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Economics 101 on Squawk Box

It’s never too early in the day for a lesson in how markets work.

screenshotExxonMobil CEO Rex Tillerson appeared early yesterday morning on CNBC’s Squawk Box and treated his hosts to a course in economics.

Not surprisingly, the first question he fielded asked about the price of oil, which has fallen roughly 35 percent since the middle of the year.

There’s been much commentary in recent weeks about the economic impact of declining oil prices, some of it very confused.

But Rex made clear there is no mystery to what is happening: It’s the fundamental economics of supply and demand. The global market is correcting for additional new supplies having come on line over the past year – much of this from America’s shale and tight oil regions – compared to less robust demand growth around the world.

Here’s the explanation Rex gave during the interview, which you can watch on the CNBC website:

You take a 1.6 million-barrel-a-day supply growth and you put it on top of a 1 million-barrel-a-day demand growth and you’ve got a surplus of capacity at a time when OPEC members are by and large holding their production flat. So you fill storage up, you fill inventories up, and at some point it’s got to show up in the price.

This is hardly the first time the market has undergone a commodity price correction, he noted.

That’s what freely functioning markets do – they communicate the needs of consumers and the availability of supply. In the process, prices fluctuate, signaling new market realities or creating incentives to produce more. This relationship between supply and demand was outlined centuries ago by thinkers such as John Locke and Adam Smith.

Rex also noted that our company’s investment decisions are made against timeframes of a decade of more. That means week-to-week, up-and-down fluctuations in the commodity or business cycles don’t factor into our major planning decisions. He explained that our investments take into account a wide range of possible economic scenarios, as well as factors such as the fiscal regimes in nations where we work.

As with the fundamentals of economics, there are also business fundamentals to keep in mind.

Rex emphasized that lower prices serve as a reminder to ExxonMobil and other energy companies to focus on the fundamentals of running a business. That means remaining disciplined with shareholder investments, creating new margins, and seeking new efficiencies and opportunities.

It’s a lot of work, of course. But as the energy sector has shown for more than 100 years, we are up to the task. With free markets and free trade, our productivity will mean that even more consumers and nations will benefit from the economic growth and technological advancement that flows from affordable, reliable energy.

 


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