Thursday, March 23, 2006

We're Addicted to Oil Because Oil is Cheap

I just got back to my hotel room in Austin after taking part in a panel discussion at the University of Texas Club sponsored by the local CFA Society. The other participants were Rich Bernstein of Merrill Lynch and Michelle Foss of the Center for Energy Economics. The overall tone of the discussion was bearish. Rich is concerned about a corporate profits recession and is recommending that investors overweight consumer staples. Michelle believes that high energy prices have been offset by cheap labor in China and India. But as more people move into the middle class in those countries, they are demanding better wages. This is likely to result in higher import prices in the U.S. Cheap labor won't offset higher energy prices forever.

President Bush made a point of saying in his State of the Union address that "America is addicted to oil." Of course, it's not the oil we're addicted to; it's the price. We like oil because oil is cheap--not compared to what it cost two years ago, but compared to what alternatives cost today. If you want to see consumption drop quickly simply raise the price. By heavily taxing oil, or by heavily subsidizing alternatives, we can dramatically reduce consumption. Of course, either choice would take money out of taxpayers' pockets and may even cause an economic recession. So as long as oil remains a relative bargain, we should continue to use it.

On an unrelated matter, I noticed that Standard & Poor's said after the market closed today that it will add Google to the 500 Index. The stock jumped 20 or 30 points higher in aftermarket trading. In my view, this makes the stock even more overvalued. However, it may stay at current levels as index funds will be forced to buy it. This buying activity will end on March 31 when Google is officially added to the S&P 500 Index. Expect the stock to weaken shortly thereafter.