Can someone please explain oil prices vs the stock market?

I may be particularly thick but I don't understand this bit of macroeconomics.  On the radio, they just said that OPEC is going to increase production of oil and it's causing the price of oil to drop significantly.  That makes sense to me due to the theory of supply and demand.

But then in the next breath they said that global markets were down, partially due to the corona virus and partially due to how this would impact the energy sector.

Question #1:  If the raw material for the energy sector gets cheaper and more available, why does that hurt that sector?

Larger question #2:  Assuming it really does hurt the energy sector, don't lower energy prices help every single other sector out there?  So why doesn't the overall market respond favorably to lower oil prices.

They want to DECREASE production. Russia is balking and saying no. Opec wants to decrease. At least thats what i heard yesterday and this morning.

If it costs 45 a barrel to extract the crude and it sells for 40 a barrel, thats how it hurts that segment.

On the last question, the population won't use it if they are not travelling due to the virus. Planes aren't flying,  cruise ships aren't leaving the dock, noone is driving to south by southwest in austin cause it was cancelled.

Mike, my understanding is that the virus concerns are dramatically dropping economic activity.  Cheaper prices don't seem like they will override this driver, so use will stay low.  Cheaper prices for oil will cause oil producers to fail.  I've read that the shale folks extended themselves with cheap loans, but at these prices they can't produce for a profit, so they will be in very big trouble if prices and activity stay low for long.  Then the lenders will be in trouble....lots of scary stuff going on.  Then again, I'm an engineer and what do I know about this stuff?  Hopefully folks that know this area very well will chime in.

from what I gather it's just an unfortunate coincidence of timing. Russia balked about restricting production during OPEC talks, and the Saudis decided to "punish" them by cutting their price, thus creating more demand for their oil (and maybe taking clients away from Russia. This is Saudi Arabia throwing its weight around). This oil volatility is not a result of the coronavirus, but is making the markets (which are already very leery because of the virus and how it might affect the economy) even more unstable.

Thanks, so I can see how Saudi Arabia selling more oil will hurt shale companies and other producers who have higher costs to produce oil.  I think I read once that Saudi Arabia can produce a barrel of oil for $18.  So question#1 is kind of answered.

For question #2 I was deliberately ignoring the corona virus stuff.  I clearly see why corona would hurt the markets.  I just don't know why the analyst was saying that the impact to the energy sector and lower oil prices were also hurting the markets.

It seems like if gas becomes cheaper, wouldn't every single other sector out there benefit?  And thus the impact on the market would be positive (on the whole)?

Otherwise we could just keep the markets and economies cranking along nicely if we just restrict oil production year after year.

Mike,

It is worth noting that OPEC is a cartel and not an individual entity unto itself.  ALL members of OPEC cheat on their quotas.  At present, Russia, though not an OPEC member, is at least trying to act like a member.  But in the end, if a provider of oil (or anything) can find a market, the provider is going to sell.  There is also a sometimes huge difference between the contract rate and the spot rate.  The contract rate is sort of a forecast while the spot rate is the actual price at any given place and time.

Regarding pressure on other industries/sectors, cheaper oil always helps just about everything outside of oil.  However, what you were hearing might very well have been describing the behavior of stock prices, which after all is a highly visible and well covered topic.  Fear frequently enters the market and when oil prices drop, those that fear for their stock prices often panic and assume that oil prices are a sort of barometer for broader economic activity.  And frequently oil is a decent barometer of the economy.  But this is mostly about stock prices and often not about “fundamentals” or the actual performance of a business output, and not the stock prices.

Good question,

Eric

Thanks Eric, that makes some sense to me.  So if the guy was saying lower oil prices caused stocks to go down, what he may have meant to say was:

"Silly people noticed a drop in the price of oil.  They misinterpreted it as a sign that demand is down (moreso than just for Corona virus) and they fear the economies of the world are slowing down.  Thus they are selling and the market is dropping."

Did I get that correct?

