Today, I'm going to give you a bit of recent history on oil prices and the factors that impacted them, and then talk about the pros and cons of falling oil prices.
Recent History: I still remember the days when crude oil prices were at $25 a barrel - not decades ago but as recently as June 2004... Crude oil, by the way, is what the oil companies extract from the ground and refine into various fuels such as gasoline, diesel, heating oil, etc. And here in the US, we typically use a type of crude that we call West Texas Intermediate or WTI - so the prices I talk about today are for WTI Crude, which broadly trade in sync with Brent Crude - the other major crude oil category that is popular in Europe and with the OPEC, short for Organization of Petroleum Exporting Countries.
So... from a low of $25 in 2004 (btw, all prices are per barrel), prices rose, more or less steadily, to $76 by August 2006 - they tripled in two years, which is pretty phenomenal. This sharp increase in oil prices was due to ravenous energy demand from emerging economies such as China, Brazil, India, Eastern Europe and so on.
Then, a combination of fundamental factors like declining oil production in non-OPEC countries like Britain, Mexico and Norway, saber-rattling statements from people like Hugo Chavez of Venezuela - a prominent oil-exporting nation, unrest tied to the Arab Spring in the middle-east, and market frenzy driven by commodities traders took prices all the way up to to $144 by July 2008 - almost double their August 2006 levels.
And along the way, many analysts including one at Goldman Sachs predicted a super spike to $200... but thankfully for us, that prediction of $200 oil did not play out.
Then, from a July 2008 high of $144, oil prices crashed, in a classical steep-drop pattern when bubbles burst, to $32 by December 2008 during the financial crisis. Which in itself is pretty amazing and interesting to a market watcher like me - that a four year rise that took prices up almost six-fold from $25 to $144, was washed out by a sharp and quick 80% fall to $32 in a mere five months... I wonder how many people got slaughtered on that one??
Then December 2008 on, oil prices recovered fairly well - again, classical recovery pattern after a crash, when people realize the world is not coming to an end and we still very much depend on oil - and oil prices reached $110 by April 2011.
But since April 2011 and $110 levels, prices have trended down to about $88 currently - on global reports of an economic slowdown in places like Greece, Italy, Spain, the Euro zone, Russia, China and other emerging nations that feel the pinch when the US and Europe slow down, by a Euro crisis and by disappointing economic data in the US like the weak jobs reports over the past few months.
Pros/Cons: So oil prices are clearly down from earlier highs... to $88 from $144 per barrel. Now, as I have discussed in the past, oil prices impact everything - the expense of running a tractor or harvester on a farm, our collective gas bills for cars, trucks, buses, trains and airplanes, home heating bills in the winter, the cost of manufacturing, the cost of food, the cost of raw materials, our discretionary spending on movies, trips to the mall or Disneyland, new clothes, your savings rate... just about everything in our modern lives is directly or indirectly linked to the price of oil. So when oil prices fall, we all stand to benefit significantly - think of your savings with gas at $2 per gallon versus gas at $4 - they add up pretty fast.
Consumers benefit, of course... lower prices of gas at the pump, less inflation in the goods we buy because so many contain petroleum based derivatives.
For example:
One 42-gallon barrel of oil creates 19.4 gallons of gasoline.
The rest (over half) is used to make things like:
Ink, Floor Wax, Ballpoint Pens
Upholstery, Sweaters, Boats, Insecticides
Bicycle, Tires, Sports Car Bodies, Nail Polish, Fishing lures
Dresses, Tires, Golf Bags, Perfumes
Dishwasher parts, Tool Boxes, Shoe Polish,Motorcycle Helmet
CD Player, Faucet Washers, Antiseptics, Food Preservatives Basketballs, Soap
We are a petroleum based consumer nation.
On the flip side, some will argue that high oil prices actually do us a world of good because they make us environmentally more responsible, encourage alternate forms of energy - so called clean energy - such as wind and solar, encourage healthier lifestyles, cause us to drive less and car-pool more, switch to public transportation, reduce traffic, buy fewer gas-guzzling SUVs, buy more fuel efficient hybrid cars, and so on. High oil prices also send more, as taxes, to federal and local governments, and arguably result in bigger government budgets - but whether that trickles down to us citizens is highly debatable. But the biggest beneficiaries of higher oil prices are companies in the oil supply chain with companies like Exxon and BP raking in massive profits, much to the delight of their shareholders.
While high oil prices may have their benefits on some fronts, they also reduce economic growth, reduce global trade due to higher transportation costs, reduce corporate profits and so reduce new jobs and spending on new factories and equipment, and generally drag the economy down if prices get too high. Unfortunately, those hardest hit in such crises are the poor and middle class for whom survival suddenly becomes a lot more difficult.
From a investors' perspective, falling oil prices benefit the economy as a whole because they increase corporate profit (except for oil companies), increase dividend payouts, lead to greater corporate investment and new jobs, and drive stocks higher. Rising prices, on the flip side, make us lead healthier lives but weaken our wallets and savings accounts, slow the economy down, and reduce discretionary corporate and retail spending which further drags the global economy down in a vicious downward cycle that can lead to recessions in extreme cases... but higher prices benefit oil producers and holders of oil shares, and increase government revenue from taxes on things like gasoline.
So, once again, what is the upshot from all this?
Our use of oil is a curse and a blessing. It has given the world an unprecedented increase to its standard of living ----that's a blessing, but our dependence on it has made our lives more sensitive to things outside our control... like what is happening on far off economies like china.
So, my philosophy is: Control what you can and be smart about it.
If you are financially vulnerable to the price of oil- and most of us are to some degree, make sure you drive a fuel efficient car, for example. Or if you work in a field that is tied to the oil industry in some way, don't invest too much in oil stocks. You don't want all your eggs in the oil barrel.
Think diversification of energy sources. Whether it is: sun or wind or natural gas, this will help you lower the effect on oil prices in your life.
And after all, creating peace of mind and financial stability is one of the reasons we spend so much time thinking about money, isn't it.
Steve Pomeranz is a Managing Director for United Capital Financial Advisers, LLC, "United Capital", and owner of On The Money. On The Money is not affiliated with United Capital.
Visit http://onthemoneyradio.org/ for weekly commentary and money advice that covers the entire financial spectrum which also airs on my weekly radio show, "On The Money!"
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Steven L. Pomeranz, CFP is a 29 year investment management veteran and host of On The Money! which airs on NPR station, WXEL in South Florida. He concentrates on serving high net-worth individuals and has been named one of the Top 100 Wealth Advisors 2007, by Worth magazine (October 2007 Issue), honoring Americas premier financial and wealth strategists.
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