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Oil Goes On A Slide

November 2014
All over the country, Americans are getting relief at the pump. Gas prices dropped an average of about $0.50 per gallon from June through October, and market trends are expected to keep the price down for a few months more.

So, what’s going on? Did we suddenly find a lot more oil? Are fossil fuels reversing their decades-long march upward? In this case, the shift in oil has to do more with business strategy than availability or politics. Here are the major factors responsible for the relaxed prices:

Competition

The boom in shale oil fracking has turned the United States into a major producer in the world oil markets. Since the United States uses more oil than anyone (almost double that of the next highest consumer, China, in 2012), a change in its importing and production is likely going to have a big impact on market value.

However, while the United States is moving toward energy independence, its fracking boom has been sustained only by high oil prices. Fracking costs around 10 times more than the traditional oil pumping done in some OPEC countries. Fracking needs expensive oil to be profitable and practical.

To smother the success of fracking, Saudi Arabia and Kuwait have increased their production to drive down oil prices. At the moment, they are more interested in discouraging fracking operations than they are in getting the highest price. With their strong cash reserves, they have few qualms about a temporary drop in profitability to prevent countries from developing their own oil reserves.

Demand

The other major factor is OPEC’s desire to protect and grow the global demand for oil. When oil prices are high or the economy is bad, most countries cut back on consumption and look for alternate fuel sources.

Economic news from the past few months has been far from stellar. Many Eurozone countries are facing renewed recession, and growth in developing economies like China and Brazil has been slowing. Lowering oil prices can help support economic growth in these countries and, in time, create greater demand for oil when things improve.

As for the United States, demand for gasoline has been somewhat slowing despite the growing economy. The total number of miles driven in the country has been flat or down since the Great Recession, while vehicle fuel efficiency is greater than ever. This trend is expected to continue to increase as older cars continue to drop out of the market and more people move to metro areas. A drop in gas prices reduces the pressure for these improvements and encourages driving, helping to keep demand for oil high.

Collateral Damage

The goal of the major OPEC players is clearly to drive out smaller competition and secure a larger future market. However, the damage of cheap oil goes beyond the falling margins of shale oil companies.

In particular, countries that have limited, but essential, oil exports are taking a beating from the low prices (e.g. Russia, Iran and Venezuela). These countries, some of which are OPEC members, have limited markets to service—they need reasonable profits from what they manage to sell and have little chance of getting a larger market share from this whole ordeal.

To a lesser extent, green technology may also be hurt by this recent shift. Any time fossil fuels get cheap, interest in renewable energy dips. However, it will likely require several quarters of low fuel prices to really damage long-term interest in the green energy sector.

Right now, American drivers are the ones getting the most from the oil price war. However, if we lose our domestic oil production and increase our gas dependency, this current relief will have a negative long-term effect on the country.

It’s difficult to estimate how long OPEC will allow prices to decline or when crude prices will climb again. Despite all the known factors, oil prices are a notoriously difficult commodity to anticipate. Even the best theories cannot account for surprise factors like international conflict, terrorism or technological developments. The safest way to profit from the current oil market is to just enjoy the extra savings the next time you fill up.

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Remember that past performance may not indicate future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, strategy, or product referenced directly or indirectly in this newsletter will be profitable, equal any corresponding historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. You should not assume that any information contained in this newsletter serves as the receipt of personalized investment advice. If a reader has questions regarding the applicability of any specific issue discussed to their individual situation, they are encouraged to consult with a professional adviser. 

This article was written by Advicent Solutions, an entity unrelated to Guidestream Financial, Inc.. The information contained in this article is not intended to be tax, investment, or legal advice, and it may not be relied on for the purpose of avoiding any tax penalties. Guidestream Financial, Inc. does not provide tax or legal advice. You are encouraged to consult with your tax advisor or attorney regarding specific tax issues. © 2014 Advicent Solutions. All rights reserved.

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