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this podcast is brought to you by
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knowledge at Warton please visit
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information Memorial Day which marks the
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beginning of the summer driving season
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in the US saw gas prices at nearly $4 a
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gallon all over the country and even
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higher in states such as Florida
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globally the picture looks more
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worrisome oil prices crossed a record
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$135 a barrel dur during the weekend of
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May 24th though by Tuesday prices had
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come down to
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$131 what's Behind These regular
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flare-ups and oil prices what are the
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major economic and geopolitical factors
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at work how does expensive oil affect
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the US and world markets and what can we
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expect over the coming months knowledge
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at Wharton discussed these questions and
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more with Finance Professor Jeremy
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seagull author of the future for
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investors and with vold Hennis a
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professor of management
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as we know oil prices jumped to a record
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$135 a barrel during this past weekend
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uh do you think they're near the top now
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and if not how much do you expect them
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to rise over the rest of the summer I
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think I would be presumptuous to to even
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uh theorize about whether we're near the
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top I don't think anyone really knows uh
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it it's my feeling that um even OPEC has
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basically lost control of the price of
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oil and they're not they're going flat
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out and I mean that they can push some
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more but not easily um and
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uh you know given given the demands it
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it obviously could go much higher and I
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don't think anyone knows I think it's a
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guess what do you think I think a a
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guess and a lot of uncertainty is
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certainly accurate there have been
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discussions recently of $200 a barrel
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oil the big uncertainties are is there
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more existing capacity in the OPEC
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nations can they produce it and will any
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one country go offline um there's a lot
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of uncertainty in African countries
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Latin American countries about whether
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they can maintain their production and
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expand it according to existing
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forecasts we simply don't know the
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answer to that and the Traders are uh
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trading based on that uncertainty
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generating the high price of oil today
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yeah I think uh a lot of people are not
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very sure about what are the major
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factors uh economic and geopolitical
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that are really driving the rise of oil
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uh could you help explain that a little
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bit for our viewers we're in a period of
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tight balance between existing supply
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and demand which is generating a lot of
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uncertainty about the future path of
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both of those variables I think the big
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uncertainties uh that um we have to
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Grapple with are how much more capacity
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does Saudi Arabia have and how much can
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they bring online in the short term we
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simply don't know they don't they
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haven't revised their existing estimates
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of reserves for some years and we simply
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don't know whether there's those are
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conservative estimates or whether they
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can be expanded and that's true in many
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countries throughout Africa and Latin
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America we don't know what the future
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capacity uh and reserves levels are yeah
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I I think as I mentioned I don't think
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there's an easy way to increase Supply
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or at least significant Supply in in the
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short run I think a lot of it is is
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economic um it's it's hard to blame
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speculators because we don't see a lot
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of inventory increase in oil which would
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be a sign that people are hoarding it uh
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at this point um and I think what is
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also the psychology is everyone wants a
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piece of oil because they want to
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protect themselves against oil price in
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increases so if I own some at least I'll
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have something that'll go up when the
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price of oil goes up well of course if
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everyone tries to do that you know it's
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almost like the sky is the limit because
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uh you know I don't think everyone can
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protect themselves completely immunize
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themselves uh against this oil increase
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and that that's what's uh that's what
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the upper threat is the other side is
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the demand uncertainty how much more
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will demand in China and India and other
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countries grow the other side of the
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equation there's also a lot of unknowns
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right I I saw that George Soros the the
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bill Aire investor was interviewed by
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one of the British peers over the
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weekend and and he said that primarily
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he thought that speculation was
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responsible and uh for for the rise in
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the price of oil but it sounds like you
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don't necessarily agree I I think I mean
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there's a fine line between speculation
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and buying for an even more expensive
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future I think uh I mean I think people
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realize how important it is uh to to
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hold some oil producing assets in their
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portfolio and if everyone thinks like
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that that will go up it's not just
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speculators running a train uh moving
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that up and this is a scarce a resource
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that the world is using more and more uh
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rapidly um uh you know peak oil is
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always in the air and um uh I I think uh
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that's generating the increases I think
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if you look the probability that one
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country could go offline driving a
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substantial increase in price is
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something that people are trading on the
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probability of is that spe culation or
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is that hedging when Southwest Airlines
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Hedges their future uh oil oil uh Supply