Several things are happening at once, related but very complex (possibly too complex to be teased apart).

Oil demand has been generally down for awhile.  The shift to alternative energy (wind/solar) is still a small fraction of total energy use globally, but it's enough to generate negative pricing pressure.

OPEC and Russia cooperate to get prices up by restricting supply.  (When they cooperate.)  But in recent years, cheap natural gas from fracking in North America has begun to substitute for OPEC/Russian oil.  Which means that OPEC/Russia are under increasing strain, having to supply less and less to keep prices at the level they want (or, actually, way below the level they want, but higher than it would be.)

Along comes the novel corona virus.  Airline travel is way down.  That's a demand shock that puts even more pressure on OPEC/Russia.  

It is feared that as economic activity is drastically reduced worldwide due to people not going to work/school and not having money to buy stuff, the demand shock (drop in demand) because of corona virus will get bigger and bigger.  

Because of the feared recession, the stock market was under pressure all last week.  Then came the OPEC/Russia news over the weekend.  As I understand it, their cozy agreement to restrain mutual production collapsed.  (The "why" of it is still obscure to me.)  So they have (or are expected to) turn on the oil taps.  

But oil demand is down!  Demand down, production up, price plummeted today.

Stock market also plummeted today.  It was probably going to plummet anyway, continuing last week's trend.  

Lots of pundits say the oil price drop contributed to the stock market drop.  But they are pundits.  It's unclear how much they should be believed.

It's obvious that cheaper oil is good for some sectors of the economy ... but only to a point.  It's great if you can get cheap gasoline, but if you don't plan to travel, how great is it, really?  Likewise if you run a factory.  All the cheap heating oil in the world does you know good if you're closed because your workers are at home practicing "social distancing" or in a hospital.  

And the petroleum sector is well represented in the stock market.  Lower prices are terrible for almost everybody in the extraction, production, refining, and distribution industries.  Stocks in all those companies should obviously go down when oil price takes a major shock like it did today.

So, the oil news is terrible for a big segment of the stock market, and the upside is uncertain because there's a perceived risk that we'll be in a huge economic retraction with no consumer demand out there.  And in that retraction, cheaper oil helps a little, but maybe not much.

Dunno if that clears anything up, but it's my understanding of what's going on.  

Thanks Dan, that explains a bunch of it.  

But...  Don't the refining and distribution industries benefit from a cheaper raw material?  Don't all the other manufacturing sectors benefit from lower priced oil and gasoline?  My previous employer used oil based raw materials extensively so their input costs would go down with a drop in oil prices.  Seems like most manufacturers would benefit.  Most shipping costs would go down.  Goods would travel to market cheaper benefiting retailers who could simply not pass the savings along to their customers.  Amazon shipping would be more affordable to Amazon.  It just seems strange to me that the energy sector is a bigger negative to the economy than the positives to the rest of the economy.

I realize this is all against the back drop of the virus.  My main thrust of question #2 was poking at the "low oil prices = bad for economy" thing.  I've heard that, and the reverse, several times in the past 20 years and never really understood it.

Mike,

I think you got that just about perfect. Oil usage/energy consumption has been a pretty reliable barometer of economic activity for a very long time.  People who get into a tizzy about lower oil prices (assuming they don’t hold energy stocks) are probably trying to make a quick buck.

On the OPEC side, things are not quite what they seem.  Being a history teacher, I sometimes go to the Federal Reserve Back in St. Louis, a Fed branch that dedicates more money to education (and especially teacher education) than all other federal reserve branches combined.  I once went to a conference where they were talking about OPEC (this was back when oil prices were skyrocketing) and how effective it Isn’t.  OPEC sets a price called the contract price by reducing output in order to raise prices over a time period (Lets say a month).  So OPEC technically lowered output and increased prices.  HOWEVER, if a buyer of oil goes to Saudi Arabia (as an example) and says “I will by 10,000 barrels of oil for a discounted price right NOW, Saudi Arabia is going to pump and sell that oil in violation of the OPEC limit.  I saw a long term graph that showed the contract price and the spot price over a decades long time period and the spot price was always less than the contract price—and that assumed that OPEC was actually acting in a functioning manner at the time.  

