It's Cheap to Fill Up..."Oil" Over the World

It's Cheap to Fill Up..."Oil" Over the World

It’s Cheap to Fill Up… “Oil” Over the World

$1.40 at the pump… equals Recession?

The fall in world oil prices that began in mid-2014 has continued into these early days of 2016, reaching a recent low of $26.68 on January 20th 1 from $111.93 19 months ago.2  Drivers – Uber and the rest of us! – in the US have received relief at the pump with commensurate drops in gas prices (down to $1.40 this past week observed on my morning commute).

Yet the financial markets have reacted so far this year with widespread gloom and loathing: as of the close on February 11th, the S&P500 Index was down some 10.5%3.  Why the sell off? What might be ahead of oil in 2016?

Oil Price Drop: Based on Falling Demand?

As Gene Epstein summarized in Barrons of February 8th, the slowdown in growth in China and elsewhere around the world has contributed to the worldwide buildup in oil inventories.  Still, he reports that world oil consumption continues to increase: from 91.9 million barrels a day in 2013, to 92.8 in 2014, to 94.5 in 2015.  Eric Lee of Citigroup projects that figure to grow by another million barrels this year to 95.5.4  JP Morgan has it slightly lower at 95.2.5

Whatever the estimate, the point here is simply this: while perhaps growing at a slower rate in 2016, the demand for oil across the planet is still projected to increase.

The Supply Side

What, then, has been shaping up on the supply side of the equation?  Epstein reports an increase in US daily oil production of a whopping 76% in the past 5 years from 5.5 million barrels to 9.7 million.  Certainly, the revolution of fracking and horizontal drilling into shale formations has lowered the costs of extraction and increased supplies considerably.  On the international markets, news stories abound that Russia as well as Saudi Arabia and the other OPEN countries have yet to announce cuts to their production.

So falling oil prices… due to lower demand or increased supply?  We’ll leave that calculation to others, but we do suggest that financial markets thus far in 2016 may be interpreting greatly lower oil prices as a sign of lower demand consistent with a global recession scenario.

What’s Ahead of Oil?

If falling oil prices the focus and concern of the financial markets… will oil keep falling in price?  NO way to predict the future, of course.  We can, however, observe the following:

  • The Number of Active Oil Rigs in the US have Dropped Considerably – in just the past 12 months, the number of active rigs – needed to pump additional oil supplies – has fallen by 796, leaving just 514 still in operation.6
  • Citigroup projects an average oil price by the end of this year of $507

As Epstein pointed out in the February 22nd Barrons, “each of the past 6 recessions has been preceded by a spike in oil prices, often called an ‘oil shock’.”8  Work by Jason Benderly of Applied Global Macro Research has found that when the prices of necessities decline, consumers initially save much of the windfall, only to spend it later.9  So drops in prices at the gas pump to this point may show up in consumer spending increases later this year and into next.

Are the recent lows in both oil prices going to be the bottom?  No way of knowing and we are never in the prediction business.  As it turns out, that’s not the point of this little essay, anyway:

Our surmise here early in 2016 is just that the much cheaper stop at the gas station today quite likely leaves a few extra dollars in the wallet that will show up in the purchase of something somewhere down the road.  Who said economics is hard!??

Stay in touch, think Spring, and SPEND WISELY!

 
1,4 “Here Comes $20 Oil”, Gene Epstein, Barrons, February 8, 2016
2,5 Guide to the Markets, JP Morgan, January, 2016, p.27
3 Google Finance
6 Rig Count Overview, Baker Hughes, February 19, 2016
7,8 “This Storm Will Pass”, Gene Epstein, Barrons, February 22, 2016
9 By The Numbers, February 16, 2016

 

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