Quicksand Is Not a Common Problem

The price of oil on the spot market has fallen to half.  Greek sovereign debt may soon be in default and the story is that that would be catastrophic.  The good question is how did this enthusiasm happen?

The answer is that price of any commodity, oil for example depends on the balance of supply and demand.  A bit simplistic but good enough for our purpose here.  There is a surplus of supply so the price must fall.  But the price change, given the surplus quantity, is astounding.

World oil consumption in 2015 is expected to be around 94 million barrels per day, worth around $5 billion.  The surplus is around 500,000 barrels worth $25 million.  The surplus is less than 0.6% of supply yet the surplus rules the price decision.  Until the price falls to the place where the surplus is bought up, no stability.  The surplus causes the price of the other 99.4% to fall too.

What we are seeing is a market, well supplied and well served (no pun intended,) where the price is established by marginal production.  The last barrel of oil sets the price for all of it.  In the longer run the bigger and consistent consumption will set the price.  Do not be too upset with short run marginal fluctuations.  In a business be cautious in reducing price to get volume.  Minimum prices affect all of your sales.

Greek debt.  There is about 200 billion Euros involved.  For me, a formidable sum, but in context of all world sovereign debt, it is immaterial.  Less than the round off.  Why does it matter more than the 80 trillion Euros or more of sovereign debt world wide that is not about to default?  Because it is on the margin.  The place where something is changing set price or establishes conditions.  Change is threatening.

Marginal factors are driven primarily by emotion.  Anger, fear, embarrassment, and greed.  People take a tiny factor, something out of the ordinary, and apply it to a more general case without considering whether that extension has merit.  It usually does not.  A Greek default may cause some to focus on other weak countries, but it says little about whether the US, the UK, France and Germany are about to default.  They owe around 30 trillion Euros collectively.  Again marginal things are interesting because they are unusual.  Unusual is not, in and of itself, important.

Pay attention more closely to the ordinary.  The unusual seldom becomes the norm.  Ordinary is likely to survive, while the marginal things will turn out to be little specks on reality.  Go with the common.

When I was a child I thought quicksand would turn out to be a bigger problem than it has.

Do not get caught up in the hype.

Contact: don@moneyfyi.com  

Don Shaughnessy is a retired partner in an international public accounting firm and is presently with The Protectors Group, a large personal insurance, employee benefits and investment agency in Peterborough Ontario.

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