Oil Economics Explained in 12 Minutes

So something insane like once in a decade insane happened recently, and that is oil spike from $80 or so a barrel up to $120 and then back down to sub $80 in the span of a few days. And there was a lot of noise and conversations going on about that. And I think it underpins something really fascinating, which is that the world, for better or worse, runs on oil. And there's this whole sequence and cascade of run-on effects that impact you and you personally, your job, your career, et cetera, when oil goes up or down. That is a very material thing. It impacts people immediately, and it impacts you over the long term in very subtle ways. And that's what I want us to think about in the next few minutes. And what I want to do in this video is sit down and just talk through the sequence of effects or the impact when oil goes up or goes down really fast and a lot in price. I think this is really important to understanding the global economy and a lot of macroeconomic shifts as a whole. It also helps you both keep your head, number one, when oil prices go up or go down a lot, and number two, knowing what decisions are shipped to make, whether in your investment approach or in your day-to-day personal finances. So that is going to be this video. Hope you all are doing well wherever you are watching in the world, and let's get into it. Now, guys, this whole video is about how certain commodities shape your financial world and how So I want to quickly share a critical minerals story that I think is really compelling right now. And it ties directly into what's happening with national security, critical minerals, supply chains, and the battery economy. And that starts with this fact. Graphite is the single largest component by weight in every lithium-ion battery. Your phone, your laptop, every EV on the road all need large amounts of graphite. And right now, just about all of that processed material comes from one place, and that's China, meaning that we're talking about a near total monopoly on a resource that's critical to everything from batteries to the energy transition, defense, and advanced manufacturing. And that is the background for the company that I want to highlight, Nova Monde Graphite, ticker NMG on the NYSC and NOU on the TSX. And NMG is aiming to be North America's first ever fully integrated carbon-neutral producer of natural graphite anode material. And these guys control the entire value chain, from a high-grade open-pit graphite deposit located north of Montreal, all the way to a battery material refining plant in Quebec. And their whole operation runs on the hydropower of Quebec, so their carbon-neutral angle directly aligns with the U.S. Inflation Reduction Act's incentives for domestic low-carbon battery material sourcing. Also, the government of Canada signed a binding seven-year offtake term sheet with NMG for 30,000 tons per year of graphite concentrate. And Canada will also participate in a 50-50 profit share above the fixed price. So the government is an actual partner in the economics of the mine. And that is about as strong as a government endorsement as you can get. And the commercial side is just as strong. NMG has a revised binding offtake with Panasonic Energy for 13,000 tons per year of active anode material, and a separate binding agreement for 20,000 tons per year covering refractory markets in North America and Europe. And they're in active negotiations with another anode manufacturer for an additional 30,000 tons. And combined, these deals could cover 100% of the mine's future production. They also just acquired a brownfield industrial site right next to one of their existing properties. And they're expanding their graphite into fuel cell bipolar plates, EMI shielding for telecom and defense, and stealth materials. To sum this up, you have a near-monopoly supply chain problem that Western governments are scrambling to solve, a company with a fully integrated mine-to-battery supply chain in a top jurisdiction, you have binding government agreements at the G7 level, carbon-neutral operations directly aligned with the IRA, and commercial agreements that could cover 100% of future output. Pretty cool. Now the tickers again are NMG on the NYSE and NOU on the TSX. And NMG's corporate websites and presentations are here and in the description. Always, of course, do your own research and see if NMG is a fit for your investment thesis. And that in mind, let's get back to the video. So the most obvious impact that we all think of whenever oil prices go up is, oh, I'm going to have to pay more money for gasoline. And that's going to cost me an extra 30 bucks a week. That's not great. And vice versa, if the price of oil goes down, great, I pay a little less every time I fill up for gas. But oil as a force goes way beyond this. It is the baseline currency of human civilization. And something like an oil or natural gas shortage in the Middle East does materially affect things like your job and stocks. Across the board, it's a lot more than that. But yes, it starts with, okay, price of oil goes up. People, maybe like you, are going to pay more when you fill up for gas. But even the direct consequences, like, okay, oil price goes up, gasoline price goes up, doesn't capture the first-order response. And that's because oil doesn't only produce gasoline. About 45% of each barrel of crude oil is refined into gasoline that you can pump into a car. But that other 55% builds the world and infrastructure as we know it. For example, the plastic in your laptop is probably made from some combination of petrochemicals. The asphalt of streets are created from a byproduct of petroleum called vitamin, right? And the fertilizer that grew the food that is sitting in your fridge relies on nitrogen fertilizers synthesized using natural gas and oil derivatives. And even for things that don't directly use those byproducts, they probably arrive, for example, in the U.S., if you live in the U.S., on a cargo ship that burns thousands of gallons of heavy bunker fuel every single day. And so just the direct consequences of oil prices goes up, results in what I think is a super fascinating statistic, which is that for every $10 increase in the price of a barrel of oil, global GDP growth gets reduced by 0.1 to 0.2%. I'll say that again, for every $10 increase in the price of a barrel of oil, you shave one-tenth to two-tenths of a percent off the GDP growth of the entire world. So if oil goes from $80 to $120 a barrel, that is upward of half a percent, if not a lot more than that, of GDP growth reduced. So even just the first-order effect of the