Oil, oil everywhere

Written by Gary Silverman, CFP®

Last week we began our look at the effect of low oil prices by looking back at what brought oil up to triple digit prices just a few years ago—four times what it’s selling for now. We left off with prices that had risen due to tremendous worldwide demand stabilizing in the face of buyers finding ways to use less oil and suppliers starting to increase production.

Really, if that’s all that happened, then we’d still be complaining about filling up at the pump. Yes, the rapid expansion of drilling and fracking definitely made a difference, but the biggest difference was the combination punch. The Chinese economy had over stretched and now was pulling back and the dollar was getting stronger. This meeting of a rapid increase in supply, a rapid decrease in demand, and a tilt in currencies resulted in the collapse of oil prices.

As I said last week, this is a very simplified explanation, but it does capture where we are. So now the question: Where are we headed?

First, realize that there is nothing to indicate that demand will increase to where it was any time soon. As the Chinese economy (and others) stabilizes and recovers, it will take years before their demand returns to its heyday. Second, realize that it will take a while for supply to be reined in. A lot of money was used to drill a lot of wells. Those firms that don’t want to go bankrupt need to get and keep those wells producing. The rest of the world isn’t helping.

Venezuela, Russia, and much of the Middle East is very dependent on energy sales. Years ago they might have curtailed production to help prices stabilize and wait for better prices before they ramped production back up. But now they’re having a really hard time with their budgets, to the point that they will have to curtail services to their population. An unhappy population can be rather troublesome. To stay in power they’ve been depleting a lot of their stored wealth. They can’t afford to stop pumping—at least without the chance of a revolution.

So, for a number of reasons, I don’t see oil at a level that will make my friends in the energy business smile any time soon. And while this dramatic drop has caught even the most seasoned professional by surprise, those same seasoned oil firms still remembered the oil gluts of old. It wasn’t something they read about, it was something that they experienced in their youth—and that memory is burned into them. So while some of the newer kids on the block over-leveraged and over-expanded, locking in a lot of costs they could not easily reduce, the older more wizened souls had in general taken a more conservative approach…which will likely save them.

But enough about what happened or may happen with the price of oil. Next week we look at why it doesn’t seem to be having much of an effect (at least not an anticipated effect) on the economy.

This article was published in the Wichita Falls Times Record News on March 6, 2016.