Stress testing the restructuring of energy prices –missing is the accelerator effect on qualitative data

We are all transfixed on the five month decline in oil prices (same duration as the past two oil price declines) and we are tempted to assume the same eventual effects as historical events. I follow the speculative and authoritative commentary – and they are all resetting the parameters of their models and philosophies.  It appears straightforward if you just rely on hard data.

However, those pesky variables known generally as ‘sentiment’ or ‘confidence’ or ‘animal spirits’ that have been lurking in the background on both economic and sometimes social decisions as an after effect of the financial crisis have been tweaked by the dramatic decline in the cost of oil.

Companies, whose hedged positions continue to mute the effect, and now resetting their budgets with significantly lower cost frontiers, and so the hurdle rates on investments decline (remember all the cash in corporate balance sheets). Families, after a couple of months, probably spend the 46% of their savings that history dictates, but they also change their attitudes about future spending and investment.  Institutions, and I think of school systems that spend inordinate amounts on fuel for buses, get some budgetary relief. Energy producers remind themselves that their models had best be robust on the low end as well.  But it is the countries where both the positive and negative impacts will accelerate beyond the hard data to the sentiments of both the public officials and the populous.

In my view ‘sentiment’ has an accelerator effect that probably brings greater impact in this price cycle than historically because of structural changes which the experts cite anecdotally, but have not yet incorporated in their thinking. The positives will be stronger and longer in effect, and the negatives will be more dramatic than prior cycles simply due to pent up attitudes and animal spirits. That is why it is called qualitative, and it has a greater role than ever.

Is this a challenge to stress testing? Quite probably. Hopefully we have built in enough robost recognition of the qualitative effects to survive extreme price data.