The impact of lower oil prices
You may have noticed that you are paying a lot less at the gas pump then you were even a month ago. To put things in perspective, in the summer of 2008, West Texas Intermediate oil, a benchmark of oil pricing, traded at $140 a barrel. Today, WTI oil sells for less than $76 a barrel, a drop of 45 percent from that all-time high price six years ago. Oil is down 25 percent since July, so what exactly caused this decline and what do these lower prices mean for the U.S economy and the rest of the world?
The explanation lies in simple supply and demand. The U.S. has increased its production of oil dramatically in recent years. Experts predict the U.S will produce 9.5 million barrels a day by next year – positioning the nation to soon become the largest oil producer in the world. Currently Russia produces the most oil at 10.73 million barrels, followed by Saudi Arabia at 9.57 million barrels.
Why is this so important? For one, it means gas at the pump will cost consumers significantly less. In some areas of the U.S. gas is now selling for less than $3 dollars a gallon. This lower gas price translates into more money for consumers to spend during the holiday season. For example, a driver who logs 10,000 miles a year could save more than $400 in gas costs over last year. Since consumer spending makes up 68 percent of GDP, this should fuel more jobs and a stronger U.S. economy going forward.
However, not everyone is happy about falling oil prices. Oil exporting countries such as Russia, Saudi Arabia and Iran have based their economic budgets on higher oil prices. With the price of oil falling rapidly, these same countries will now have to ramp up production to get the same amount of income, which in turn, will only drive down the price of oil even further.
Falling oil prices have also impacted oil and gas stocks, but for the most part this is reflected in those stock prices today. The largest integrated oil companies continue to pay meaningful dividends and are poised to increase their dividends next year.
When it comes to investing in energy related companies, lower oil and gas prices may pose a challenge to newer entrants that aren’t as experienced in dealing with volatile prices. That’s why we generally prefer to invest in companies that have a longer and more successful history of handling the ups and downs of oil and gas prices.
In the short run, it appears that oil prices could fall even further in the months ahead because of the slowing global economy and a stronger U.S dollar. Europe is on the verge of another recession and China’s economy continues to decline. Since oil gets priced in U.S dollars and the price of oil is impacted every time the U. S currency moves up or down, today a stronger dollar exacerbates the weakness in oil prices. It’s believed that when oil falls below $50 a barrel, it becomes uneconomical for producers to extract oil. When this price point is reached, it may cause a reduction in the supply of oil on the market. That action naturally puts a floor under prices; eventually leading prices to rise when demand returns.
Consumers should enjoy cheaper gas at the pump during the holiday season, but one should avoid getting too complacent. As we all know, prices can go up just as fast as they come down, particularly with such an uncertain geo-political situation in the Middle East and Ukraine.
Going forward, the increase in domestic oil production provides huge upside. Less dependence on foreign oil will help the U.S. continue to grow its own economy, with energy-related jobs and much cheaper manufacturing costs. America may also have more leverage around the globe militarily if we don’t have to appease our enemies to satisfy energy-related demands – wouldn’t that be for nice a change?