Few inputs impact the U.S. economy as much as the price of oil. Oil powers the cars, trucks, and airplanes that transport people and products for the entire economy. As oil prices rise, costs go up for transportation companies such as airlines and freight delivery companies, squeezing their profit margins. Downstream of these companies, customers who rely on them to get products to market are similarly impacted by higher prices. In contrast, most companies in the energy business benefit from higher oil prices, either from higher revenues for oil, or because of increased demand for substitute energy sources such as ethanol and clean energy. Car companies with fuel conservation technology -- such as hybrid engines -- can expect sales to go up as consumers feel the pinch of higher prices at the pump, while those who rely on sales of SUVs may find their business models challenged.
[edit] Oil Trading Price Updates
- 11/21/07 - $99.29 for U.S. light, sweet crude
- 11/29/07 - $92.50
- 11/30/07 - $88.50 - drop occurred at announcement of a ruptured Enbridge pipeline being quickly fixed
- 12/05/07 - $89.07 - rise connected to OPEC's announcement that they would, contrary to rumors, hold output steady
- 12/12/07 - $94.02 - $4.37 spike at announcement of central banks increasing world money supply
- 12/20/07 - $91.36
- 12/28/07 - $97.25 - Prices spike at assassination of former Pakistani Prime Minister, Benazir Bhutto.
- 01/02/08 - $100.09 - Crude trading finally breaks the magic barrier at the possibility of violence-induced Nigerian production cuts.
- 02/20/08 - $100.74 - Oil prices finally break the $100 mark again, and crude closes above $100/barrel for the first time, with theories as to why ranging from the Venezuelan supply cut to Exxon (unlikely) to political unrest in Nigeria (more likely) to a fire at an Alon USA Energy refinery in Texas (most likely).
- 03/05/08 - $104.52 - Oil prices spike after Bush's demand for more oil from OPEC was denied, with the cartel blaming speculation and "mismanagement" for the U.S. economy's problems.
- 03/11/08 - $109 - Oil prices continue to rise.
- 03/20/08 - $99.20 - Oil coming down?
- 03/27/08 - $107.95 - After surging nearly $5 on 26th, light, sweet crude for May delivery rose as much as $2.05 to $107.95 a barrel on the New York Mercantile Exchange yesterday (Thursday) as concerns about violence in Iraq compounded the effect of supply concerns. A bomb exploded at the Zubair-1 pipeline in Basra, which transports crude to export terminals at the Persian Gulf, Wednesday. Basra is the third largest city in Iraq, and has been the staging ground of several clashes between Iraqi forces and militants loyal to Muslim cleric Moqtada al-Sadr.
- 04/22/08 - $117.76 - Another record high driven sheerly by trader speculations that the price will rise forcing demand up.
- 04/28/08 - $119.93 - Rebel attacks in Nigeria, political stress in the Persian Gulf, and a strike at a Scottish refinery that forced a pipeline to close all contributed to a $1 spike that set another new record.
[edit] Why Oil Prices Rise or Fall
Generally speaking, there are four reasons for oil prices to rise:
- Increases in Demand: Demand for oil, as well as demand for energy in general, is closely tied to the global economic cycle. In periods of economic growth, new factories consume energy, shipping companies transport more goods and consumers purchase more automobiles and take more plane trips. This demand for energy -- or even news suggesting the economy is heating up -- pushes up energy prices. For example, a recent announcement that five major central banks will pump money into the world economy to help mitigate the current credit squeeze caused the price of oil to jump over $4 at speculation that energy demand would increase. Conversely, during periods of economic contraction such as recessions, demand for oil and other types of energy tends to fall, leading to reductions in price.
- Reduced Supply: Oil's supply can be disrupted in a number of ways, driving prices up as a result. Cartels such as OPEC periodically decide to pump less oil out of the ground in an effort to raise prices and increase revenues for countries that export oil. Additionally, oil supply can be impacted by terrorist attacks or other disruptions to the transportation and refining networks -- including pipelines, shipping facilities, and refineries -- that bring oil from where it is extracted to the consumer. Strong hurricane seasons can damage oil platforms in the gulf, reducing the amount of oil supplied to the U.S. Supply can also be artificially reduced or increased by government taxes or subsidies on oil production. The recently passed U.S. Energy Bill, for example, was expected to cut tax breaks for big oil companies, thereby sending oil prices through the roof; because of the industry's lobbying efforts, however, the bill did not contain the taxes that were expected, so oil prices stayed relatively stable.
