The Slippery Slope of Oil By: Gabriel PotterMBA, AIFA® 2018.11.20

For the past several years, we have had a carefree, hands-off approach towards energy sector.  When we wrote about the changes to the sector in our December 2014 monthly article, we posited a range bound circumstance where the price of oil would not deviate from $40 per barrel to $80 per barrel in the near future.  The $40-$80 range was chosen because that range encapsulates the marginal cost of hydrofracking in the United States.  Since then, the efficiency of hydrofracking has somewhat improved, thus lowering the marginal cost range, but ordinary annual inflation costs would increase the marginal cost range.  Thus, the actual price has mostly stayed inside this (admittedly large) window.

From an investor’s point of view, this is a perfectly rational way to consider an individual commodity market.  Unless you’re deeply invested in futures, royalty trusts, or daily operations which require oil as a raw material, you may be content with a broad call which discounts the probability of worst case scenarios or huge spikes (like $160 per barrel, found in June 2008). 

On the other hand, if you are a commodities trader or end-user, this blasé attitude is probably cold comfort.  Even regular investors note the fact that oil prices are a large variable in the United States quarterly earnings because we are a net energy exporter.  Assuredly, this will become a factor when Q4 2018 earnings are finalized.

While we at Westminster have been largely ignoring the shift in price, traders are keenly aware that there has been a huge oversupply of oil lately.  Reuters reports the US, Russia, and Saudi Arabia have been producing at all-time highs.  Iran has been allowed to circumvent sanction restrictions, creating more available supply.  Ongoing trade disputes, tariffs, and rising interest rates are muting expectations for global growth and oil demand.  Thus, Oil prices have fallen 25 percent in the past five weeks, which represents about $1 trillion of market losses. 

To offset the glut, both OPEC and Russia are negotiating lower production targets for their cartel members.  Time will tell if they can control enough marginal supply – we’ll probably get a better sense of their direction by the December 6th OPEC meeting. 

Gabriel Potter

Gabriel is a Senior Investment Research Associate at Westminster Consulting, where he is responsible for designing strategic asset allocations and conducts proprietary market research.

An avid writer, Gabriel manages the firm’s blog and has been published in the Journal of Compensation and Benefits,...

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