TL;DR OPEC has very limited control over oil prices.

Eric

Mike Haasl wrote:
But...  Don't the refining and distribution industries benefit from a cheaper raw material?  Don't all the other manufacturing sectors benefit from lower priced oil and gasoline?  My previous employer used oil based raw materials extensively so their input costs would go down with a drop in oil prices.  Seems like most manufacturers would benefit.  Most shipping costs would go down.  Goods would travel to market cheaper benefiting retailers who could simply not pass the savings along to their customers.  Amazon shipping would be more affordable to Amazon.  It just seems strange to me that the energy sector is a bigger negative to the economy than the positives to the rest of the economy.

All that is true in times of normal demand.  If you can do or sell any thing that uses petroleum as an input, then cheaper inputs means more profits.  But only if you can continue to do or sell your thing.

That's how come we can't separate this issue from corona virus.  If demand is cratering, all the cheap oil in the world doesn't help.  If you aren't doing/selling, you can't use the cheap oil, so you can't benefit from it.

I agree with you that intuitively, it feels like cheap oil ought to be guaranteed profit for much of the economy.  And it does make many things easier/better.  But it can't make a consumer want to get on an airplane when they think it's not safe to fly.  

Stock prices are no longer tied to fundementals, they dont make sense in that they are not realy where you would expect due to how the various companies are doing.  The stock prices were driven high due to emotional reasons, hope, etc... that's why we say it is a stock bubble.  They were also driven high as people with money want to park it somewhere to make a return the fed has been keeping interest rates low since 2008 crisis, so you dont get a return putting money in a bank or buying bonds, not very much money anyways.  SO, they speculate in the stock market

Mike,

I could talk all day about energy, energy production and energy in history.  I did s masters in history largely based on the role of energy in history.

I agree with the majority of what Dan just mentioned.  However, you are correct that high priced oil does hurt refineries as they need to pay more for their raw material.  A lot (A LOT!) of people assume that all oil industries are one big corporation and don’t understand that there is fierce competition among and between them.

Another issue that absolutely terrifies major oil producers is that any time oil prices stay high for any length of time, new technologies surge into the market to capture a share of that lucrative market.  Right now, fracking (though widely derided) not only yields up natural gas, it also brings up “crude” oil that almost looks perfectly refined already.  Making it into motor fuel is a very simple task.  This has made the US a net exporter for the first time in decades.  And to make matters even better more interesting, there is more oil in shale than in liquid deposits.

Anyhow,  I am just trying to explain how bizarrely complex the energy market is.

Eric

We will pretend for a moment that the stock market is actually tied to the real value of companies these days... Which is becoming a more and more dubious thing to believe, but let's pretend...

Others have given a better synopsis of the oddities going on in the oil market than I can, but I'll give a bit more information on the markets.

I think what's confusing you Mike, is that a lot of analysts tie the economy really closely to the stock market, which is not really true. It doesn't matter all that much that there's a record stock price, if companies are not going out and using the money they are making from stock shares to invest in their company, hire people, etc (which are things that help the economy). So something could be good for the economy, and not necessarily good for the stock market index. Here's a good article : https://www.marketplace.org/2019/09/30/the-stock-market-is-not-the-economy/ . I like what they say, which is basically, the stock market is rich people betting about the economy.

Oil companies are large, highly valued members of the stock market(s). When their value falls (because they expect to lose income/demand/make less money/whatever), their PORTION of the stock market index (which tracks the value of the members of the index) falls. In Canada, they just suffered a 30% drop in stock value. Overall, the stock market is an average of the values of it's members. So when the price of one portion falls, the whole market, on average, may fall, unless the other portions make up for it. As of 2019, the energy industry made up about 16% of the value of the TSX. So... assuming the index had a value of 1000, and then something worth 16% (160) of it fell 30 % (1000-0.3*160 =  952 -> 952/1000 = wow, the market fell 5%!!! ( I may be slightly screwing up % change, and it's slightly more complicated, but I am tired)). And as a result, maybe other investors lose confidence, and sell their shares for less money, because, wow, the market has fallen 5% - and now the market's fallen 6%, 7%, etc...  Is the economy negatively affected? No, not really, except....

