Amid the doom and gloom of Monday’s ‘flash crash’ (which actually started on Friday), it was easy to be pessimistic. Nothing captures the public eye like a stock market in apparent free fall. Such an event carries with it a very visceral understanding of the amounts of notional wealth that can vanish over lunch. But as with most panics, this understanding soon turns to over-estimation and emotional rather than rational inference. Consider, for instance, effects on the energy market. Commodities are inherently volatile, so surely volatility on the equity market must induce volatility on the energy market as well? At least according to standard public belief.
There is some element of truth to this, since commodities are defined as those products which have very inflexible supply curves but very flexible demand curves, and therefore the perception that the equity market shifts will lead to swings in gasoline prices (as an example) could become a self-fulfilling prophecy. But this is not to say that the underlying market fundamentals in the gasoline market have changed; consumer opinions about them have. This is a question of demand, not supply. Sustained over a sufficiently long time frame, this pessimism could work its way upstream. Integrated producers – those with exploration and production facilities as well as refinery and sales operations – could notice a ballooning or collapse of demand at the pumps and either ramp up or mothball swing production.
But the further upstream we go, the longer the time scales on decision factors become. E&P divisions dealing with a decade or more between identifying a promising field and selling that field’s first cargo surely realize that daily shifts do not a trend make. With no significant change in the amount these producers put into the pumps likely coming in response to any single headline, the demand-side dynamics could just as easily change the next time there’s a major holiday, or a different headline, or some other seasonal factor.
But could it be that the malaise which the equity plunge is deemed to hint at also affects the energy market on a more fundamental level? Not likely. Energy prices have remained lower than many producers might have wanted. Conceptually, it is possible that large producers could lay off en masse if they absolutely had to cut costs. But US oil majors have recently become amazingly disciplined at finding value in their existing supply chains and can live with low prices. Moreover, the underlying US data suggests a sustained draw-down in commercial refined product stocks. With US employment at record counts and the industry approaching spring refinery turnaround season, there is a lot of room for this trend to continue. This would either increase refined product prices now (assuming we’re running out of slack in that sector of the market), or later (by going a long way towards eating into this slack).
It’s important to remember that a stock index is a generally accurate tool to predict and analyze economies in the long term. For instance, the Toronto Stock Exchange, with its relative focus on the Canadian energy industry, is down by about 7.8% (at time of writing) from its 3-month high on January 4th . This decline is due to exposure to the US economy and the equity rout on Wall Street, since the US accounts for such a dominant share of Canada’s foreign trade. But to focus on this headline-making drop actually misses the more serious problem in the TSX’s valuation over the course of a bad to mixed year; delays in getting energy transport projects underway, constraints on rail networks affecting container and energy movements, cost of living increases constraining consumer sentiment, and the risk of NAFTA talks collapsing. To focus on a single day’s trading is to obscure the far more numerous decisions that get made by many different people over the course of months, if not years. The Canadian oil industry has made it very well known the problems they face. These concerns were already priced into their output and hence their equity, and they would surely prefer policy makers and market movers concerned themselves with these longer-term issues rather than the avarices of stock market sentiment.
To put it another way, the Dow Jones fell by as much as 1597 points; a record in point terms but hardly notable in relative terms. This is a rationalizing of asset prices – debatably overdue – but one that should confine itself to notional rather than tangible values. Unless you can make a strong case that something like the leases for offshore drilling rig plots are as over-valued on a structural level as personal real estate was in 2007, then what’s happening is starting to look more like a historical blip – and a good time for some bargains if you take a much longer view.
Note: None of the above is offered as nor should be considered as investment advice or solicitation for the sale of securities and/or other investments.
Colin McCann is an Oil & Gas analyst with Navarik Corporation. The Navarik Data Products team analyzes Navarik's proprietary data sets and external sources to provide insights into the oil & gas shipping market. The resulting analysis enables physical and paper traders to see ship movements across the barrel before anyone else in the market.
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