price of oil increasing affects the entire economy. And that applies on the personnel or the individual side, but also on the company side. If you go from $80 to $120, every single company in the S&P 500 suddenly has their margins compressed, right? Amazon's logistical and network costs start to explode. Delta Airlines would probably have their entirely quarterly profit eliminated if barrels increased by $20, much less $40. And take something like Walmart, that's pretty stable, right? Imagine how many trucks they're paying every single day, and how much an extra $50, $100, $500 a day, whatever the number is, per truck adds up to be. And so this is where we start to get to the second-order effect. So okay, the price increases, therefore the price of all these other things increase, therefore corporations and individuals pay more for that entire set of things, not just gasoline. But what do the corporations do? These are businesses. They are commercial entities. They have a responsibility to their shareholders. They pass those costs on to you. And so here's where we get to the second-order magic word when it comes to oil, which is inflation. So there's a thing called core inflation, which is basically the Fed's measure for inflation minus food and energy. And so inflation in the cost of energy, or basically the price of energy increasing, doesn't just stick to that category. It starts to bleed into core inflation itself. And I'll give you a material example there. Let's say you hire a plumber who comes out of town to fix something in your home, and he needs to pay an extra $12 in fuel costs, and he's charging $100 for the service. He's not just going to sit there and eat a 12% decrease in his business, because he probably only makes 20-30% margins there. He's going to raise his price to $110, and you suddenly are paying 10% more for the same service because indirectly of the price of oil. And that applies to Delta Airlines. That applies to Walmart. That applies to Amazon. That applies to every business out there. Some portion of those costs will get passed on to you indirectly. And so we now get services inflation. We get product inflation. Basically the price of things increase. That is the second order effect. And what happens when prices start to go up or inflation starts to be a concern? Well, normally what the federal bank does, or the government, is they raise interest rates. This is our third order effect. And that's because, and we've covered this in other videos, if you raise interest rates, it becomes more expensive to do things commercially. So people do less things commercially. If you do less things commercially, growth decreases. So price decreases. And if the price of goods and services decrease, then inflation goes down. And so by raising interest rates, you can try to decrease inflation. Now, there's a little bit of a counterpoint there, which is that if people just can't afford these new prices, if you destroy demand so effectively and you get deflation, then the feds would actually want to increase interest rates to increase economic growth and consumption. But the more standard story there is you get inflation, you get increased interest rates. So we'll stick with that for now. But keep in mind, there is a little caveat there. So now we're on to fourth order effects, which are the effects of interest rates getting raised. And when that happens, number one, mortgage prices increase. For example, right now you're in the six plus percent range for mortgages that used to be three percent. That more than doubles your monthly cost. And so now buyers get locked out of buying new homes because they can't afford the monthly payments. And then sellers refuse to sell because they don't want to give up their pre-inflation mortgages. And so then you freeze the entire housing market. That's number one on the real estate side. Now, on the public equity side or basically just corporations or companies, the higher interest rates are, the more you can earn by buying those interest rates instead of investing in the companies. And so that ties into the cash flows of the businesses. And companies are based on discounted future cash flows or how much money they're going to make over some future period of time adjusted for how much you value having money now versus later. Now, if the discount rate increases, your discounted cash flows become less valuable. And that should, in at least in theory, drive the aggregate prices or the valuations of equities down, basically meaning your real estate gets hit and your stocks get hit. And so this is where we can circle back around to the caveat. If your stocks get hit, your real estates get hit, your growth starts to slow, you can't afford anything. Then we get back to that point of the opposite of the thing happens that the Fed raised interest rates to try to prevent, which is stagflation, where you have high prices, but the economy itself or growth is very low. And this causes, guess what, a recession. So that overall is a demonstration of the ways in which everything, economically speaking, is tied to oil prices. And I don't see this as an exercise in theory only. This is a pretty common set of things that can happen and do get priced into global markets, whether equities, whether oil futures, whether policy decisions based on these set of things that happened around oil, like we just saw earlier this week. Now as a few prescriptive ideas there, if you understand the cause and effect there, if you generally understand the cycle a little bit, I think you're going to be better off. You're going to know why things are happening. You're going to know in advance, okay, these prices might go up, the Fed might do this, and that can help you make decisions now about spending and about investment. Number two, if you want to hedge, you can always just own things that will go up when the price of oil goes up. So you can work on hedging out the risk induced by, for example, a supply shock to global oil. And that in mind, never get too panicky about this stuff. The world is not going to end tomorrow. If that was not demonstrated by anything else than oil increasing by 30, 40% in a 36-hour period and then going right back down, then I don't know what's better. Just hang in there. Keep your stuff. Do not panic and just try to think through the effects, the things that will happen in the future and how that should and can affect your decision making now. That in mind, I hope you found this video a little bit useful in understanding oil and the big macroeconomic markets out there. I appreciate you being here and I will see you in the next one. Cheers.