OPEC, the Organization of Petroleum Exporting Countries, is a trade organization that serves as a cartel. The membership focuses on attaining the highest possible stable price for oil for the benefit of producing nations and those who make capital investments in the exploration, production, oil services and refining sectors of the global petroleum business.
The bottom line is that energy is a staple commodity that powers nations around the world. The leadership of producing nations depends upon oil revenues while consuming countries rely on oil flows to meet energy requirements. These factors all make crude oil a highly political commodity and changes in the price of the energy commodity will influence the portfolios of all investors.
Reason Two: Economics
All commodities are economic animals, and oil is no exception. The price of oil tends to increase to a level where higher-cost production will meet all demand and stockpiles rise. When an oversupply develops at high prices, demand tends to decline causing the price to peak and move lower. As the price declines, production will decrease. Eventually, oil will fall to a price where inventories begin to decline and demand rises. Since production is lower at lower prices, a bottom forms and the cycle begins all over again. Classic economic theory operates in crude oil and all raw material markets.
As a ubiquitous commodity, the price of oil has important effects on all other asset classes. In commodities, the production of metals, minerals, agricultural products, and other raw materials all depend on power supplies for production. Oil is often a critical input cost in the production of other commodities; therefore its price affects the prices of other raw materials. In the equity markets, there are so many oil-related companies that make up the vast universe of stocks so a booming oil price contributes to corporate profits and a bear market in the energy commodity will result in a decline in earnings. Major equity indices tend to correlate with the price of oil. Finally, higher oil can be inflationary. The inflation rate is one of the key determinates of fixed income or debt prices.
When it comes to the global economic landscape, the price of crude oil is a significant variable.
Reason Three: Technology
Technology plays a major role when it comes to the price of crude oil. When the price of oil is high, the demand for automobiles that use less gasoline increases. Over recent years, technology addressed oil prices over the $100 level as new hybrid and electric cars became more popular. Additionally, an increase in heating oil and other product prices tends to cause investment in new technologies in the energy sector such as solar, wind, and hydroelectric power sources.
Technology is responsive to the economics of oil. When the price of oil declines, the sales of automobile that consume more fuel like SUVs and other gas-guzzlers tend to increase. Additionally, when the oil price moves lower, technological advances in drilling and extraction can lower prices. When the price of oil dropped precipitously from 2014-2016, it fell below production cost in many producing regions of the United States. Horizontal rigs replaced vertical rigs and improved output efficiencies, lowering total production costs making the North American crude more competitive when compared to lower-cost producers. While the total number of rigs in operation declined, those that remained produced more oil at a lower cost. As you can see, there is a significant technological angle to crude oil and the development of new technologies can change the fundamental equation for crude oil and other raw material markets at times.
Reason Four: Opportunity
The crude oil market has a long history of creating opportunity. The economies of Texas and Oklahoma, both critical oil-producing states in the U.S., have traditionally gone through boom and bust periods with changes in the oil price. Oil volatility creates opportunities for many other businesses in these states when there has been a rise in the price of the energy commodity. During bull markets, workers have flocked to these areas causing prices in local real estate markets to appreciate. Conversely, bear markets have had the opposite effect. Texas and Oklahoma are a microcosm of what happens around the world in areas that are rich in oil reserves and have the technology to extract the energy commodity from the earth.
When the price of oil falls, it also presents some areas of the world with growth opportunities. On a microeconomic basis, lower oil means lower energy bills for consumers and more disposable income for spending. Lower energy costs also cause the cost of production in the manufacturing sector to decline, increasing profit margins for some companies.
A higher or lower oil price can create opportunities for different sectors of the economy around the globe. We feel the effects of these possibilities or changes directly in our investment portfolios.
Reason Five: Utility
The utility of crude oil can alter business decisions for many companies thus affecting share prices. For example, a lower oil price could encourage a manufacturer of a product to hire more workers, increase production, and even cut the price of a finished good as their profit margin grows. Alternatively, a higher oil price could cause the same manufacturer to increase prices and cut back on existing staff.
The price of crude oil is one of the most important variables for many companies that trade on the stock exchange. Therefore, since these companies watch the price of the energy commodity and at times change corporate business plans to reflect changes in the oil price, all investors must keep an eye on this critical commodity. Success as an investor depends on interpretation and anticipation of changes in macro and micro-economic trends. When it comes to the price of crude oil, the highly volatile commodity can change those patterns, and every investor needs to monitor crude oil and understand the factors that will drive its price.