Debt Ceiling = Oil Ceiling?

Jim Brown
 
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The oil market is used to dealing with things like wars, uprisings, strikes, sabotage, hurricanes and embargos but a debt ceiling is a new challenge. Why does a debt ceiling matter?

Unlike gold or silver, which is used as a currency reserve, inflation hedge and long term investment, oil has value that fluctuates based on geopolitical events but you can't put it in a wall safe or store it under your mattress.

Oil prices are a fundamental response to demand. Oil demand comes from the actual use of oil in refined products such as gasoline, diesel, jet fuel, chemicals, asphalt, plastics, etc. Demand is created when industries produce products, consumers commute to work and business travelers move about the globe.

The debt limit debate today has no real physical impact on demand today. However, it has a real psychological impact on things that create demand. Businesses are worried the economy will fall back into a recession as a result of spending cuts enacted by Congress. Since Congress has a really bad record on actually implementing any cuts this fear may be misplaced but it does exist today. Because the debt limit debate has been droning on now for about six months with increasing intensity many businesses have cut back on hiring, halted expansion and reduced inventory. The memory of the Great Recession is still vividly etched on owners minds and they don't want to go through that again. This time they will plan differently and not over extend themselves in hopes of a recovery. This time they are storing up cash and trimming inventories, equipment and people in anticipation of austerity ahead.

By making the debt limit debate such a high profile political battle our lawmakers, including the president, have triggered some unintended consequences. Those consequences have been a "sharp decline in economic activity in June/July" according to multiple corporations who have lowered guidance in their quarterly earnings reports.

Effectively lawmakers have lowered the pace of the economic recovery and may have possibly knocked the country back into a recession. Way to go gang!

In the weekly EIA numbers released this week oil demand declined by -261,000 barrels per day last week. Even worse U.S. gasoline demand has now declined for four of the last five weeks to the lowest level since May. Demand declined to 8.99 million barrels per day compared to 9.63 mbpd in the same week in 2010. This is supposed to be the high demand driving season but spending money on gasoline appears to be the last thing consumers want to do today. Vehicle miles traveled declined by -2% in May.

U.S. Gasoline Demand Chart

If the U.S. is hit with a ratings downgrade as a result of the debt debate the results could be dramatic. Interest rates for everything will rise and that acts as a speed brake on the pace of business expansion.

We already have stated unemployment at 9.2% but that only counts people who have been unemployed for less than two years and are still receiving benefits. The total for unemployed and under employed is closer to 18% and roughly 25 million people and that is a major factor in the reduction of oil demand. That is a lot of people not commuting to work every day or in the case of the under employed commuting closer to home to flip hamburgers while they wait for a full time job in their field.

The exceptionally low interest rates of the last three years are about to end. The Fed can't afford to buy more treasuries so they can't force the rates to remain artificially low. When higher rates come in the form of ratings downgrades it will be a lasting legacy to the debt debate. Once the austerity genie is out of the bottle it may take years to stuff it back in again and return to our current AAA rating.

The slowing demand over the last five weeks could rebound slightly with a debt deal but more than likely it will be a very slow climb. Until the economy appears to be finding traction again there will be an extreme reluctance to hire and expand.

Fortunately Asia, the Middle East and Latin America are booming. Demand is growing rapidly and they will offset any slowdown in the USA. However, the arrival of an austerity recession in the U.S. could delay peak oil by another 12-18 months if U.S. demand declines like it did in 2008.

MPG Standards Rising

Don't worry about high gasoline prices because the White House is looking out for your well being. The White House is prepared to announce the new mileage standards for U.S. vehicles. The president is set to announce 54.5 miles per gallon as the new target for future vehicle production.

The current target is 35 mpg by 2015 and that will increase by 5% per year for cars and 3.5% for light trucks/SUVs through 2021 then both will increase by 5% per year through 2025.

Reportedly auto companies will introduce things like auto engine shutoff if the car has been idling for more than a set amount of time. No more pulling into a parking lot to make a cell call or read an email with the air conditioner running in the summer time. No more starting the car to let it warm up before driving in the winter.

The government is your friend and they are here to help! Unfortunately that means we will all be driving skateboards with seats by 2025. Of course with gasoline in the $10 range by then we may be happy to be driving at all.

Jim Brown

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