How Oil Prices have Killed the Energy Market

Over the past six months crude oil prices have been plummeting, as oil prices hover around $45 a barrel, reaching six year lows, which has been sending ripple effects across the overall energy market.  The energy market has been limping along much slower than the market overall, as the previous graph showed.  The S&P 500 Energy market, as I am writing, has only seen a 4.04 percent increase over the past 3 years, while the S&P 500 overall index is has grown 18.46 percent over that same time, and much of that increase has come since last June, when the stock market began to make a robust recovery.  Not included in those numbers is the significant drop in value of the small energy companies, which fell 47% in the last six months, according to the Wall Street Journal.

With the nature of energy companies (energy consumption continues to increase at a high level), many investors may think that now is the time to buy into the energy markets to expand their portfolios.  Unfortunately for those profit hungry investors, looking to get into the energy market may be folly, as many analysts seem to believe that oil prices, the driving factor in the energy market, will continue to decrease for a small time before eventually stabilizing at the end of the year.  Russ Koesterich, chief investment strategist at BlackRock, chimed in that he felt “You can’t look at the sector and think that you’re going to be lucky enough to time the bottom.  You have to be thinking about it for the longer term, realizing you may see the stocks down 10 percent or 15 percent before they bottom.”

After previously high levels of income and profit increase, the oil industry is now cursed by volatility and a lack of growth in the past year.  It is very intriguing that the energy industry, which continued to grow (at least fairly steadily) and create ludicrous profits throughout the financial crisis, has now come on tough times now that the American economy, at the very least, is gearing up for recovery.  Oil firms, especially American ones, have been cutting their production to match the correlating price level, a common response.  However, it is intuitive to think that with lower prices, consumer demand would continue to rise or at the very least stay at the same level it was, meaning that production will continue.  Oil tycoon Boone Pickens believes that American oil producers, such as the ones in West Texas and North Dakota, “can’t produce oil for $45.”  Since American producers cannot produce oil at an effective cost at that price level, American oil production must be cut back, which has been observed in the past few months.  Pickens also said that “In the last 30 days they’ve dropped 300 rigs… You’re gonna reach an all-time high on the inventory of oil, and it will be reached within the next six weeks, and then it will start to decline.”  With high levels of inventory, the price would continue to stay low, and as the inventory is used up, logic would predict that the price would rise.

Politically, the death of the Saudi King will have some effect on the oil market, but Saudi Prince Alwaleed Bin Talal doesn’t believe that oil prices will hit the $100 mark again in this lifetime, which would not be an ideal situation for American oil producers per Pickens’ thinking.  Also according to Pickens, the fall in oil prices was American oil driller’s fault, and will have to be an American solution.  The rationale behind Pickens’s thinking being that Americans, under economic duress from rising Middle-East oil prices, increased domestic production, outstripping consumer demand, meaning that prices had to be dropped for the market to remain in equilibrium.

This is not the first time that the energy industry has faced uncertain times, but there are many signs that would point towards at least a slow recovery.  The biggest signal of growth is the ever present increasing consumption of Asia, as was seen on the consumption graph above.  Additionally, energy consumption has yet to slow down on a worldwide basis, so it is likely that demand will not change nor decrease in the future, given that there is not a radical new development in the world of energy.  If that is the case, invest in that and drop Exxon Mobile.  However, the slow climb back to $100 a barrel will be upon us soon, yet it is probable that the prices will drop a little lower first, so gas up!

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