Macro Commentary
Let’s talk turkey. With the American holiday of Thanksgiving coming upon us next week, we will take a moment to consider the cornucopia of macro offerings put forth in anticipation. To start the week, the announcement of a technically defined recession in Japan gave rise to swift response from Prime Minister Shinzo Abe. As discussed in prior write ups, the swift increase in the sales tax rate in April of this year continues to reverberate as Q3 caused a 1.6% annualized contraction in economic activity which followed Q2’s 7.3% fall. It seems the gift of an enlarged purchase program from the Bank of Japan is doing little to foster fundamental improvement. Announcing immediately that the next step up in sales tax is postponed, Abe took action to dissolve the lower House of Parliament the way some holiday hosts wish they could cut short the visit of out of town guests. This paves the way for a snap election and a referendum on his policies which we continue to feel lack the critical structural reform. Japanese equity investors may have eaten dessert before they first focused on their greens – a recipe for indigestion.
Looking forward, we will be checking the news as we sit down at the dinner table on Thursday, November 27 to see what the members of OPEC conclude as the oil markets reacted to Saudi Arabia’s recent decision to sacrifice price to protect market share. While there is a plethora of drivers in the price of crude which makes specific forecasts a fruitless enterprise, we think it was the announcement from the Middle East that caused the recent bullish sentiment to crack. When you look back, the front month contract for the US benchmark price for oil well exceeded the longer dated expectation of prices by which operators make their capital expenditure decisions. The change between the longer term price then versus now is much less. Reports say that forecasters are split on what OPEC will do, an unusual circumstance for what is generally not a newsworthy gathering. As this summary is written, we are sitting in the middle of the Permian Basin having met with several operators who say that activity continues with renewed focus on the best basins. Smaller independents may slow activity some in the near term as uncertainty looms in the context of the big dollar spend for a horizontal well, but the larger players with access to capital are likely to drill through. Oilfield services will likely feel the squeeze as the recent high spot prices led to enough profit margins for producers to be generous, but now they will sharpen their pencils. A longer term price below $70 would be problematic, especially for those who have levered up to increase drilling programs. More conservative operators would see that shakeout as opportunity.