In Canada low oil prices = expensive technologies like clean oil sands production aren't economically viable = projects cancelled = money not spent = people laid off/losing jobs = less money for consumers to buy things, which hurts the rest of the economy. Low oil prices also mean that clean tech companies are priced out of feasibility, too. Low oil prices also really hurt oil producing provinces  tax revenue, as is being seen right now with some austerity measures going on in Alberta, which further affects consume spending, the housing market (another big market), etc.

Theoretically - the rest of the market could balance out these drops (which has been happening for the last few years, as oil prices fall). But only if the fundamentals for those other sectors are strong as well.

Meanwhile, stocks have been (imho) overvalued for years, priced with no reflection for the actual "Value" of the company and it's earnings (cough, Tesla, cough). Even before coronavirus hit, companies were reporting poor earnings forecasts, and yet their prices still continued to rise at incredible rates with no real reason. With coronavirus, people are expecting decreased consumer spending (coronavirus), travelling, etc. Several large companies (Samsung, etc) are going to have products delayed due to coronavirus closures. There will also probably be supply chain issues for several other products. China, one of the fastest growing parts of the world economy, is reporting 90% less than average car sales, and slaes of other things are down. And now large swaths of Europe are closing. The tourism industry is down, the car industry is down, the oil industry is down, the technology industry is down, and no one is willing to spend.

Suddenly, people start looking at the "valuation" of their portfolios, and questioning them. Which is dangerous in this confidence-based market where things are only worth as much as people are willing to pay for them.

Right now, the TSX / S and P Composite is at the same point it was a year ago or so. Which is also the same point it was in 2016. And we don't have much economic stimulus available (short of negative interest rates like parts of Europe) to prop it up, especially considering the US has been going on a tax cut and spending spree and didn't raise rates much after the LAST recession. Tax cuts and spending are typically drivers of recovery, but when they aren't available, recessions may last longer. A lot of the recent US tax cuts have resulted in corporate buy backs of stocks, rather than increased spending, which has artificially boosted the market without much of a resulting increase in spending, which would be a better "long term" basis for continued market growth.  

Right now - we are at about Nov 2016, or January 2019 prices, depending how you care to look at it. Basically - we have been in a bubble for a while, and people are starting to realize the current crisis is likely to lead to long term impacts to profitability. The stock market only goes up until people are no longer confident in it, and then it falls... And that's what seems to be happening.

So, in summary - the market is a confidence scheme tied loosely to profitability of companies and also kinda sorta related to the economy, and only has value until people lose confidence, and could be messy, might be recover tomorrow, but... it's probably, as always, a good time to have a garden!!!

Thanks Catie!  

<rant>
I spent several hundred hours two years ago researching investment options, and various management strategies. My take away was that:
- The whole thing is a flim-flam game driven by hyper active salesmen let loose by top dogs in the investment banks and brokerages.
- Ethics are below negative
- Methods are anything-goes
- Intelligence (if any can be found) is not needed nor used
- Regard/consideration for the value and stability of the whole is non-existent
- Essentially NOBODY understands the ramifications of the myriad new "products" getting pushed
- There is NO widespread institutional interest in proper accurate reporting which would allow regulators to maintain control
- The industry as a whole vehemently and actively tries to kill any slightest efforts toward transparency
- The financial industry, banks and stock houses have thousands of "rules", but no actual safety net - at all.

It is a fairyland gambling casino, promoted by the tallest and most dignified and powerful figures in the world. For some people it's addictive. It's horizon is, at most 1 year. Mostly it plans by the quarter and often by the hour or minute - or even seconds.