- Peak Oil: Peak oil theory also presents an idea of how oil's supply will decline; since oil is a limited resource, eventually half the world's reserves will be used up. As reserve extraction approaches this halfway point, production increases, and at the halfway point, prices are lowest and production volumes are highest. Once the halfway point has been passed, production begins to fall and prices begin to rise. Many analysts believe oil production is at or past peak oil already, since price are now at record highs and production volumes are slowing; world production fell 0.5% between 4Q07 and 1Q08 and U.S. production fell 2% during the same period, indicating that mature regions like the U.S. are declining in productivity faster than the world on average - but world production is still declining.
- Currency Fluctuations: The United States imports much of its oil, and that oil is purchased abroad in U.S. dollars. The changing value of the dollar in comparison to other currencies impacts the price paid by end users. A strong dollar means a lower price, in dollars, and a weak dollar means more dollars must be spent to purchase the same amount of oil. Currency fluctuations are complex (for a more complete discussion see currency fluctuations) but the value of a currency is impacted by the relative value of goods imported and exported (known as the trade balance), interest rates, the size of the national debt, and the state of a nation's economy. As the U.S. economy sinks further into recession, the U.S. currency continues to depreciate, causing the recession to compound the rise in oil prices. Though loans from the Fed are currently keeping the markets afloat, if these loans stop, many analysts predict the markets will crash and oil will go through the roof.
- Speculation: Some analysts believe that oil prices have been spiking recently because of increased speculation about the future value of oil. Specifically, these analysts claim that the belief that oil supply is lower than it is and belief that future oil supply will be just as low has led traders to inflate oil prices in the present. While much of the data shows that production has been slowing, it's likely that speculation could account for some of the present price spikes. Since oil prices closed at record highs for five days in a row during the week of May 5th, 2008, a House of Representatives committee has announced an investigation regarding the role of hedge funds and investment banks in pushing up prices.
- Instability in Oil producing countries Security issues with countries such as Iran and Iraq, have led to a dramatic increase in the prices of oil. After surging nearly $5 on 26th March, light, sweet crude for May delivery rose as much as $2.05 to $107.95 a barrel on the New York Mercantile Exchange yesterday (Thursday, 27th March 2008) as concerns about violence in Iraq compounded the effect of supply concerns. A bomb exploded at the Zubair-1 pipeline in Basra, which transports crude to export terminals at the Persian Gulf, Wednesday. Basra is the third largest city in Iraq, and has been the staging ground of several clashes between Iraqi forces and militants loyal to Muslim cleric Moqtada al-Sadr. Iraq’s average production in the month of February was 2.4 million barrels per day. Basra Rumaila South and North oil fields produce approximately 1.3 million barrels per day. The city is also the site of one of Iraq’s largest refineries, the Shuaiba refinery that has been operating at a capacity of 100,000 barrels a day, short of its full capacity. An average of 1.54 million barrels of oil day flow through the city of Basra each day. The recent spate of violence has cast serious doubts about security in the region and sent the price of crude soaring. "The market will get significantly tighter if the roughly 2 million barrels a day we get from southern Iraq is taken offline," Rick Mueller, director of oil practice at Energy Security Analysis Inc. told Bloomberg.[1]
 Oil Price per Barrel since 1997 [edit] Positive Exposure
Several categories of companies stand to gain from rising oil prices:
- Companies with Energy-Conserving Technology such as Toyota Motor (TM) benefit from higher oil prices because high oil prices lead consumers seek out ways to reduce the amount of gasoline they use.
- Oil exploration and production companies prospect for oil, and then sell the rights to their discoveries or the crude they produce to a larger company. These companies are particularly sensitive to the price of oil, as they commonly take ownership of dilapidated oil fields and apply advanced (and expensive) technology to squeeze more oil out of the ground. At low oil prices, they cannot profitably extract any oil, but when oil prices rise these companies' valuations can skyrocket. Companies with right to extract oil from Canadian oil sands are particularly sensitive to changes in the price of oil because of the expense of producing oil in this fashion. Deepwater drilling contractors like Transocean (RIG) and Diamond Offshore Drilling (DO) are also affected as the dayrates for their rigs correlate closely with oil prices.
