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Understanding decling oil prices in relation to cattle and beef

published: January 25th 2016
by: Kerry Halladay
source: Wall Street Journal

What’s cheaper than a barrel of oil these days? For one, the barrel used to hold it.

As of press, a barrel of light crude was $29.72/barrel, having lost roughly 20 percent of its value in a month. What’s worse is it is projected to go lower as supplies are expected to increase.

“Iran’s return to the oil market confirms what has been inevitable for six months since the P5+1 deal was signed in Vienna last July. Now the suspense is over, attention switches to the impact on oil market balances and the likelihood of further declines in oil prices following a torrid start to 2016,” reported the International Energy Agency (IEA), an international group that focuses on energy economics in its monthly Oil Market Report.

“Some analysts argue that the easing of sanctions on Iran is already ‘priced in’ to the market. There are considerable uncertainties around the quality and quantity of oil that Iran can offer to the market in the short term and the not inconsiderable challenge of finding buyers willing to take more oil into an already glutted market. However, if Iran can move quickly to offer its oil under attractive terms, there may be more ‘pricing in’ to come. Time will tell.”

The IEA report noted that investment banks have warned that both WTI (West Texas Intermediate, also known as Texas light sweet) and Brent Crude oil are could fall below $25/barrel. Some estimates placed the possibility as low as $10/barrel. The IEA report additionally pointed out that oil giant British Petroleum eliminated 4,000 jobs since December and that Petrobras “slashed its five-year investment programme by 25 percent.” The group called these moves clear signs of expected low oil prices for a while to come.

“We conclude that the oil market faces the prospect of a third successive year when supply will exceed demand,” the report continued, projecting that whatever declines in non-OPEC (non-Organization of Petroleum Exporting Countries) oil production that is forecast will be more than offset by higher production coming out of Iran.

“Nor can we expect other Middle East producers to stay on the sidelines; their regularly stated policy is to protect market share and allow the price to find its level. Saudi Arabia’s sharp increase in domestic fuel prices is a sign that OPEC’s top producer is preparing for a long period of lower prices.

Cattle connection?

Though cattle and beef markets are connected to oil markets, the link is not the most direct. It can come into play in a number of ways on the domestic and international front.

On the domestic front, declining oil prices tend to result in lower gas and diesel prices for both consumers and people trying to move cattle. According to the U.S. Energy Information Administration, the average cost of gas across the country last week was $1.91/gallon, down 15 cents from the same time in 2015. Average diesel across the country was $2.11/gallon, down 82 cents.

For consumers, this added savings at the pump often translates into increased spending for food items like beef. However, beef- and cattle-market analysts have been noting repeatedly in recent months that energy savings have not translated into consumer demand for beef as might be expected.

Declining oil prices also mean risks to employment in the domestic oil industry, however, and that is generally negative for the economy and beef demand.

“Aside from the savings that consumers are feeling, the negative side of it is that so many industries are tied to oil—mainly your gas and oil industries that are trying to sell it, but also those secondary industries that they are buying inputs from. Their margins are falling, they can’t purchase as many of those inputs, and they aren’t expanding production. So you’re seeing some hurt on that side, and also those employment numbers on the oil and gas side are probably going to start going down here again. That is probably going to hurt some of those economies around the U.S. that are dependent on it,” Jessica Sampson, Agricultural Economist with the Livestock Marketing Information Center, explained to WLJ.

Sampson also pointed out that oil prices are often an indication of the health of general economies, and that beef demand tends to be dependent on economic health rather than on the movement of one specific commodity.

On the international side, however, low oil prices can have a big—and often negative—effect on the economies of important trade countries, even if they are not important trade countries to the U.S.

“There is broad acknowl edgement that the collapse in crude oil prices could have significant negative impacts for a number of countries. What is unknown/unknowable at this point is how the situation may unfold, especially in emerging markets,” commented the CME Daily Livestock Report last week.

“Recession in countries such as Russia, Venezuela and Brazil were particularly negative for beef demand in 2015. The risk is that a global recession could further limit U.S. beef exports while at the same time continuing to attract more beef imports into the U.S.”

Andrew Gottschalk of Hedgers Edge had a similar warning last week:

“The greatest risk to our market is external events which could further derail domestic and international consumer confidence. The global financial market collapse has already wiped out over $15 trillion in equity since June.” — Kerry Halladay, WLJ Editor

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