I'm sorry, but I will stand by the above assessment. I would even bet on it, if I had to, and I'm not a gambling man. But one thing I do fairly well, even anally, is research. And part of what took me so long was that I was approaching this with an open mind and tasked myself with learning what was really available and "how to do it". I insist on understanding, on my terms, stuff that may be very important to my future. I kept trying, I couldn't believe what I was finding, but I literally found NO UPSIDE when viewed from any ethical, responsible, sensible, even patriotic, point of view.

The above assessment appears totally consistent and continuous over the last 50+ year, but has gotten truly unbelievable in the last 30 years. 2008 did NOT bring any kind of responsible controls.

I have money in the stock market. I am trying to work my way into investing in local real estate, but that is a LOT of work. I don't think the house of cards will completely dissolve, but "there _will_ be blood". in cycles. Everybody will be hurt but the ones hit _really_ bad will be those  who cannot see their monthly checks shrink to nothing for 3 to 5 to 10 years. Milking the stock market (a perfect way to look at it) or floating on it, only works over 10+ years and longer is better.

As I said, I have investments and that won't change quickly. One reason is that there are precious few alternative ways to park money.

One interesting follow-on thought:  It might not be such a fantastic idea to try to "park" money. It might be far, far wiser to "invest" in life, trying to encourage those kinds of change which matter to you. Real estate (eg. Turtle Island if that guy is still doing his thing, Wheaton Labs...) or tools, or learning or children. InOtherWords spend the stuff! <g>

But I don't think you can go wrong by looking at the stock market as a particularly brainless type of herd which dashes after any hint of profit and spooks at any hint of the unexpected.


Cheers,
Rufus

One bit of investment advice I found (but which won't really help anybody): Try not to invest in businesses dependent (like farmers) on short term loans.

The reason is that the banking industry is _not_ stable or wisely run. They are gambling more and more and when there is a banking crisis, credit will dry up... And businesses depending short term credit to work... Will stop working. This thought comes out of my really discouraging study of the banking industry. They really are a house of cards.

It's not easy to discover which businesses  run on short term credit, but it's somewhat possible if you want to spend lots of hours in research and learning how different industries work. And if you can follow the line of control through the various holding companies.

So I guess this bit of "advice" is worth about what it cost you... On the internet, no less! <g>


Cheers,
Rufus

I agree with what everyone said, though at the end of the day it's a bunch of absurdly rich families neighbouring the Persian Gulf, and one despot in Russia with mates, waking up in the morning and deciding it's time to shake the cage a bit ... or not.

Then the whole world plays musical chairs and Joe-citizen is left without a seat.

To further confuse things, it depends on where your country trades oil - I think we use the Singapore market, could be wrong.

In essence, trying to rationalise oil prices is nonsense, other than typical market mechanisms where demand drives up the price until equilibrium is achieved, etc.

I agree with well thought out and careful worded analyses above, but would like to add some information. Although true that Russia sucks up oil at low rates, they can refine the product and make profit at 20$. Saoudi Arabia can too, but the Saouds have a lot more costs, they have no economy to speak off. They have to pay a lot of money to their citizens to keep the calm. There is a lot of unrest there. Royals get put into custody and forced to invest into certain companies. They're at a costly bloody war with neighboring Yemen. They need prices to be about 60$ a barrel.
Russia on the other hand, doesn't have this problem, their economy is more diversified and there are little government hand-outs, they have become close allies with China since the sanctions took root after the take-over of Crimea. They have set up a non GMO food system, because imports were down from the West since.

This might just be a revenge for the sanctions.

