3 Things 10-17

Thing One It’s The Regulations, Stupid The California Energy Commission wrote a letter to five of its oil refiners — Chevron, Marathon Petroleum, PBF Energy, Phillips 66 and Valero — demanding an explanation for why gas prices jumped 84 cents over a 10-day period even as oil prices fell. In the letter, they told the refiners that they had “not provided an adequate and transparent explanation for this price spike, which is causing real economic hardship to millions of Californians.” Just prior to that letter, the governor of California explained to a gathered crowd that, “Greed and manipulation” were the cause. An executive at Valero, Scott Folwarkow, then responded to the letter and explained to the Commission and anybody else who cared to read it, the real reason the price of gas in California is so high. The whole letter is worth reading, but here are some great explanatory excerpts: “As the Commission knows, and as countless investigations have demonstrated, market drivers of supply and demand, together with government-imposed costs and specifications, determine market price. Ironically, on the same day we received the Commission’s letter, a federal judge in a 103-page reasoned order, following review of thousands of pages of documents and hours of depositions and discovery, yet again threw out another case alleging price conspiracies by the fuel industry finding no basis for the allegations... As to separation between California prices and the prices in the rest of the United States, we can offer the following information. For Valero, California is the most expensive operating environment in the country and a very hostile regulatory environment for refining. California policy makers have knowingly adopted policies with the expressed intent of eliminating the refinery sector. California requires refiners to pay very high carbon cap and trade fees and burdened gasoline with cost of the low carbon fuel standards. With the backdrop of these policies, not surprisingly, California has seen refineries completely close or shut down major units. When you shut down refinery operations, you limit the resilience of the supply chain. From the perspective of a refiner and fuel supplier, California is the most challenging market to serve in the United States for several additional reasons. California regulators have mandated a unique blend of gasoline that is not readily available outside of the West Coast. California is largely isolated from fuel markets of the central and eastern United States. California has imposed some the most aggressive, and thus expensive and limiting, environmental regulatory requirements in the world. California polices have made it difficult to increase refining capacity and have prevented supply projects to lower operating costs of refineries. We believe the Commission experts understand that California cannot mandate a unique fuel that is not readily unavailable [sic] outside of the West Coast and then burden or eliminate California refining capacity and expect to have robust fuel supplies. Adding further costs, in the form of new taxes or regulatory constraints, will only further strain the fuel market and adversely impact refiners and ultimately those costs will pass to California consumers…” In other words, California’s regulatory environment is the main cause of its high gas prices. It seems the laws of supply and demand work despite politicians’ and regulators best (or maybe worst) efforts to circumvent them. And it also seems we keep having to learn that lesson.

Thing Two Earnings And Stock Prices: A Brief, Historic Perspective It’s a truism in investing that stock prices tend to follow earnings over the long run and it’s also true that expectations around earnings in the near term can have a significant influence on a stock’s current price. With that bit of information and the currently popular notion that corporate earnings estimates are too high and will be coming down, Josh Brown, CEO of Ritholz Wealth Management explained something to his clients after the following question was asked by one of them: Q: If you know earnings are coming down, why would you want to be invested in anything? A: We ran the numbers on S&P corporate earnings from 1930 - 2021 and found that year over year earnings were positive in 61 of those years and negative in 30 of those years. So, about one third of the time, corporate earnings were down year over year. We found that if over that 91-year span you only invested in the 61 years where YOY corporate earnings were up, your annualized return would have been 10.2%. If, on the other and you stayed invested through the whole period, your return would have been virtually the same at 9.8%. So the path of earnings doesn’t necessarily tell you what stocks are going to do in any given year. This is yet another argument for going long and understanding that risk and volatility are not the same thing.

Thing Three Just A Thought "What anyone might prefer to believe at a given place or time has nothing to do with what the hard facts are." - Thomas Sowell