The Flipside to Deflationary Price Pressure

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Macroeconomics

As deflationary price pressures mount, some look to variables such as oil for guidance on trends. In the metals industry, the correlation between metals prices and oil prices may not be as tight as say oil and logistics. But nevertheless, oil price trends do play a role, take aluminum, for example. Though oil does not feed through directly into smelter power costs, in most cases power costs adjust over the long term. Now under $70/barrel, crude oil is at a ten month low. Oil has a high statistical correlation to aluminum because speculators link the oil price to power costs and often make aluminum investment decisions based upon the oil price.

So where is oil going? It’s tempting to think that because a gallon of gasoline is now under $3.00/gallon, the oil price might be back at it’s “historical average” or at least trading in a semi-normal range. But according to this article in the Wall Street Journal, oil futures cost more than the current spot price. The difference between the two, $21.50/barrel, accroding to the article represents an “unprecedented discount.” In addition, the supply market conditions indicate oil won’t remain at current price levels. Here are the elements working against [low] oil prices:

1. Lower supply investments – discouraging higher cost energy alternatives

2. OPEC cut production by 5% since September

3. Only 660,000 barrels will come from non OPEC producing countries

The speed of price drops has us concerned about the rate in which the oil market could bounce back. If one takes the analysis from the article (statistics and projections from the International Energy Agency) as valid in terms of supply market constraints, it seems logical that higher oil prices are indeed more than a slight possibility. And as we all know, high oil prices create all sorts of inflationary price pressure which would knock a hole in the deflationary price scenario we reported on earlier today.

–Lisa Reisman

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