What's Going Down with Oil?

A lot of shocking things occurred last year.  One of them was the plunge in oil; another was the dramatic rise in the U.S. dollar.  Both have some very interesting implications for us.  Today, I’m covering oil, leaving the discussion on the Dollar for another day. 

Here’s a chart of Oil futures since the beginning of 2014.  Oil peaked in June at $108, and then did an abrupt about face.  It’s now trading at $46, down 57 percent. 

So why has this happened, and what are the possible ramifications?    

But first, please note.  I am not predicting what will happen next, and I caution you against it as well.  Just about everyone thinks oil is going lower.  Two months ago, the prediction was $40.  Now it’s $20.  I find it fascinating how everyone “knows” it’s going lower, when nobody predicted it was going to fall in the first place.

Why did oil fall?

Reason #4:  U.S. Fracking.  By creating hydraulic fracturing, the United States is on her way to energy independence.  We’re not quite there yet, importing ¼ of our oil.  Still, in five short years, our production has almost doubled.  More supply equals lower prices. 

Reason #3:  World Economic Weakness.  Europe is struggling economically, although they are not in recession—yet.  China is slowing down.  Japan is trying to print itself out of deflation.  Consequently, the rest of the world is buying less oil.  Less demand equals lower prices.

Reason #2:  The U.S. Dollar.  The dollar has risen over 10 percent in the past year.  Because greenbacks are the reserve currency, they usually have an inverse relationship with commodities.  Check out the following chart.  Dollar Futures are in blue.  Oil Futures are the red and green lines.  

Reason #1:  OPEC, specifically Saudi Arabia.  Over the past decades, when oil supply has exceeded demand, Saudi Arabia would cut back on its production in order to prop up oil prices.  Not this time.  They have decided to make no changes in production.  Some surmise this is their way of hurting ISIS, Iran, and their supporters (e.g. Russia).  All of these nations are dependent on oil to finance their activities; and this hits them in their pocketbook.  Others believe Saudi Arabia is doing this hoping to drive fracking competitors out of business.  Regardless of the reason, they are defending their market share this time.

You might be asking, “Why should I care?  Isn’t this a good thing?”

The short answer is yes and no.  I read pieces by a lot of smart economists and money managers.  Some believe it to be good and some bad.  Their reasons all make sense. 

It seems to me that since the U.S. is still a net importer, it’s overall a good thing.  But not as quite as good as it used to be back in the 1990’s.  Lower oil prices will give Middle Class Americans more discretionary income—money that can be used to buy more stuff or pay off bills.       

However, it will result in lots of high-paying jobs being lost as energy companies try to balance their budgets.  Most energy companies need oil to stay at $70/barrel to break even.  Right now, they are losing money. 

The biggest concern is what some oil exporting nations might do if oil continues lower.  Some nations like Ukraine and Russia may default.  Or worse, rogue nations like Russia or Iran may start a war which would cause oil to surge.                         

Time will tell.  For now, enjoy the trip to the gas station!