Rosenberg: Oil unlikely to hit bottom for months

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David Rosenberg, a guest columnist for Inside the Market, is chief economist and strategist at Gluskin Sheff & Associates Inc.

The debate continues to rage over whether the sustained move down in the oil price is reflective of demand or supply forces. The truth is that it is both, but I would peg it as four parts supply and one part demand.

The fact of the matter is that China has been slowing for more than four years now. No surprise.

Japan has been stuck in the mud for 25 years. Is that new news?

The euro area has been in and out of recession for six years now.

India is doing just fine, thank you very much.

As is the U.S., even if we have hit a bit of a fourth-quarter speed bump (though part of this has reflected the strike at the West Coast ports which now looks set to come to an end).

Look at the facts:

• Copper trades at a level that in the most recent past coincided with $75 (U.S.) a barrel on WTI
• Lead is at a level consistent with $85 a barrel in the past
• Both tin and zinc are trading as if oil is back to $100

None of these cyclically sensitive metals are trading anywhere near April, 2009, levels – which is where oil is today. Base metals in aggregate are about 70 per cent higher than they were the last time oil was trading below $50 a barrel – if this was principally a broad-based global turndown story, the industrial-commodity complex in general would follow suit as they did six years ago.

Much of the turmoil in the oil price is strictly related to supply dynamics within this market itself and it will take significant production cuts to ameliorate – and Saudi Arabia has already made it clear that it is willing to wait it out and it has the financial reserves to do so.

The problem is that even though the rig count is declining along with investment and exploration plans, U.S. output is hitting new highs (ditto for Russia and the Organization of Petroleum Exporting Countries itself is exceeding its quota).

The bottom in oil prices will only occur once the surplus is eradicated, and that looks to be several months away.

The next question is what this means for the economy. It is devastating for the western provinces, but a plus for Central Canada – Alberta and oil comprise a greater share of the national economy so in contrast to past periods, this comes out as a wash for the Canadian economy.

There are winners and losers in the U.S., to be sure, but a true dynamic analysis shows a net contribution to real GDP growth of 0.4 per cent.

There are second-round impacts to be sure – even on credit quality, given how this move in oil will affect reserve estimates as well as how the cut to underlying collateral values triggers a decline in credit availability for this credit-reliant sector. But unlike the collapse in technology in 2001-02, oil is a cost to consumers and many non-energy producers – as such, this is a boon to spending power for households and margins for most retailers and wide swaths of manufacturers.

From my lens, the latter impact dominates (note that the U.S. is still a net oil importer; energy self-sufficiency has been a goal, but one that remains elusive despite all the shale hype).

Time now to debunk some myths. Declining oil prices are not deflationary – back to 1980, the correlation between the energy component of the CPI and the core inflation rate is close to zero. Oil has plunged this past year, but U.S. core inflation has not budged at 1.7 per cent because service-sector inflation is sticky at 2.5 per cent.

There also is no question that with the U.S. running an oil trade deficit of roughly $200-billion at an annual rate as it still consumes more than it produces, the net result of what has happened to oil prices is a gain for the economy – though the contrarians out there have certainly done a good job at grabbing the headlines.