Aren’t low oil prices good? It depends on why.

//Aren’t low oil prices good? It depends on why.

Aren’t low oil prices good? It depends on why.

Back before “fracking” became a household word, most people considered cheap oil a good thing. Gas was once under a dollar a gallon; airlines liked cheap aviation fuel; chemical companies liked cheap raw materials.

Of course, we were dependent on imported oil, and every OPEC meeting sent a ripple of unease through the markets as the threat of a price increase hovered in the air. Expensive oil was considered bad for the economy.

Now that fracking and other improved recovery methods have dramatically increased domestic supply, there are concerns that cheap oil will stall the economy. Does this make sense?

It is true that oil producers and economies dependent on oil production are facing serious issues. Venezuela is the poster child for a directed socialist economy reliant on oil and failing as its income declines. Russia, OPEC and domestically, Texas, are all feeling the pinch.

Profitability of oil producers and their suppliers is affected as the price declines, but the corollary is that consumers of oil benefit, and there are more consumers than producers.

Oil is used for all forms of transportation – road, rail, air and water. Heating oil is a winter necessity for much of the world. Oil is vital for lubricants and the petrochemical industry — fertilizer, synthetic fiber, synthetic rubber, pesticides, perfumes, paints, dyes and on and on.

The reason oil’s price has declined is not that the economy is weakening, it is that production has increased, and even as the price has declined, producers are finding cheaper ways to extract oil, allowing them to keep producing at lower prices. From the consumer’s standpoint, this is a virtuous cycle.

The accompanying chart shows a long-term steady increase in both supply and demand for oil. Sometimes they get out of balance and presently supply is ahead of demand, and that is the reason for a declining oil price. Eventually an equilibrium will be reached.

The performance of the stock market generally seems to be the inverse of the price of oil. In early 2014, the S&P index hovered around 1700 as oil topped $100 a barrel. Through most of 2015 and 2016, both were fairly flat, with the S&P in the 2000 range and oil as low as $30 a barrel. Since then, oil has remained cheap and the S&P has reached new highs approaching 2500.

There are, of course other factors, perhaps most important, politics, but clearly cheap oil has not hurt the stock market over that time.

As consumers around the world benefit, producers will continue to adapt; those that don’t will fall further behind. Corporations may shrink, while oil-dependent economies like Venezuela may well collapse and Saudi lifestyles may have to change.

2018-02-22T09:52:01-05:00 June 21st, 2017|Market|0 Comments

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