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they're lauded uh as being smart
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relative to the rest of the airline
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industry that's not speculation that's
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hedging that way you know many of the
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media reports seem to make a connection
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between the weak dollar and the rise in
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the price of oil again could you help
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explain what the connection might be
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it's it's more than just uh the dollar
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going down because even if you measure
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it in Euros which has been one of the
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strongest currency they've had a huge
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increase uh recently um and today we had
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the truckers in Britain uh calling for a
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strike because the price of gasoline is
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going up so high there and they can't
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pass on the charges quite as easily as
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we can and uh it's it's it's now a
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worldwide phenomenon I mean certainly as
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a year ago in dollar terms we're up more
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than the rest of the world but over the
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last three four five months the increas
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has been so rapid that it's it's
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affected every currency I
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agree uh what what effect Is high oil
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having on inflation the US Stock Market
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and the economy more
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broadly uh you know it's uh it's
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surprising that many economists felt
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that by now we would begin to see uh the
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higher oil prices move into what we call
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Core inflation which is uh you know
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those those those basic goods and
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services that are not directly oil and
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energy because just in manufacturing Etc
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we haven't really seen it because
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there's been downward pressure on home
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prices now there's been some downward
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pressure actually on physician prices
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medical prices surprisingly have been
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very soft over the year sort of offset
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the increases in oil but with these
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recent increases that we've had they've
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been so massive and so rapid we haven't
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really had time to see how they might
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figure in to the indices and that's why
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I think over the next uh couple months
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it's going to be really important to
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look at these price indices I don't
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think they're going to be as good I
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think there are two direct channels or
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sorry one direct and one indirect
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channel that are really interesting to
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watch one is just the cost of
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Transportation uh and that'll spill over
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into High um uh spill into certain Goods
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including foods and others uh and also
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the indirect cost as we start as the
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price of oil keeps going up we're
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starting to spend more on alternative
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fuels and and divert uh efforts into
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renewable fuels that's driving up the
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cost of Agriculture so they're both
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direct and indirect channels which we
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can foresee in the next 12 to 24 months
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and we see the substitutes for a while
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particularly in natural gas has gone up
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dramatically just over the last 3 months
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after remaining stable for many years
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did not go up with o oil which is over
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the last 3 or 4 months it's gone up
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around 40 or 50% right you know another
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thing that many Asian countries have
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recently announced uh for example Taiwan
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Indonesia Malaysia is that they're going
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to get going to get rid of all the the
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subsidies for for fuel what impact do
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you see that having on on both the
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markets and the countries themselves I
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think there's a question as to whether
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that's credible It Was the removal of
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fuel subsidies that led to the downfall
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of suaro and Indonesia whether it's
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really credible that they'll actually
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follow on that promise in the face of
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popular unrest is is a big uncertainty
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so I I take a step back and say whether
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that can actually happen uh before we
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really analyze its impact although it's
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certainly more expensive now to maintain
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price lids and it might be that some of
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these governments just don't have money
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it's you know to to be able to buy at
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the world price if they are importers
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and then subsidize it down to the level
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that uh you know they had been in the
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past so um um it could provoke a lot of
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uh unrest uh even uh if the government
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had wanted to keep the prices lower
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right uh turning now to the US economy
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uh home prices fell in 20 us
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metropolitan areas in March uh the case
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Schiller index fell 14% compared with
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the level a year ago do you see any
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Silver Lining at all in the housing
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market or will the downturn continue for
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the foreseeable
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future well I the the good news is if
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you didn't own a home and you were
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intending to buy one uh you're getting a
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potentially good deal out there uh if
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you had been renting for instance and
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waiting for the prices uh to go down
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also for those people who wanted to
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upssize their home you know we planning
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to do it and wait it people people lost
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of course are those who bought in the
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last year two years three years at the
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peak and that's what we're worried about
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because many of them are underwater with
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a threat of foreclosure Etc and so on
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that's been a very major uh depressing
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point so it really depends on what
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position there are sing lining for some
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people but but uh certainly not for
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all and and more uh economic indicators
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are scheduled to be announced this week
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ranging from new home sales to consumer
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confidence and also a few others we
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actually got the consumer confidence
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today and was not good it was I think it
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was another like a 15 or 16 year low uh