Since the 2008 crisis there has been non stop quantitive easing and low rates. The FED and Central Banks world-wide have tried to manipulate the markets. Cheap money for banks to loan to people, so they spend it and the economy gets rolling again. This worked partially, but for the little people it's still pretty bad and prices have risen, Homelessness and addiction are rife. A lot of the cheap money was lend to multinationals at very low, close  to  zero interest rates. Which was meant to be used to be invested in these companies, boosting the economy, but used for a large portion to buy back their own stocks. Which is very lucrative, because a lot of CEO bonuses are tied to rising company stock prices. This has created a huge bubble. Enormous profits for stock owners, and CEO's but price rises for the less fortunate. The economy is not so great at all. Trump said this before he took office, he changed his tune now.

Markets prefer bad news over uncertainty. Bad news leads to more quantatative easing (QE), which leads to stock buy backs and "great" economies.
Now there is a lot of uncertainty over the illusive Corona virus already which they don't like, and then Russia decides it's good timing to pop the bubble and say Njet to halting oil production.

The good news is that after one of the biggest stock market corrections in all time as i write this the stock markets in Asia have stabalized somewhat. That's due partly i think because South Korea has been able to get a handle on the Corona -outbreak, because of their rigirous testing regimes. They text bomb citizens if a new case has been discovered and they can go online and follow the last 72 hrs of the new case and apply for a test whenever they see they've crossed paths. And they think markets will stabilize in three month or so and even get going again.
In Europe however Italy has the whole country in Lock-down since last night, not only the north. We'll see how the markets in Europe will react to this news soon. And then 6 hours later Wall Street opens.

The bad news is the not very well known fact that France, Spain and Germany are steadily climbing in their Corona numbers, they're in nine days where Italy is now. I don't know if they will take these drastic measures as well, because if they do i don't think the overinflated stock market bubbles are not going to handle this well.

But who knows? It might be a great time to buy the dips, i'm no expert on these matters.

I am going back to Mike’s original question about how falling oil prices can tank other markets.  Mike had everything just about nailed down, the only confusing was about the term “markets.”

In this case, markets does not mean shopping at a local store, or ordering things on Amazon.  In this particular case, markets refers to stock markets.  The price of oil is frequently and for good reason used as a barometer for the economy as a whole and especially as an indicator for stock markets in the near future.  Oil prices have a tendency to predict (somewhat loosely) stock market prices, but they don’t by themselves force stock market prices.  Rather, the economy as a whole determines both energy prices and stock market prices.

Now given that bit of information, if oil prices tank and stocks plunge, this is a pretty good time to get into the stock market.  Why?  Because one will have bought low—exactly what a person is supposed to do.  It is also worth noting that if a person is buying with the intent to hold or create a nest egg, then day to day fluctuation—even large ones—simply don’t matter.  It only matters if you sold low.

Now professional investors have a different strategy in mind.  They need to make a quick buck and they have resources to sell faster than you or me.  The professional investor can bail on a stock well before it hits rock bottom.  But an individual investor should never just play follow-the-leader.  Individual investors lack most of the necessary structural equipment to really make a huge killing in the stock market on a day-to-day basis.  But investing over time can yield good results.

Long story short, oil prices are sometimes good indicators of future markets but the stock market by itself is not a real indicator of people buying and selling on a day-to-day basis.  Mike, to more specifically answer your question, lowered oil prices might make for lower stock prices, this is not an indicator of recession, depression, etc.

Hope this helps,

Eric

Why oil is down may have a factor on how it effects the market.

If it is down from overproduction or competition,  then i could see a benefit to Amazon, airlines, etc of increased profits from the savings. Heck, every other business could see increases just from common people spending less to fill up their vehicle. It could be the difference in going to a movie or not, or eating fast food vs a nice dinner. New paint for the bedroom. New tires. It helps all other businesses.

When the drop is due to lack of consumption, its an indicator that things are slowing down. Less gas used to transport goods equals less stuff being bought. Less numbers travelling equals hunkering down. Fear of something. Less confidence about tomorrow (job security).

On the flipside, you can predict an upturn by looking at transport purchases. When Penske announces a purchase order for a bunch of new trucks, things are trending up. They see it first.

Yes Wayne, that's exactly how I thought things were supposed to work.

This economist is amazing, imo!