Feb

7

What’s Fueling the Drop in Oil Prices?

How long will it last? Who wins & loses from it?

On the New York Mercantile Exchange, a barrel of light sweet crude is currently worth well under $60. Prices have dropped more than 25% in a month and almost 45% year-over-year. What is behind this free-fall? How long will prices keep dropping, and who does this development hurt and benefit?1

Oil prices haven’t cratered simply because of lessening demand. Make no mistake, waning demand is a major factor – and in its latest 2015 forecast, the International Energy Agency projected global demand for crude weakening further. But this is just part of the story.2

Saudi Arabia has made a punitive political move. It is the big player among OPEC nations, and it sees no point in thinning the crude supply glut. The longer it lasts, the more pressure it can put on two of its biggest competitors – Iran and Russia.3

Saudi Arabia has long feared Iran’s potential to develop nuclear weaponry, and if there’s too much oil on the market, the economy of Iran – which is extremely dependent on oil – could very well tank. Iran’s currency reserves are diminishing to the point where it needs oil prices up at the $130-140 level to balance its budget. Saudi Arabia has about 10 times Iran’s currency reserves, so it is much more equipped to ride out this oil bear market. Given enough economic pressure, Iran could finally make a deal with the world’s superpowers to wind down its nuclear program and signal to the Saudis that “enough is enough.” Russian president Vladimir Putin just told reporters that such a deal was “very close.”3,4

Speaking of Vladimir Putin, Russia has long supported the governments of both Iran and Syria – to much bad publicity, and now to its economic peril. Like Iran, Russia is a major oil supplier. It needs oil prices above $100 for any kind of economic stability, which it certainly lacks at present. No one has faith in the ruble, which has sunk against other currencies – and in response, Russia’s central bank just hiked its key interest rate by 6.5% to try and rescue it.5,6

Iraq and ISIS – the first making money from oil legitimately, the second illegitimately – are also punished by OPEC’s decision to sustain supply.

How will other emerging-market economies handle this tactic? Some might fare better than others. It might exacerbate the appalling economic conditions in Venezuela; it might foster additional unrest in Nigeria, where oil contributes to a third of GDP. Brazil and Mexico aren’t as reliant on oil as they once were; their economies might be able to weather the price drop in the short term, but not if the downturn in prices becomes a “new normal.”6

An oil glut could even give the economies of China and India an indirect lift. How? China imports massive amounts of oil and has very little oil and gas reserves – so inexpensive crude is a real gift. China spends about $500 billion a year on oil and gas imports, and it could actually end up halving that cost thanks to the plentiful global oil inventory. That could give its powerful economic engine a tune-up. India, too, is a major oil importer. About 75% of the oil it uses comes from overseas. Sustained cheap oil might soon improve its growth as well.6

What would this do for America? Well, cheap oil can translate to cheaper consumer and producer prices, i.e., lower inflation and more money in household wallets. While energy shares took severe hits this month, in the big picture this may bode well for consumer spending, manufacturing and the service industry.1

Could we actually see $60 oil for a year or more? Maybe. In fact, some oil industry analysts think West Texas Intermediate crude prices will head below $50 by February or March. World oil supply is still increasing, and inventory should continue to swell with no sudden pickup in demand being forecast.7

While $55 oil sounds cheap, you could argue that it really isn’t. In inflation-adjusted terms, the average price of WTI crude since 1985 works out to slightly above $40 per barrel. Still, inventory will decrease at some point. Analysts at the energy-focused investment bank Tudor, Pickering & Holt recently predicted that “the current oil price is going to crunch supply by late 2015/2016” and OPEC may change its stance if Saudi Arabia gets what it wants in the next few months.8

 

Citations.
1 – markets.on.nytimes.com/research/markets/commodities/commodities.asp [12/18/14]
2 – proactiveinvestors.com/companies/news/58785/dow-drops-over-300-pts-to-end-worst-week-in-3-years-58785.html [12/12/14]
3 – business.financialpost.com/2014/11/13/lawrence-solomon-saudi-arabias-war-of-attrition/ [11/13/14]
4 – reuters.com/article/2014/12/18/us-iran-nuclear-putin-idUSKBN0JW1BM20141218 [12/18/14]
5 – bloomberg.com/news/print/2014-12-15/russia-increases-key-interest-rate-to-17-to-stem-ruble-decline.html [12/15/14]
6 – nypost.com/2014/12/14/saudi-arabias-oil-war-against-iran-and-russia-2/ [12/14/14]
7 – tinyurl.com/qxjlt25 [12/17/14]
8 – forbes.com/sites/christopherhelman/2014/12/01/after-a-bloodbath-in-oil-what-next/ [12/1/14]

This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. The NASDAQ Composite Index is an unmanaged, market-weighted index of all over-the-counter common stocks traded on the National Association of Securities Dealers Automated Quotation System. The Standard & Poor’s 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. It is not possible to invest directly in an index. NYSE Group, Inc. (NYSE:NYX) operates two securities exchanges: the New York Stock Exchange (the “NYSE”) and NYSE Arca (formerly known as the Archipelago Exchange, or ArcaEx®, and the Pacific Exchange). NYSE Group is a leading provider of securities listing, trading and market data products and services. The New York Mercantile Exchange, Inc. (NYMEX) is the world’s largest physical commodity futures exchange and the preeminent trading forum for energy and precious metals, with trading conducted through two divisions – the NYMEX Division, home to the energy, platinum, and palladium markets, and the COMEX Division, on which all other metals trade. Additional risks are associated with international investing, such as currency fluctuations, political and economic instability and differences in accounting standards. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This material was prepared by MarketingLibrary.Net Inc., for Mark Lund, The 401k Advisor, Investor Coach and author of The Effective Investor. Mark offers investment advisory services through Stonecreek Wealth Advisors, Inc. an independent, fee-only, Registered Investment Advisor firm providing 401k consulting for small businesses and financial Advisor services for professional athletes and individuals. Stonecreek is located in Salt Lake City, Murray, West Jordan, Sandy, Draper, South Jordan, Provo, Orem, Lehi, Highland, Alpine, American Fork all in Utah.

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Mark K. Lund is the firm's founder, CEO and author of The Effective Investor, a #1 Best Seller. He has written articles for or been quoted in: The Wall Street Journal, The Salt Lake Tribune, The Enterprise Newspaper, The Utah Business Connect Magazine, US News & World Report, and Newsmax.com, just to name a few.  Mark publishes two newsletters called, “The Mark Lund Growth Report” and “Mark Lund on Money.”  Mark provides CPE (continuing professional education) courses for CPAs.  You may also have seen him on KUTV Channel 2, or as a guest speaker at a local association or business. Mark provides investment and retirement planning services for individuals and 401(k) consulting for small businesses. In his book, The Effective Investor, Mark exposes the false narrative magazines, media, big Wall Street firms, and most advisors want you to believe. The good news is that Mark will show you that you don’t need their speculative ways of investing in order to be successful. Get a free copy when you schedule your initial consultation.

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