Wall Street's investors and OPEC's sheikhs
Mindful of threats of a price war, no longer enjoying a corner on world oil supplies, OPEC ministers convene today in Geneva -- their second meeting in less than a month. Halfway around the world, the American stock market has been hitting record highs. The stock exchanges in Tokyo and London have rallied strongly, too.
Is there a connection?
Although interest rates and economic policy have a more immediate effect on the stock market (most of all, Federal Reserve chairman Paul Volcker's indications that credit conditions will remain fairly loose in the United States), moderating oil prices have helped the Wall Streets of the world in several ways:
In the tank. Oil prices directly affect transportation and utility issues -- which have soared in recent weeks. Airlines, trucking companies -- any operation that burns a lot of oil -- benefit from lower energy prices.
At the bottom line. To a lesser extent, industry in general -- with one obvious and important exception, the oil companies -- gets a boost from lower oil prices. The US Treasury has estimated that a $5-a-barrel drop alone would nudge gross national product growth by 0.5 percent, while trimming 1 percent off inflation.
As fuel costs drop, most corporate profits rise; dividends stand to gain from that.
In the economic equation. Oil also has an influence on the stock market as a whole, since oil is linked to inflation . . . and inflation to interest rates . . . and interest rates to stock-market performance. And when the sheikhs and oil barons of the Organization of Petroleum Exporting Countries are having difficulties, that gives a boost in attitude to the stock market.
If other things are keeping the damper on inflation, moreover, the Fed can have a relatively easy money policy so as to stimulate the economy without too much fear of reigniting prices and wages. (Mr. Volcker last week announced that the Fed was indeed remaining fairly easy in its governance of the money supply.)
Wall Street has reacted fairly positively to all this.
The Dow Jones industrial average closed at 1,3xx.xx Friday -- a xx.xx-point gain for the week. There was, however, a degree of dissatisfaction as the week closed. Economic data, including the revised second-quarter gross national product report, indicated continued sluggishness with American business. Profit taking was evident.
Nevertheless, since late June, the Dow has been in uncharted territory above the 1,300 mark. The main burst of mid-month economic data -- all of it somewhat less than impressive -- has passed. This week, all eyes will be on Geneva to see if decisions made there will keep inflationary pressure minimal for the foreseeable future.
OPEC, of course, will be trying to stabilize oil prices. But the pressure is on. Egypt was set to cut its per-barrel price by $1.50 or so last week. Mexico trimmed its by $1.24 two weeks ago. Threats of a price war hang in the air.
Before the Geneva meeting, Kuwaiti Oil Minister Ali Khalifa al-Sabah warned that if OPEC loses control, ``I'm afraid prices will drop dramatically.''
OPEC probably will try for a modest (50-cent or $1-a-barrel) decrease in prices at the Geneva meeting, most oil-industry analysts agree. Sanford Margoshes of Shearson Lehman Brothers figures there's a 60 percent probability that OPEC will ``muddle through once again.''
But there is still a 40 percent probability, he says, that Saudi Arabia will become exasperated, flood the market, and try to take control of production. The Saudis are running huge trade and budget deficits because of their loss of oil revenue. In part this is because of the cheating by fellow OPEC members.
Whatever the outcome of the Geneva conclave, Mr. Margoshes and other analysts expect prices to continue to fall on the spot -- or noncontract -- market (some 80 percent of all oil traded in the world is sold on the spot market today). That, in turn, would put pressure on OPEC to cut its prices further as the year wears on.
A recent Merrill Lynch analysis noted that OPEC appears so weakened that it will not be able to keep things together, and ``prices will come down sharply before year-end.''
Good for most. But there's one set of Americans companies that is anything but gleeful.
Like oil-producing nations, American oil companies would face big problems. As prices fall, the companies garner less revenue.
Still, some do better than others. Those that buy oil for their refineries benefit from the cheaper crude prices. Those oriented more toward exploration, drilling, and pumping do worse.
The stock prices of integrated oil companies were fairly strong at the start of the summer, however, so even if they weaken, they will still be a long way from the cellar.
Frederick P. Leuffer, senior oil analyst with Cyrus J. Lawrence Inc., predicts that ``except for one short spurt in [oil] product prices in July or August, that might be brought on by restocking,'' profit margins for oil companies will slip lower and lower.
``We estimate that after-tax income for the 14 major oils would decline by $7 billion if oil prices were to drop by $5 per barrel,'' Mr. Leuffer says.
If that $5 drop occurs, Phillips, Unocal, Texaco, and Mobil would be hit first, he estimates. And if a $10 drop occurs, only Royal Dutch/Shell, Imperial Oil, and Kerr-McGee of the 14 major companies would still be in fairly good financial shape.
Still, the fortunes of the integrated oils might improve by the end of the 1980s, Leuffer says -- especially if prices drop to $22 a barrel, since this would eliminate direct competition from alternative fuels and decrease conservation.
For now, oil analysts agree that erosion of oil prices and, as Margoshes puts it, ``a consequent loss of confidence in the oils'' as investments are bound to occur. Chart: Interest Rates. *Yields; Source: Bank of Boston.
Percent Prime rate 9.50 Discount rate 7.50 Federal funds 7.88 3-mo. Treasury bills 7.17 6-mo. Treasury bills 7.25 7-yr. Treasury notes 10.16* 30-yr. Treasury bonds 10.51*