Trump and Oil

So, I try not to go off too much on what President Trump tweets on his Twitter machine. I don’t think complaining does much good. For one, I think complaining encourages a mindset that makes taking personal responsibility lose some of its importance. And besides that, I think Trump’s use of Twitter is PR, and not really related to policy. 

But it drives me nuts when aspects of the economy or markets get misrepresented. There are already plenty of misconceptions about how markets work…

My head starts to throb a little bit at the temples when I see a tweet like this one: 

Looks like OPEC is at it again. With record amounts of Oil all over the place, including the fully loaded ships at sea, Oil prices are artificially Very High! No good and will not be accepted!

OPEC was formed in 1960. It’s been “at it” for 58 years. And what is this “it” it is doing? Why, it’s controlling supply to keep prices where it wants them. OPEC has roughly half the world’s oil production. It is not at all uncommon for a company that controls the supply of something to adjust supply to keep prices where it wants them. 

Nike makes a limited number of Air Jordans because that exclusivity keeps the demand going. If Nike made as many Air Jordans as it could, the brand probably would have died out years ago. Intel doesn’t flood the market with CPUs because that would crush the price and its profit margins. 

Of course, Air Jordans and Intel chips have a value-add component. Intel chips are often seen as being more reliable than chips from, say, AMD. Air Jordans are just cooler than other shoes. 

Not so with oil. Sure, quality varies with location. But there’s nothing you can do to make the oil you have better. There’s no special pumping technology that can change the makeup of what’s in the ground. It is what it is. This is why oil is a commodity. And commodity prices are driven by supply and demand.

It’s a Simple Question 

The oil market is pretty easy to understand. Demand is fairly steady at roughly 96 million barrels a day. Supply can vary, often depending on what OPEC — and Saudi Arabia — wants to do. The Saudis have the ability to open the spigots and let around 12 million barrels a day flow. Of course, as we saw in 2014, that level of production puts too much oil on the market, and prices fall…

I still marvel at that huge mistake. I still don’t understand how the Saudis thought oil prices in the $40s would work out. I mean, I know what they thought — that they could put U.S. oil production out of business. But they made a huge error, misunderstanding the degree to which U.S. oil companies could cut costs. 

U.S. oil companies cut production costs in half. And Saudi Arabia lost control of the oil markets. Not only that, but it also lost around $250 billion in currency reserves and had to sell bonds to make ends meet. The only control the Saudis and OPEC have left is to cut production to get prices higher. 

Now, I get that nobody wants to pay more for gasoline. But there are several reasons higher oil prices aren’t the worst thing that ever happened.

It’s definitely good for U.S. oil companies. They’ll make more money, pay down debt, maybe even do some hiring. Around 16% of the average gallon of gas goes to state and federal tax coffers.

And for the global economy, higher oil prices means more cash for emerging economies, which will help support global GDP growth. 

And finally, as selfish as this might sound, maybe we can get an actual rally for oil stocks? I think so — that’s why I added a beaten-down oil stock to the Wealth Advisory portfolio last week. Oil companies account for 8 of the 10 biggest estimate increases for 2018 earnings. So we have that going for us, which is nice…

Open Mouth, Remove All Doubt

When Trump complains that oil prices are “artificially high,” it’s a pretty meaningless observation. Oil prices are always artificial because OPEC sets its own production levels. Because of this, it’s not really a free market. At least for now…

However, I see a scenario playing out where oil moves toward being more of a free market. You see, as Saudi Arabia/OPEC acts to get price higher, it will inevitably bring more oil production online. Gulf of Mexico oil may not looks so great at $40 a barrel. But at $70? Different story. 

Plus, with cars getting more energy efficient and more electric cars hitting the roads, the case for dramatic increases in demand seems pretty shaky. Seems to me that the Saudis’ ability to support higher oil prices won’t have a lot of long-term strength. 

And this is where I have the biggest problem with Trump’s approach to issues like this. Why not look to the future, try to assess where growth is going to be, and foster those industries? 

Coal is kind of an obvious one. Yeah, I know, coal use has improved a bit lately. But it’s not a stretch to think the future isn’t so bright for coal. The emerging cannabis sector is a much better example. Trump’s choice of Sessions as Attorney General means we’ve basically ceded a $50 billion consumer market and perhaps a $40 billion pharmaceutical market to foreign companies. 

Trump’s administration is basically ignoring artificial intelligence (AI), while China has a full-court press going. Rather than complain about the Saudis, we should be fostering growth wherever it’s possible.

Until next time,

Briton Ryle

@BritonRyle on Twitter

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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He is also the managing editor of the Wealth Daily e-letter. To learn more about Briton, click here.