Oil

The price of a barrel of oil in the New York futures market has fallen about 33% in the past 2 months.  Prices at the gas pump are lower, but not by 33%.  Some are happy about oil’s drop and some are not.  What should you think about it?  What is going to happen with oil in the future?  Read on.

Offshore Oil Rig

Reasons

There are several reasons out there as to why oil has declined this much this quickly, including but not limited to the following:

  • Concern about lagging global growth in the future;
  • The relative strength of the US Dollar as the world reserve currency;
  • A current glut of supply worldwide;
  • Seasonal issues – we are between the busy Summer and Winter seasons when more oil is used;
  • Relative geopolitical calm so far, particularly by Iran;
  • Increasing availability and affordability of alternatives to oil as an energy source;
  • The Saudis have opened the spigots in order to placate the world in the face of a PR nightmare due to the murder of the journalist Khashoggi;
  • Increasing production in the US coupled with the low cost of production in the US relative to the remainder of the world.

Contango

The 2-month drop in oil prices has resulted in a “contango”, which means that the price of oil available today, known as the spot price, is lower than the price available to pay for delivery one year in the future.  This contango situation is reflective of the current supply glut.  It is also is somewhat abnormal, as current spot prices are usually above prices a year out in the future, a condition known as “backwardation”, the opposite of contango.  It also means that prices a year out in the future have not fallen as much as have immediate spot prices, which is a healthy sign.

OPEC in Vienna

As you read this, OPEC is meeting in Vienna.  Likely they are discussing this drop in prices and what they should do about it.  There is talk out there that Saudi Arabia, the largest producer in OPEC, will leave and disband the cartel.  I don’t think that is likely – Saudi Arabia needs OPEC right at this moment.  Russia has involved itself in OPEC in recent years and likely will do so again.  Look for moderate self-imposed production cuts to come out of this Vienna meeting, which should at least temporarily boost the price of oil.

Is It Good for the USA?

10 or even 8 years ago a drop in the price of oil would have been an unquestioned good thing here in the US.  Now, however, with so much job growth in the country tied to oil production, and with the US now either even or ahead of Saudi Arabia as the leading oil producer in the world, lower oil prices are not such a good thing.  

IMO

I don’t see oil falling significantly farther because winter usage will soon kick in, because future global growth indicators will turn out to be stronger than anticipated, and because the current $50/barrel level is the lowest necessary for US producers (at a macro level) to make money.  That said, don’t bet on oil doing a quick reversal and going straight back up.  V-shaped recoveries have not typically happened in the oil markets throughout history.  Oil is an extremely complicated commodity and a lot of economic and geopolitical issues play a factor in its price.  

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