Playing the Oil Game
Dramatic swings in prices have enormous economic consequences.
First Vice President
On April 18, 1977 a solemn Jimmy Carter sat in front of the American people and told them we are “running out of oil”. Earlier that year he wore his buttoned down cardigan in front of a roaring fire and said “we must face the fact that the energy shortage is permanent”. These were grim times. By April 1980, oil reached a new high of $115 a barrel on an inflation adjusted basis. However, by the end of that year we had an ‘Oil Glut’ and prices fell steadily until 1986. In more recent history, there was the rhetoric in the summer of 2008 as gas was over $4.50 a gallon at the pump. Some analysts at the time predicted a barrel of oil would reach $200 in the next six months, only to see it drop to $46 by the end of the year.
These dramatic swings in prices have enormous economic consequences. Like all commodities, oil prices are driven by supply and demand, though speculation can also temporarily affect price. The near-historically low price of oil today is due to the fact that supply outweighs demand. As is almost always the case, there are winners and losers in this.
On the plus side, lower energy prices mean real savings for the average consumer, from filling their cars to heating their homes. Globally, the biggest winners of cheaper oil are net importers of energy, the largest of which are the United States (7.39 million barrels per day), Japan (4.66), China (4.50), South Korea (2.24), and India (2.20).1
On the other hand, the adverse effects on companies and countries that derive significant amounts of income from selling oil are obvious. When wells become unprofitable they are closed and jobs are lost. Areas that boomed from the rewards of oil production begin to suffer layoffs and local housing and services industries grind to a halt. There are significant geopolitical consequences as well. Countries that derive a significant portion of revenue from oil exports are dealt a heavy blow. The most dependent countries include Kuwait (57.5% of GDP), Libya (44.2%), Saudi Arabia (43.6%), Iraq (42.9%), Angola (34.6%), Oman (34.5%) and Azerbaijan (33.9%).2 Each of these countries need oil revenue to maintain political stability, fund social programs, and shore up their currencies.
Observers have wondered why OPEC would not chose to cut production in an effort to reduce supply, thus stabilizing prices. For Saudi Arabia, given its low cost of production as shown in the graph, this option is not as attractive as continuing to supply an already flooded energy market, forcing prices down and possibly pushing some competitors with higher production costs out of the market. The United States, however, is not nearly as reliant on oil revenue and through technological advances, has consistently lowered their cost of extraction. The winners of this energy game have yet to be determined.
For investors, there are many ways to take advantage of the effects of lower oil prices. Call your Wintrust Wealth Management Financial Advisor to discuss options and determine which might be best for you.
1. U.S. Energy Information Administration, June 18, 2015
2. The World Bank
3. Company reports, Energy Aspects
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