The Internet, Oil and Y2K

In the coming weeks and months, one of the most reliable leading indicators for the U.S. stock market will not necessarily be a broad-market, capitalization-weighted index or momentum indicator. It will instead involve a commodity that seemingly has little bearing on stock prices. At the same time, this "indicator" will serve as one of the best indication of how severe the Y2K computing crisis may be. The commodity to which we refer? Crude oil.

Specifically, oil has a major bearing on the Internet, and by extension, the Internet stocks. Since the Internet stocks and Internet-related mutual funds are the driving force behind the U.S. equities market, anything that has an impact on the Internet will eventually affect the stock market itself.

So how exactly does oil fit into the picture? While it is true the Internet is a digital mechanism with no direct dependence upon oil as a fuel or commodity, it nevertheless is dependent upon oil indirectly. In fact, oil is a crucial variable to the successful and smooth functioning of Internet commerce. Without oil the Internet loses its value as a medium of commerce.

To illustrate our point, we quote the following excerpt from an article by Thomas Lipscomb in the Winter 1999 issue of American Outlook magazine:

"…By far the largest percentage of information technology sales on the Internet and through other consumer outlets remains in hardware and software products. Intel now reports a billion dollars a month of revenues from the web, comprising 65 percent of its sales. Current government estimates predict that Internet commerce in the United States will exceed $30 billion by the year 2002, but less than 10 percent of these sales are expected to involve pure digital information products. Ironically, the vast majority of what is being sold over the Internet requires physical warehousing and fossil fuel-powered vehicles for delivery."

As Lipscomb observes, "fossil fuel-powered vehicles" remain the backbone of Internet commerce, the linchpin that makes product delivery possible. This is true because most products purchased through the Web require physical delivery, with only a marginal amount of this commerce representing digital information products.

It follows logically then that oil remains a critical aspect of Web commerce. It follows further that in order to better be able to forecast trends in Web commerce and the Internet sector in general we must follow closely trends and developments in the oil sector, specifically, the price of crude oil.

Of concern to Internet investors, the crude oil market has recently experienced a reversal from its ongoing bear market with the price of crude oil leaping by several dollars over the past few weeks in response to a variety of factors (technical, fundamental and geo-political). This new-found strength in the crude oil market has already spilled over into the petrochemical and fuel markets. Of particular concern, the price of gasoline has risen between eight and 12 cents (depending on state) and is showing signs of further strenth. Some experts are predicting a significant rise in gasoline prices by summer. This factor, if realized, could hinder the Internet outlook to some degree since gas prices influence product prices and deliveries on Internet orders.

On the bright side, it is entirely possible that Internet stock prices will not react adversely to these bearish developments since Internet stock valuations are mostly speculative in nature and rarely reflect supply/demand fundamentals. Indeed, as we argued in a recent Internet Stock Outlook commentary, the Internets have replaced high-volume commodities as the trading mechanism of choice among day traders due to their tremendous momentum and enormous liquidity.

While crude oil prices may not have a direct bearing on Internet valuations, they still play an important role in the future prospects of the Internet itself. This becomes even more evident when viewed in light of the coming Y2K problem.

By now, most investors are familiar with the basic problems Y2K presents (or at least threatens). Y2K is the great unknown and we have no way of knowing with assurance what will transpire on that fateful hour when the clock strikes midnight on January 1, 2000—only eight short months away. Based on recent developments, however, Internet investors do indeed have cause for concern, even if Y2K is not the disaster many are predicting it to be.

A recent headline in Criminal Politics magazine presented the following frightful specter: "No Gasoline After 2000." The article stated:

"…Because of the potential for massive explosions, the local press [in Houston, Texas] has been forced to come clean about a grave crisis…which has not been discussed in any publication that we are aware of. That is, the potential for sabotage of petrochemical plants. These facilities are some of the most complex engineering facilities ever produced by man. They are exceeded only by the National Power Grid. Some of them are two football fields in size, including massive storage tanks for petroleum and the resulting products of gasoline, heating oil and other items.

"Because of the danger to the local population, the Houston Chronicle finally let loose with a horrible, shocking release of Sunday, February 14th—cover story—warning the population of grave risks after the 2000 period arrives: 'Officials Race Computer-Driven Clock to Avert Disaster at Local Plants.'

"The article describes the grave danger of explosions after the 2000 period and much life has already been lost in Texas and other states due to explosions over the decades. The article goes on to explain that Herculean efforts will have to be undertaken to provide reasonable safety for workers at the plants (who may not even want to show up)—and the surrounding neighborhoods. Each one of these plants could turn into a fireball the size of a mini-atomic bomb!

"To avoid this, the article explains that they are going to drain the tanks to make sure that this does not happen and that, therefore, storage facilities will not be able to provide the public with the assurance of either crude oil supply or the resulting product supplies. In other words, scarcity is guaranteed no matter what happens—simply because of safety preparations and precautions to protect the workers at the plants and the surrounding neighborhoods which may be endangered…

"…The Oil and Gas Journal, a leading trade periodical, last fall called the Y2K bug, including safety ramifications, 'a problem of unprecedented scope.'"

Notwithstanding the emotive tone of this article, it cannot be denied that the points made in it are of real concern. Since much of the nation's fuel comes from the Houston area, a shutdown of petrochemical plants would certainly have an adverse affect on Internet stock prices as well as the delivery mechanism for the Internet in general. To what degree these affects would be felt is still unclear. And since stock prices tend to anticipate and discount such events well in advance, we could reasonably expect a downturn in Internet stock prices sometime in the next few months. Monitoring for such a downturn is now one of our top priorities and we will warn you in advance as soon as our indicators detect these changes (if indeed they occur).

Yet another consideration is the recent heightening of tensions in the Middle East and surrounding areas. If full-scale war breaks out this year, another oil shock similar to the one the U.S. experienced in the 1970s is almost guaranteed.

An even larger concern, of course, is the Y2K "bug" itself. How much effect will it have on computers, and by extension, the Internet? Will Internet commerce be severely disrupted by Y2K-related problems? Time alone will provide us the answers to these questions. But an even better indicator, in our view, is the price of crude oil. From now until the end of the year we will monitor crude oil's price in order to detect possible roadblocks in the months ahead. Before such problems are anticipated by Internet stock prices they most certainly will register in oil and oil stock prices and will give us a reasonable "heads up" as to problems on the road ahead.