Will Oil Recover?

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Unless you’ve been living under a rock for the last ten years, you vividly remember when filling your car with gas was a painful event. What has happened over the past several months is an amazing turn around that many of us never expected would happen.

SUV owners had to take out a second mortgage on their homes just to keep their vehicle on the road and vehicle downsizing became a national obsession. So to what do we owe this extraordinary reversal in the price of gas at the pump and oil by the barrel and will we ever see $100 per barrel prices again?

U.S. Finally Controls its Own Energy Destiny

For as long as anyone can remember, U.S. Presidents have been talking about how their administration would reduce our dependency on foreign oil. Here are a few data points from a an article that provides some historical perspective:

  • America’s dependency on foreign oil rose from 26 percent to 46 percent between 1985 and 1989
  • By 2012, American energy independence has decreased by 22% since Truman was President
  • America’s oil imports fell to 36 per cent in 2013, down from a high of 60 percent in 2006

While this all seems great for consumers, it may have a profound impact on the world economy going forward.

Is There a Downside to Low Oil Prices?

According to an article in oil-net by Tom Therramus and Steve Austin, the far reaching impact of reduced oil prices could cause a stock market crash unlike the world has ever seen.  They report that every stock market crash and recession over the past fifty years was directly linked to dramatic changes in oil prices.

“Nearly every stock market crash and recession of the preceding 50 years . . . occurred after a large and abrupt change in the price of oil.”

During the mid-1980s Saudi Arabia grew increasingly frustrated with cheating on agreed oil production quotas by other members of OPEC. In 1986 the Saudis gave up honoring their own quota commitments to the cartel and the price of oil plummeted.

With this perspective, it is very important to understand if and when oil prices may return to their 2014 levels.  Let’s look at some of the global realities that have a direct impact on if and when oil prices may recover.

Chinese Energy Usage Slows

At the same time that the U.S. reduced its reliance on foreign oil, the Chinese Government announced plans to reduce its explosive growth in energy consumption. From 2006 – 2013, China’s energy usage surged 45 per cent. They announced in November of 2014 plans to reduce their energy consumption to 28 per cent for the seven-year period to 2020.

Bloomberg News says:

“Reflecting its rapid industrialization and economic growth, China has become a voracious consumer of energy, changing global energy markets and the geopolitics of energy security.”

Two Large Consumers of Worldwide Oil Slow Demand

With these two huge industrial nations curtailing their demand for oil on the open market, it does not take a geo-physicist to put 2 and 2 together and come up with more than 4!

The following factors all point to a classic case of how supply and demand impact commodity prices:

  • Reduced international demand
  • Energy reduction strategies all over the world
  • Innovative exploration and drilling techniques
  • The discovery of huge new deposits of oil

Supply Up and Demand Down

Economics 101 says that when demand decreases and supply increases, prices go down. 

There is a strong likelihood this current oil supply and demand phenomenon may continue. Sure, there will be blips on the radar screen where the price per barrel goes up because of some terrorist event or other temporary disruption in supply but until the economic engine that fueled the explosive growth of the past fifty years, it is highly unlikely we will see $100 per barrel oil prices again any time soon.

Economic growth is fueled by oil and while the REAL world economy continues to falter, oil will stay at its current level for the foreseeable future.  

It’s the economy, stupid, as President Clinton famously stated during his successful presidential campaign in 1992.

The Law of Unintended Consequences

Nearly everyone is familiar with Murphy’s Law of “Whatever Can Go Wrong, Will Go Wrong,” but not as many are familiar with the Adam Smith maxim that “each individual, seeking only his own gain, “is led by an invisible hand to promote an end which was no part of his intention,” that end being the public interest.” Or as my Dad used to paraphrase an old nursery rhyme, “what’s good for the goose, <may not be> good for the gander.”

Lower gas prices and reduced dependence on foreign oil all sounds great on paper, but when you consider the oil-net article and some of the other unforeseen events resulting from the reduced price per barrel, we may not want to start dancing in the aisles or at the gas pumps quite yet.

Here are just a few of the possible unforeseen results from reduced oil prices:

  • The sharp oil price fall from $100 last summer to below $80 in just three months will bankrupt small US oil producers who need at least $80 per barrel to be profitable.
  • The Oil Industry employs nearly 10 million people.  What impact will reduced production have on national unemployment?
  • Fracking is a huge burgeoning industry in the U.S. What happens if all of that suddenly reverses?

Summary - Don’t Bet on an Increase in Oil Prices Any Time Soon

So in the end, while lower gas prices may seem like an answer to prayer, it could lead us into a recession that makes the last one look like child’s play. Stay tuned and watch that price of oil. You may actually want it to go back up, but wishing and hoping does not mean it will happen.

As one of my early mentors pointed out, “put spit in one and hope in the other, and see which hand fills up first.”

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