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Sub $50 Oil Takes The Pressure Off Interest Rates

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Wall Street is famous for some of its trite little sayings. One that sticks out is, “ A rising tide lifts all boats”. Well all the tides in the world don’t seem to be working this year for crude oil prices or energy stocks.

The tide that lifted oil’s boat came last year when the price of crude nearly doubled to a year-end close of $52 a barrel. Last year oil producing company CEO’s saw the value of their stock options raise dramatically. They had to do very little more than shut down production in order to get rewarded. The price of oil bounced off a 10 year low around $26.

This year, the price of crude hasn’t done much hovering around the $50 level. The story is quite different when stock prices are measured. The S&P Energy Sector has fallen nearly 14% since the start of 2017. This has placed energy near the top of the losers list.

We decided to use the S&P Energy Sector because is includes more than just oil. It is a broader measure of things that move American goods, services and people.

Now here is a surprise, America is consuming just about the same level of oil as it did 40 years ago in 1978. Considering how much the population and the rest of the economy have grown over the years, this shows how conservation has been working.

It also shows the slow progress of alternative fuel sources have been making in the whole consumption picture.

Hydro Fracking Is Making A Difference 

Oil consumption in America may be holding steady, but production has been on the raise. Over the past 10 years US oil field output has increased more than 40%. Keep in mind; this figure excludes increased production of natural gas, solar and wind power.

Ask an energy expert what been going on and most will point to the role of Hydraulic Fracking as Americas answer to higher output.

Fracking, as it is known, is environmentally very controversial. In places where fracking is most heavily practiced, like Oklahoma, a record number of earthquakes recorded last year. Serious contamination to ground water has also been documented. This is definitely not cool.

On top of that, President Trump’s intent to withdraw from the Paris Climate Accord will loosen restrictions on energy drilling and that could encourage even more hydro fracking activity.

Hydro Fracking’s Redeeming Value

When taking a global environmental view, fracking has a well-earned bad reputation. Several documentary videos have shown the side effects on farm animals, crops and the drinking water in areas surrounding these wellheads.

But even Charles Manson has his moments.

Here is one for the demons of energy drilling. According to experts, fracking activity is far more nimble in responding to changes in price levels than traditional drilling activities. This flexibility has the potential of improving the stability of prices. This obviously improves the predictability of prices as well.

For the past two years oil prices have generally held between $45-$55 per barrel. At the lower end of this range is where fracking starts to become economically attractive.

Much above $50 and fracking production activity picks up quickly. Much below $45, as was the case starting in late 2015, fracking activity falls off dramatically.

Ok so here is the good side of a nasty business. General price levels in the US have benefitted over the last three years from dramatically lower oil prices (down from $100 per barrel in 2014). If anything, there has been a greater risk of price deflation from this decline than concern over inflation. The recent softness in oil prices means that a huge determinant of inflationary pressure is neutralized.

This is excellent news for an economy whose slow sputtering pace this year has so far been disappointing. This is also good news for those who have hopes for continued low interest rates. In the final analysis the Fed needs to find a way to unload $4 trillion from its balance sheet without getting dinged by higher rates. This is a force in their favor. That means that the rally in the US 10 Year Note that started back in March, might continue a while longer.