- Oil majors are the very largest, fully integrated oil companies. These companies explore for and produce crude oil and natural gas; they transport it by pipeline and tanker; they refine crude oil into finished petroleum products; and they also market crude oil, natural gas, and refined petroleum products to industrial users and retail consumers. As oil prices rise, these companies' proven reserves increase in value; they can sell their product for more money on the open market and stand to benefit from higher revenues. Major companies include companies such as ExxonMobil Corp. (XOM), ChevronTexaco (CVX), ConocoPhillips (COP), Royal Dutch Shell (RDS'A) and British Petroleum PLC (BP)
- Independent Oil and Gas producers are partially, but not fully integrated oil companies. For example, an independent oil company might produce, transport, and refine but not market petroleum products to the end user. Or it may produce and transport without refining. These companies include companies such as China Petroleum & Chemical Corp. (SNP), an integrated oil company which also manufactures plastics and operates drive-thru McDonalds franchises in The People's Republic of China, or CNOOC Ltd. (CEO), a company which explores for and extracts oil from the South China Sea. As the price of oil goes up, these companies can sell oil at a higher price, increasing their revenues. Other independents include Devon Energy, Anadarko Petroleum, Occidental Petroleum, Comstock Resources, Apache, Chesapeake Energy, Cabot Oil & Gas, EnCana, and EOG Resources.
NOTE: Recent gains in oil prices have been offset by rising oil production costs stemming from higher labor and equipment costs (and, possibly, increasing difficulty in discovery and exploration). Though oil prices have risen above $90/barrel, earnings per barrel have not significantly changed, making the profitability of the current oil trend questionable.
- Oil and Gas Refining & Marketing companies purchase crude oil, process it and re-sell it to the end-user. Companies include Sunoco (SUN) and Valero Energy (VLO). These companies sometimes benefit from higher oil prices, depending on whether the price they pay for oil from companies that extract it from the ground goes up as well. If rising oil prices are a result of limited refining capacity, these Oil and Gas Marketing companies will benefit from higher oil prices because their prices will tend to stay the same even as their revenues increase. If higher oil prices are a factor of limited production, however, these companies lose, as they must pay more for the crude needed for their refining processes, causing margins to shrink.
- Oil and Gas Equipment and Services companies sell technology, equipment, and expertise to companies prospecting for oil. These companies benefit from higher oil prices because their most expensive technologies become cost-effective only when oil prices are high. Major players include Schlumberger (SLB) and Halliburton (HAL), and Patterson-UTI Energy (PTEN) . Smaller companies highly leveraged on oil include Parker Drilling Company (PKD)--the major players are often diversified outside of oilfield services.
- Oil and Gas Pipeline companies build supply pipelines and stand to gain from increased construction when oil prices are high. They include Williams Companies (WMB) and Enbridge.
- Industrial gases companies such as Praxair (PX) will benefit because hydrogen, which they sell, is necessary for the extraction of heavy and non-conventional oil (i.e. tar sands, shale oil), and production of these types of oil increases as prices rise.
[edit] Negative exposure
Rising oil prices pose challenges for many companies as well as US consumers, which is why rising oil prices are often seen as damaging to the economy.
- Rising oil prices increase costs for many companies. These costs may be difficult to pass on to customers, thereby eroding profit margins.
- Rising oil prices reduce consumer demand for products that consume a lot of oil.
- Rising oil prices make travel more expensive
- Shipping companies are harmed by higher oil prices because oil is necessary to operate the planes, trucks, and ships that transport goods around the globe. These companies include brand-name trucking companies such as Federal Express (FDX) and UPS as well as industry-focused companies such as TNT (TNT) and Con-Way Trucking (CNW) and international shipping companies such as Teekay Shipping (TGP) and Frontline (FRO). Interestingly, LTL trucking companies are relatively shielded from fluctuations in diesel fuel prices, as the industry generally passes on fuel price surcharges to its customers like Wal-Mart Stores (WMT).
- Airlines such as Southwest Airlines (LUV) and Delta Air Lines (DAL) are harmed by rising oil prices as jet fuel accounts for as much as 30% of the cost of running an airline. Because most airlines' profit margins are already fairly small, rising oil prices can eliminate many airlines' profits.
- Other vacation and travel alternatives, for example, cruise lines Royal Caribbean Cruises (RCL) and Carnival (CCL), are at risk of decreased consumer discretionary spending as well higher fuel costs for their ships.
- Metal manufacturers such as US Steel (X) and Alcoa (AA) are hurt by rising oil prices because the process of manufacturing aluminum and steel both require a lot of energy.
- Online Retailers such as Amazon.com (AMZN) and Overstock.com (OSTK) are harmed by rising oil prices because these companies often subsidize the cost of shipping products to their customers. Rising costs of shipping make these subsidies more expensive.
- Car companies heavily dependent on sales of SUVs for profits such as General Motors and Ford are harmed by rising oil prices as consumers tend to reduce their purchases of these cars when oil prices are high.
[edit] Ways To Invest in Oil
Stock investors can buy or short-sell oil-related ETFs. One of the most traded ETFs is USO. Also consider DCR, UCR, DUG and OIL.
- ↑ Money Morning Analysis
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