"Kee" Points with Jim Kee, Ph.D.


Oil shocks: The current conflict in Iraq has added to the ongoing uncertainty in energy markets created by the turmoil in Russia/Ukraine. Russia is one of the “big 3” with respect to global crude oil production (the others being Saudi Arabia and the US), with Iraq in the top 10, so it is not surprising that crude oil prices having been rising. Brent crude, which most reflects global supply/demand conditions, is around $113/bbl. That’s up from a week ago, but below prior spikes over the past two years.


Kee Points readers know that I am skeptical of economists and analysts’ ability to predict the impact of oil prices on the economy or markets with any real accuracy. That comes from 20 years of observation, as well as attempting to do it myself when I worked with macroeconomic forecasting firms. But it is also a conclusion drawn from theory: The impact of a price change first of all depends upon whether it is demand driven (e.g. global growth) or supply-driven (e.g. expected disruptions in oil producing countries like the current situation). One also has to account for the fact that the oil intensity of the economy, or energy use per unit of output, has been declining over time, making studies based upon prior episodes less reliable. Finally, the impact of an oil price change on the economy depends to a great degree upon whether the change is expected to last for a short period of time or whether it is expected to have a longer duration. On this last point, Christian Ledoux, STMM’s Director of Equity Research, pointed out to me that the current Brent price spike has boosted the stock prices of conventional energy companies much more than non-conventional companies (e.g. wind/solar). That would suggest that right now the market expects the current price spikes to be transient rather than permanent.


All of this is not to say that as a professional investor you should just ignore energy prices! Just a warning against spurious precision. One of the more thoughtful attempts that I have seen to quantify the impact of oil on the economy comes from Dr. Daniel P. Ahn, who spoke at our energy symposium last month. Dr. Ahn concluded that global economic growth tends to stall when more than 10% of GDP is spent on energy (it was 8.1% in 2012). I asked Dr. Ahn this morning for a rough estimate of what crude oil prices would have to be in order to really start impacting global growth, that is, to move global spending on energy above that 10% bar. His response was $150 a barrel, so, keep that number in mind.


M&A: Interestingly, although geopolitics have heated up as of late, confidence here in the US has been rising based upon both consumer and small business surveys. I think that explains some of the pick-up in mergers and acquisitions (M&A) that we have been seeing. In fact, numerous high profile deals were announced today, including Medtronic buying Covidian, Level 3 Communications buying TW Telecomm, Williams Energy buying the rest of Access Midstream Partners that it doesn’t already own, and Sandisk buying Fusion-IO (again, thanks Christian Ledoux). In my opinion, this follows the pattern of broadly lower global risk measures since the Great Recession. When risk is high, companies just hold onto their cash. As fears of global collapse subside, they then move towards spending some of it, first on lower risk share buybacks, then dividend payments (which are riskier because it looks bad if you then have to cut them), then M&A, and finally capital spending. I think we are in the M&A stage right now, with a pick-up in capital spending to follow.