The Price of Oil
Oil prices have dropped precipitously in the last few months. Today, January 12, 2015, oil dropped to below $46 at the close of business. You know what it means to your wallet, but how does this affect the markets?
It is very difficult to tell what has caused this tremendous drop in the price of oil. By any measure, consumption has not been reduced. There is more supply in the economy, as the US, Canada, Mexico, and many other countries have been drilling oil wells over the past few years. However, the supply/demand equation is not changed that much, as countries like India and China have increased their demand for oil. Africa and South America are also developing and consuming more petroleum based products.
As a result, I think this decline in oil prices is temporary. Consumers should enjoy the low prices, but not permanently budget for less expenditure in gas. The only way to really consume less gas is to drive less or drive an alternative fuel vehicle. At this time, sales of these vehicles is still negligible worldwide.
In the short term, lower fuel prices will lead to greater consumption and consumer discretionary stocks should do well. However, this sector has already enjoyed a significant upswing and their increased sales, revenue, and earnings may not be result in significant increases in the stock price as these earnings are already reflected in the stock price.
The IMF assesses that a 10% decline in oil prices leads to a 0.2% increase in global GDP. According to the Economist magazine, every dollar drop in oil prices saves China an annual $2.1 billion. In other words, they are saving 60-70 billion dollars in 2015 versus 2014, if prices stay around 50 a barrel. For the United States, the benefit of low oil prices is huge, but it is a mixed bag. The US is simultaneously the world’s largest consumer, importer, and producer of oil ! US producers are most likely to pull back on production with a significant decrease in prices. Low oil prices will most likely lead to some consolidation in the US energy sector. Again, since we consume more than we produce, the US economy benefits overall. *
Another beneficiary would be those emerging markets that are not petroleum exporters. Countries like India, Vietnam, Indonesia, Malaysia, Kenya, and Peru benefit from lower oil for their exports such as food and manufactured goods.
Monetary policy may be affected by low oil. The Federal Reserve is doing its best to cause inflation. Food prices are high, but energy prices have gone down, so this would affect their numbers. This may lead the Federal Reserve to keep interest rates low for longer than anticipated. The current consensus is that the Fed will raise rates by June of 2015.
Perhaps the best thing to do is to take those costs savings and invest in energy companies, as they will inevitably recover through a return to higher prices, market consolidation, and corporate restructuring.
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