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As we all happily know, gasoline prices have been dropping at the pump since mid-June. That’s because the price of crude oil has fallen nearly 25% over the past four months. From a high of $115 to about $87 per barrel now and driven gas prices lower. I know all of you have been spending a lot less on tanking up and I want you to take advantage of this externally created situation and channel those savings into building a more secure retirement portfolio.
…channel those savings into building a more secure retirement portfolio
While I knew what was driving this drop in gas prices, I wanted specifics, so I did some digging and came across a recent article titled “Lower Oil Prices Carry Geopolitical Consequences” by analysis and forecasting firm Stratfor, and want to credit them for data that I plan to share with you today.
The strategic importance of oil
So why do oil prices matter? Simply because oil is one of our most dependable sources of fuel – that drives transportation, petrochemicals, materials and a host of other industries… and because oil prices impact just about everything we buy as consumers because of underlying production and transportation costs.
As a result, oil has strategic and geopolitical importance… and many nations, including the U.S., have gone to war to protect their oil interests. So a structural change in oil markets reverberates throughout the world and creates clear-cut winners and losers.
Since the beginning of 2011, countries that consume large amounts of energy have been coping with high oil prices – above $100 per barrel – even as many of them struggled to emerge from the 2008 global financial crisis. So the current environment of lower oil prices comes as major relief to countries that are net importers of oil – which really is most countries in the world!
Major oil producers, on the other hand, have grown accustomed to high oil prices and have used this oil wealth to enrich their leaders and boost national development, primarily on mighty infrastructure projects. So, sustained low oil prices will cause these oil exporting nations to rethink national budgets and spending – but don’t feel too bad for them, oil at $87 per barrel still gives them considerable profits.
What’s driving the drop in oil prices? Supply side dynamics
Okay… so what’s really behind this drop in oil prices? Turns out it’s those two usual suspects – supply and demand!
On the supply side, oil production has been steadily ramping-up here at home – in the U.S. – as new technologies such as hydraulic fracturing and horizontal drilling make oil extraction from America’s shale fields and deep formations economically feasible… driving up supply and reducing our reliance on oil imports. Over the past four months, U.S. oil production has increased by 500,000 barrels per day – from 8.5 million bpd in July 2014 to about 9 million bpd at the end of October – that’s a pretty phenomenal increase over a short four-month span. And I know from reading quarterly reports of major oil companies that they continue to have bold new projects that will further expand production capacity because, over the long run, demand for oil is expected to far exceed conventional production over the next few decades.
Looking ahead, into 2015, the growth prospects for energy production in North America continue to be positive. Even after production grew by about 1 million bpd in 2012, 2013 and again in 2014, the U.S. Energy Information Administration expects U.S. oil production to increase by another 750,000 bpd in 2015… and that figure could be conservative because U.S. producers have consistently beaten EIA growth estimates over the past few years… so U.S. production increases could well exceed that 750,000 bpd level in 2015.
In addition to the U.S., other oil producing countries have also been ramping up production. For example, oil-revenue-desperate Libya has increased production from about 200,000 bpd to more than 900,000 bpd – that’s an increase of 700,000 barrels of daily production. And the 3 major oil producing nations – Saudi Arabia, Nigeria and Iraq – have also increased production in recent months… and, globally, oil production is now at its highest level in two years.
In parallel, Oil Producing & Exporting Countries – or OPEC as they are collectively called – are reluctant to cut production to boost prices because they simply cannot afford to lose out on revenue from oil sales. So production is unlikely to taper off anytime soon, specially if oil holds at near its current $87 per barrel level.
Also… just to put things in perspective – some of you may remember oil at $25 a barrel – a level that was then touted as a stable, equilibrium price that was best for everyone – producers and consumers… so relative to $25 per barrel, OPEC countries see $87 oil as a mighty windfall and will sell as much oil as they can without cutting production.
And while rich countries such as Saudi Arabia, the United Arab Emirates and Kuwait can economically afford to cut production, they have little incentive to do so, especially because past experience shows them that cuts in production rarely boost oil prices. Moreover, they don’t see the U.S. or any of the other producers idling production capacity anytime soon, so they have absolutely no incentive to do so themselves.
The other “poorer” producers – Libya, Algeria, Iran, Iraq, Nigeria and Venezuela – simply cannot afford to take oil production offline because they need all the money they can get to finance their budgets, boost defense spending to ward off terrorism and maintain social spending programs to supply basic amenities to their populations.
But one thing is also clear… if oil prices drop substantially below current levels, U.S. producers – with their focus on metrics such as return on investment and return on assets – will rethink the economics of producing a commodity that delivers little marginal profit and could cut production. On the flip side, if oil prices hold, U.S. production will likely grow.
Demand side dynamics
On the demand side, reports of economic weakness in Europe and a gradual slowdown in China are adding downward pressure on oil prices, and analysts believe low demand is likely to linger for a few years. Further, oil consumption is also structurally in decline in the U.S. and Europe as electric vehicles, solar, natural gas and other alternatives continue to make their presence felt, albeit very slowly, and as economic sluggishness persists in Europe.
Recent reports from China show that its economy continues to descend from the peaks of its post-2008 investment and construction boom, with a decline in the housing market and related industries at the heart of China’s economic slowdown. Investors also fear that a potential collapse in China’s housing market – which many see as having bubble-like valuations – could send China’s economy into a tailspin and subsequently dampen demand for oil. If that happens, the Chinese government may step in with a stimulus program similar to our Federal Reserve’s quantitative easing program.
The International Energy Agency also weighs in – it estimates that global oil demand grew by only 700,000 bpd in 2014, roughly half of the total increase in production – so this too supports the thesis that oil prices are unlikely to rise anytime soon… but, hey, I for one, am not complaining!
Capitalize on the drop and boost your savings
This drop in oil prices creates clear-cut winners and losers: It helps countries that consume large amounts of oil because it substantially reduces what they spend on oil imports, and leaves them with more money to shore up their economies. And it hurts the economies of major oil producers by reducing export income and shrinking government budgets.
As for you and me, we should look at lower gasoline prices as heaven-sent, and continue to keep a tight leash on our spending habits while channeling our fuel savings into investments, and seize this opportunity to reinforce our retirement portfolios.