5 Reasons Every Investor Needs to Monitor Crude Oil

High Oil Prices Continue To Drive Gas Prices Steadily Upwards
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Crude oil is probably the commodity that investors around the world watch most closely. The world requires energy, and crude oil is a necessity in every nation around the globe. Oil is the raw material that becomes gasoline, heating oil, jet fuel, diesel, and many other products when it passes through a refining process.

Oil is a highly political commodity; its price can make or break governments around the world.

While producing nations cheer when the price is high, consumers benefit from low prices. The politics of oil are as complex as the structure of the oil market that causes the price to move up and down.

Before 2004, NYMEX crude oil futures never traded above $41.15. In 2008 it peaked at all-time highs of $147.27 and was over $100 per barrel in June 2014 before massive supplies of shale oil in North America caused the price to move lower. Higher prices have caused new production to come to market as it creates the environment for more expensive oil’s extraction from the crust of the earth. In late October 2016, the price of oil was trading around the $50 per barrel, above its pre-2004 historical price.

More than 50 percent of the world’s oil reserves are in the most turbulent political region on earth, the Middle East. The nation with the largest reserves is another country that has been less than stable, Venezuela.

The United States and Russia are both major producers of oil with significant reserves. However, the majority of the world’s oil production comes from members of the international oil cartel, OPEC.

The price of crude oil has a tremendous influence on other markets across all asset classes. It takes energy to produce most commodities.

Therefore, oil is a cost of goods sold component in the production cost of other raw materials. Many of the companies that trade on equity markets around the world are either producers or consumers of oil or are in some way connected to the oil industry. The link between the price of the energy commodity and oil exploration and production companies, oil servicing companies, and oil refining firms is direct. When it comes to consumers, the price of oil becomes a critical cost input for manufacturers and other businesses that require energy in their daily business.

Currencies have a healthy relationship with the price of oil. As the dollar is the reserve currency of the world and the benchmark pricing mechanism for oil all around the world, a strong and stable dollar tends to cause the price of the energy commodity to move lower, and a weak dollar does exactly the opposite. The currencies of countries that are oil producers tend to strengthen when oil moves higher as revenues increase.

Finally, fixed income products can move with the price of crude oil as well. Inflation influences the prices of bonds and energy can be a significant harbinger of inflationary pressures. Higher interest rates tend to cause lower oil prices as the cost of financing inventories increases.

5 Reasons Every Investor Should Monitor Crude Oil Prices

There are five important reasons why every investor should monitor the price of crude oil even if they do not trade or invest in the commodity.

Reason One: Politics

The majority of the world’s low-cost production is in some of the most politically challenging areas of the world. More than 50 percent of reserves are in the Middle East. Venezuela has the earth’s single largest reserves of the energy commodity. Additionally, Russia has significant proven and probable oil reserves. The politics of crude oil has been an important reason for price volatility over recent decades.

In the late 1970s, gasoline lines in the United States were because of political changes in the Middle East, namely in Iran during the Islamic revolution. More recently, in 2010, the Arab Spring swept political change across many nations in the Middle East resulting in concerns that supplies or logistical routes would suffer.

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.