will also pressure the U.S. shale industry. That industry has fueled much of the job growth we’ve seen in recent years, and continued declines in oil will undoubtedly shut down many producers.
It also could lead to many shale producers defaulting on loans. This could harm many financial institutions such as regional banks that have heavy energy-sector loan exposure.
As we outlined in Tuesday’s Afternoon Edition, "The Saudi War on U.S. Oil," the de facto controllers of OPEC have been on a mission to:
• To keep production higher
• Force oil prices lower, and
• Starve out U.S. shale producers.
Shale production in the U.S. becomes a losing proposition when oil is below $60 per barrel. So, the Saudis will just keep the production spigot going and wait until its North American competition withers away.
Well, I was pleased to receive many outstanding comments from readers on this issue. Here are some of the representative opinions that are out there about this situation. I’ll also offer up my responses for your consideration.
Why is it ‘good competition and marketing’ if U.S. companies want to increase market share, but it is ‘war’ if other countries (especially Middle East or ‘communist bloc’) attempt to do what they feel is in their best interest?
The Saudis are waging a war on U.S. oil? I don’t think so. What did the U.S. think — that the Saudis would politely reduce their market share and profits out of deference to the new U.S. fracking surge? What massive arrogance on the part of the U.S. Welcome to capitalism, folks. If the U.S. wants a bigger piece of the pie, it needs to compete for it.
Brad comment: My characterization of the Saudi war on U.S. oil producers was an observation of fact, one that the Saudis also would admit. They’ve made a strategic decision to defend market share — a decision they reiterated last week at the Vienna OPEC meeting.
I am not sitting in judgment of this decision, and I don’t think it is somehow "unfair." That’s even despite the fact that cartels are illegal in the U.S., but not when it comes to nations that choose to collude.
If U.S. shale producers want to survive, they have to either find cheaper ways to produce oil, or stand pat and wait for oil prices to climb enough to make them profitable.
We should exit the global oil market and stop buying OPEC oil, the proceeds from which fund international terrorism. I’m willing to pay whatever price for gas that makes energy independence for the U.S. financially viable, and we have the oil reserves to do this for the foreseeable future.
I hate tariffs, but I believe for the purpose of National Defense this is reasonable in this case. Setting up a structure in the U.S. to ensure that marginal shale production remains profitable would keep U.S. business from going bankrupt.
The Saudi battle strategy is basically to starve U.S. oil producers, and send them out of business. There is also the goal to ensure that Iran makes the least amount possible on the huge inventories they will hit the market with in the coming months. The Saudis’ goal is to minimize that windfall for their enemy. On a positive note, we will reap the benefits of lower energy for the foreseeable future while conserving our domestic resource.
Brad comment: I am not a fan of tariffs. Of course, I understand Americans’ desire to want to "fight back" on the attempt to crush U.S. shale producers. But tariffs would just make oil prices artificially high for us all.
Tariffs would, as Jack points out, also negate the benefits of lower energy costs that benefit us all in many ways — particularly the nationwide benefit of gasoline prices now below $2 a gallon in most states.
The bottom line here is that the Saudis are playing a strategic game with the resource they basically control, and it’s a game that they currently have the upper hand on.
While we might not like this reality, it is one we have to grapple with at this stage in history.
As always, thank you for the thoughtful responses to the issues we bring up in this service. I love to engage in the conversation, so let’s keep it going.
Stocks finished lower in volatile Wednesday trade, as the major indices took their lead from the gyrations in oil prices. The Nasdaq fell almost 1.5% as techs tumbled under the weight of Apple (-2.2%), Netflix (-2.2%), Yahoo! (-1.3%) and Lululemon (-13.1%).
Elsewhere in the markets…
• Dow Chemical (DOW) is in late-stage talks to merge with DuPont (DD), in what could be the largest-ever merger in the chemical industry.
• Yahoo! (YHOO) said it will shelve its plan to spin off its Alibaba (BABA) stake amid concerns by shareholders that the U.S. government may claim taxes on the deal, costing them billions of dollars.
• Freeport-McMoRan (FCX) said it would suspend its dividend and further reduce its capital spending by $1 billion over the next two years, as the mining giant deals with plunging commodity prices.
• TerraForm Power (TERP) shot up some 30% today on news that it might acquire Vivint Solar (VSLR) at a lower price than previously announced.
• Energy MLP Kinder Morgan (KMI) announced Tuesday that it will slash its quarterly dividend by 75%, to 12.5 cents from 51 cents. And yet, shares shot up nearly 7% in today’s trading.
Good Luck and Happy Investing,
Uncommon Wisdom Daily