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Sunday, February 27, 2011

40 Years of Watching Oil Prices Impact the Auto Industry

When the price of oil rises SUDDENLY, usually caused by some world event, there is a rush to produce and sell at the higher world market price. This mitigates the shortage in a short period of time and invariable produces a glut. As the price rises, greed drives some members of OPEC to sell over their agreed upon allotment creating a "black market" supply. Sometimes Saudi Arabia tries to counter this by cutting back on it's on production, despite the higher world price. Other oil producers rush available supplies to market. In the U. S. oil patch, dormant wells are revived as the higher price makes it practical to borrow money to repair and update pumping and storage equipment. Small producers in the oil patch generally fix up their equipment when the price goes up and run the equipment until it fails or needs a general overhaul. If the market price is still high, they go ahead and spend the money to make repairs. If not, they shut down the well and wait for the next price spike. The bankers they do business with understand this cycle.
Tankers and storage facilities are topped off and tankers will end up anchored offshore waiting to off load. When the price falls, it takes a while to move the high priced oil through the system, resulting in prices at the pump that stay high seemingly longer than they should. Oil companies who were sitting on low priced inventory suddenly have that inventory revalued at the new higher price, resulting an really high short term profits and a grassroots backlash at oil companies in general.
In the meantime, one can watch the stock price of tanker companies like Frontline Tankers. As the market senses a boost in oil production sparked by higher market prices, their stock moves up in anticipation of higher traffic.
Even in periods of low oil prices, producers try to produce higher volumes as they attempt to make up for the low market price with volume, which tends to further keep the world market price down over time.
The residual value predictors are again proven "wrong," although their numbers are usually pretty good except during these "artificially" triggered market price spikes. Dealers experience extreme value drops on held pre-owned inventory that is not deemed fuel efficient by the current market. This makes them extremely wary of trading for more of the same at any price as auction prices no longer provide any useful information of true value. Often, a dealer will take a "heavy" to the auction sale and it won't even draw a bid. The term "toxic asset" applies here. If the dealer practices "mark to market" accounting, he/she will write down "heavy" inventory immediately, causing a huge loss and drawing the extreme scrutiny of the dealership's lenders and investors. If "mark to market" is NOT followed, inventories are drastically over stated. The entire new and pre-owned auto market is disrupted as consumers look to trade off their heavies and move to something more fuel efficient. This despite the fact this cycle has repeated itself at least a dozen times over the last 40 years.
Trading "heavies" during a time of high fuel prices can be a punishing experience for the consumer, as their trade in has been devalued by market forces and the fuel efficient vehicle they want to buy carries a premium. Historically, consumers become dissatisfied with their new fuel efficient ride about the time fuel prices drop again. Many of these consumers will go back out into the marketplace to trade their new fuel efficient vehicle in on another "heavy." Again, market forces have driven down the value on their trade and placed a premium on what they want to buy. The consumer becomes frustrated and blames their plight on the dealer.
As we move into a new era of vehicles where fuel efficiency can be achieved in ever larger vehicles, it is not clear if the historic formula will continue to replay itself in exactly the same way.
For example, the Hyundai Sonata achieves 34 highway/28 city MPG in basic 4 cylinder form. A tiny MINI Cooper only achieves 37/29 MPG.
In my own view, everything is relative. The person trading a Tahoe on a Malibu will still be dissatisfied even though the Malibu offers tremendous size and comfort while still getting excellent fuel economy. But a Malibu isn't a Tahoe. It won't tow and it won't go off road. And it won't carry 7 passengers. So my money is on the cycle to continue along historical lines.
In the 1980's Lee Iaccoca proposed a 25 cent fuel tax. Conservative car guy Bob Lutz continues to call for a European style fuel tax. Recently, New York Times columnist Tom Friedman called for an increase in fuel tax of 5 cents per month for 20 months, making the case that the buying power of the current fuel tax has been halved by inflation since the last increase in 1993. He proposes to pay down the national debt with the money. I presume he thinks that is a better way to go than instituting some new tax brackets at the top of the income scale. Or perhaps he proposes to do both. Even people like Alan Mullaly and Bill Ford have expressed the desire for a fuel tax, instituted in such a way as to provide some market predictability. On the QT, most auto execs AND politicians will whisper the same thinking, although they are reluctant to come out with it publicly.
No doubt the country's politics will prevent us from getting a pure solution. The system in use in Europe and Japan works way to well for us to adopt it. It seems evident that the Middle East will continue to be impacted by events such as are happening in Egypt and Libya. It is reasonable to expect that the dissatisfaction of the masses will drive change in many more oil producing countries, including Iran, Saudi Arabia, and Venezuela. I suspect the world price of oil to remain volatile for years to come with shortages caused by political events followed by gluts caused by backlash over production. There will be a great profit opportunity for those who can predict these cycles while auto manufacturers and dealers will suffer from the whip saw effect.
A little perspective follows:
38 -- That's the number of miles per gallon (US gallons) that the average passenger car in the UK is getting according to the British Department of Transport.
22.4 -- That's how many miles per gallon (US gallons) the average passenger vehicle in the United States is getting according to the Bureau of Transportation Statistics.
9200 -- How many miles the average UK driver travels in a year.
13000 -- Number of miles driven each year by the average US driver, 40% more than in the UK.
"To put those numbers in some context, the average US driver will use 580 gallons of fuel each year, compared to 242 in the UK, 139 percent more. Even allowing for fuel that’s less than half the price ($3.88 per gallon vs. $8.52 per gallon, currently), US drivers are still poorer to the tune of nearly $200 a year."
Source: Ars Technica