Some Thoughts on Oil

“Come and listen to story ‘bout a man named Jed

Poor mountaineer barely kept his family fed

Then one day he was shooting for some food,

And up through the ground come a bubbling crude.

(Oil that is, black gold, Texas Tea)”

The Ballad of Jed Clampett

The Beverly Hillbillies.  The 1960’s sitcom that became an iconic part of American Pop Culture.  Though I was not old enough (or should I say alive) to watch it when it first came out, I watched the reruns on Nick at Nite along with the other TV classics such as I Dream of Genie, Bewitched, and Green Acres.  I would be lying if I said I didn’t ever think about coming across oil in my backyard in southeastern Virginia.  I was 8 at the time, so the geographic improbability of that happening did not cross my mind.  So here I am, jumping on the bandwagon, or should I say the 1921 Olds Roadster Jalopy, and writing about oil.

Oil has fallen from about $100 per barrel at the end of 2013 to the lowest price we’ve seen since 2009, $55.80.  What’s driving this drop?  Econ 101 at work here.  Supply is greater than demand.  Simplistic, yes.  But in general that’s about it. However, that begets the next question…why is the supply so much greater than the demand?  Part of the issue is that OPEC members are committed to producing a certain number of barrels of oil per day.  At their current rate of production, they are producing 600,000 barrels of excess oil per day (Huffington Post, “The Consequeces of Falling Oil Prices,” Dec 9, 2014).  At the end of November, OPEC members failed to come to an agreement to curb production, which was one catalyst to the precipitous drop we have experienced.  Now that the US is largest oil producer in the world, we are not importing as much oil as we used to.  This is one reason the demand from OPEC members has dropped causing the buildup of supply.   You could buy into the conspiracy theories about how this is being done intentionally by the Saudis in an effort to shut down US shale production since it is a threat to their economy.  Or turn around and say that the US and Saudis are working together to crush Russia and Iran.  Economic warfare at its finest.  This could be the invisible hand manipulating the market, but it’s really not worth losing sleep on.  However, if you have the creative mind to do so, this would make a fantastic political thriller a la the style of Vince Flynn.

From a US consumer standpoint, falling oil prices are a good thing.  It means it frees up cash flow for consumers to divert their dollars elsewhere and many analysts are predicting those saved dollars will be put to use in the retail sector.  It is also being said that if the oil prices continue to stay low, the consumer will continue to rebound into 2015 and we could see the fastest rate of economic growth in a decade (Financial Times, December 11, 2014).  The US GDP is 70% consumer driven, so as the consumer spends, manufacturing and retail picks up, unemployment (typically) goes down, oil demand goes up, oil prices go up, and so on.  It’s the cyclical nature of the beast.  These low prices won’t last forever, so we may as well enjoy it while we can.

The impact of low oil prices to oil companies will more than likely create a drop in earnings and short term volatility.  The smaller oil producers in the US will be hit the hardest because they are likely more leveraged and have a higher “break even” point on a barrel of oil.  This is not to say that the energy renaissance in the US is over, I just think it means it will slow down for the time being.  I also believe that certain regions in the US will be hit harder than others during this slow down; areas such as Houston or the Bakken region in North Dakota.  The drop in oil prices can affect, jobs, real estate, service companies, and so forth for these particular areas that have seen a boom in their local economies due to the shale oil production.  There’s no way to predict the ultimate impact of these low prices, but it is something to consider should prices stay low for an extended period of time.

At the end of the day, I do not think low oil prices are indicating a global recession.  The economic numbers in the US have been relatively strong over the past year and the forecasts are indicating similar patterns to come.  I think that the oil markets have overreacted to the recent developments and that it will eventually recover to a reasonable level.   In the meantime, the quandary with oil will create some volatility in the stock market and the bond market until things settle down.  Until the price stabilizes, I will enjoy being able to fill up my tank for $45.

One last fun fact to wrap up…when the Beverly Hillbillies aired in 1962, the price of a gallon of gas was $.31.  And to think, the oil he found made him a millionaire!

Until next time,

Carolyn Menker

LPL Wealth Advisor

Williamsburg Financial Group

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