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Schork Oil Outlook: Have Producers Lost Incentive?

According to the Bureau of Economic Statistics, the latest Producer Price Index (PPI) came in above analyst expectations of a 0.1% increase with a 0.4% increase, while the Consumer Price Index (CPI) came in below expectations of a 0.1% increase with a 0.0% MoM change.

While we discussed the minutiae in Monday’s edition of The Schork Report, the CPI/PPI ratio has implications for the economy on a much larger level. The CPI/PPI ratio can be considered the producers’ “incentive to produce”; an increase implies that producers were able to pass on higher costs to consumers.

This was the case for Q2 2010, as the ratio rose for four consecutive months between April and July. However, the last two reports have reported drops, as illustrated in today’s Schork Report newsletter.

There are two likely consequences of this drop: (1) Manufacturing will decrease or (2) The price paid by consumers will increase. We already expect the latter as discussed in the latest CPI data, but what about the former? Industrial production for manufacturing fell by 0.1% but this may soon rebound.

Consider the relationship between manufacturing IP and the USD/EUR exchange rate. As the rate drops, American exports become cheaper for global clients, thus the correlation co-efficient between the two time series stands at a firm -0.257.

The bottom line is that, with consumer price increases pending and the dollar (even after yesterday’s rally) trading near 2010 lows, we are not heavily concerned about weakness in domestic production.

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Stephen Schork is the Editor of The Schork Reportand has more than 17 years experience in physical commodity and derivatives trading, risk systems modeling and structured commodity finance.

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