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yeah this is the conference board comes
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on the last Tuesday of every month now
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we got that at 10:00 a.m. and um um uh
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it was another downtick I mean the the
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the double whammy of the home prices and
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the rising price of oil is is Weighing
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on the psychology and um you know it's
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it's all the surveys show uh near record
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consumer dissatisfaction um with the way
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the governments are holding the economy
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and confidence in the economy itself so
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what's based on what you said what's
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your prognosis for where the economy as
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a whole is going and what can we expect
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to see well I did some just kind of back
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of the envelope type of calculations um
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and uh they were it was pretty
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sobering um at uh we imported about 12
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million barrels of oil a day um and uh
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at $130 a barrel no one knows it's going
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to stay there could go higher or lower
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um uh that's that's about 4% of GDP uh
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over five almost $600
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billion and uh that's doubled uh over
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the last year so uh first oil was
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occupying 2% now it's gone to four so
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that's like 2% can be just ch if we
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could stay at these levels chopped off
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the growth rate for a year of our our
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our GDP and given that like productivity
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is up on average around two years of GDP
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this whole process so far would would
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cost a whole Year's prod AC ity gain
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into the US economy now with that said
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um it still seems like we're muddling
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along above
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zero um and uh uh or our quarter is two
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two months over um and uh most people
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are still saying this is going to be a
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positive quarter just like last ones too
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nothing great but nothing negative the
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way you would think of in a
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recession I think to to end where we
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started a little bit thinking about the
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uncertainties you know the impact so far
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has been uh substantial but we're still
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above zero the uncertainties as to
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whether the credit crunch spills into
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auto loans as was reported this morning
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uh spills into uh other uh highly
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leveraged debt uh whether the oil price
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has KN on effects um in food prices such
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as I already mentioned uh whether it
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causes uh whether uh it leads to other
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spillover effects and instability in
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Africa instability um uh in Asia um
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these are the things we can't see that
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could really cause something devastating
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in the coming months so what are the the
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key geopolitical risks that you are most
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concerned about going forward if this
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economic situation continues well under
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the current circumstances any attack
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which would uh impact the the supply of
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oil would have devastating consequences
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an attack in the spratley islands uh an
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attack in the Gulf region uh an attack
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on a Refinery we just don't have the
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spare capacity in the short term so
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we're really at risk of of any uh break
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in the supply talking about terrorist
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attacks when referring to that uh this
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just this morning I think there was a
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report that an attack in Nigeria uh was
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uh responsible for an uptake in the
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price of oil yeah some of the hopes
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about the price of oil Falling Up
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Buffett called it a bubble recently were
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on the on the back of Nigeria's suppli
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supposedly finally coming back online
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under shell and others but we can't we
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can't be sure that that's actually going
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to happen so yes I think those
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uncertainties are really Paramount on
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the geopolitical front yeah it seems
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like every time we say oh
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you know the price went up because of
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this this and that then then that thing
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disappears and the price still goes up
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so there's got to be much more forces
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than some of the commonly used uh you
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know phrases and explanations for for
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that I think deep-seated increases in
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demand deep-seated hedging real hedging
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uh against against that uncertainty um
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and a relatively fixed uh short-term
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Supply I think is just fueling um
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fueling this increase so uh to end with
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a variation of the question that we
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usually ask we ask uh you most often to
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comment on what should be the strategy
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for investors going forward this time
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I'd like to ask what should investors
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and oil consumers be doing going forward
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what what do you
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think well you know let me let me
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comment a bit on investors because I I
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follow that that area pretty closely I I
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I I still claim if this this is a market
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that would want to go up if it wasn't
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being hit over the head with oil uh at
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ever increasing prices because that is a
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big chunk as a major world importer of
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oil um uh if if there can be some
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stability here or if we can get back
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down to 100 and just stay there I think
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we see the market up 15% from where it
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is because you can just see the way it
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wants to Gap and then oil oil oil but if
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oil continues at this rate or or
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continues to rise I think it's going to
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be hard slugging uh in in the market not
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a panic not a real sell or sell off but
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it's going to be going to be tougher for
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for Equity investors in the short run we
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told any final comments no I defer to
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Jeremy on the on the broader macro
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questions well thank you both for
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joining us today really appreciate your
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time thanks for having us thank
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you for more information please visit
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knowledge. won. up.edu
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