Oil Is Up … Is That Good?

Oil Is Up … Is That Good?

Oil prices have been rising steadily since late 2017 and have reached their highest level since $107 per barrel in June 2014.  With President Trump’s decision this week to terminate the JCPOA – Joint Comprehensive Plan of Action – which is known as the Iranian Nuclear treaty, oil moved above $70 a barrel.

This is the primary driver of rising oil prices this year – fears related to the US cancelling the agreement with Iran, and what that would do to production and finance related to the industry.  But it was, and is, not the only driver of higher oil prices as there is a litany of geopolitical brush fires that are impacting price:

1)            Saudi Arabia’s quarantine of Qatar and its proxy war with Iran in Yemen;

2)            Sanctions on Russia which inhibits Russian production;

3)            Chinese claims of sovereignty in the South China Sea – driving up insurance and transportation/energy demand;

4)            Multi-front war in Syria;

5)            Virtually no production from Libya thanks to its failed-state status;

6)            Collapsing production in the failed-state of Venezuela;

7)            US fracking entrepreneurs getting out of the game when prices were lower;

Price elevation in oil has occurred in spite of the unprecedented strengthening of the dollar throughout 2018.  Usually oil prices go up when the dollar weakens, but not this time, as tightening by the Federal Reserve and small, slow, but noticeable rate hikes has made the Larry Kudlow mantra of “King Dollar” come back to life.

Additional rate hikes are expected, as well as continued strength in the US economy.  This should keep the dollar elevated throughout the remainder of 2018.  But it won’t be the only variable that impacts the price of oil.  What are the pros and cons for the US economy of higher oil prices?

I. What are the Pros of higher oil prices?

  1. “Energy company stocks will keep going up”:   US energy can profit from rising prices, as it increases the stock value of American energy companies – anywhere from transportation to large multi-national oil companies like Exxon.
  2. “US refineries will increase profits”: US refineries remain the highest caliber and most productive in the world, despite their aging physical infrastructure.  Higher prices mean greater profits for refineries, and therefore higher stock prices as well.
  3. “Growing economy”: Oil prices cannot go up, and stay up, unless there is continued demand.  Continued demand for energy products means we have a healthy, growing economy.

II. What are the Cons of higher oil prices?

  1. “Pocketbook issue – it can hurt consumers”:  While the “pros” can suggest a growing economy that benefits stocks which can be in your investment portfolio, the daily bread-and-butter issue of disposable income, money in your pocket, will be a negative for all but the upper income groups.  Higher gas prices is less food, less movies, less money to spend on everything else.
  2. “Weakens over-all economy”:  Like with consumers, energy stocks can benefit, but overall, the cost of doing business goes up as the price of energy goes up.  If businesses are spending more on energy, that is reducing profit … reducing pay increases, reducing hiring, you name it and there will be less of it.
  3. “Strengthens our enemies Russia and Iran”:  Higher prices increases the revenue to our enemies – Russia and Iran.  It’s that simple.  We can sanction Iran’s oil production and ability to sell their oil on the open market, but sanctions can only be effective to the extent we have partners willing and able to help us enforce them.  In both cases, neither government has to care what their public thinks, since they are not democratic and not beholden to public opinion.

Oil drives markets.  It does not matter that the United States is near energy independence, since energy markets like oil are fungible.  The rising price of oil can and will have an adverse effect on your portfolio, and on the larger economy.  Avoiding that volatility impacting retirement money should be a primary objective of financial planning.

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