Oil, innovation and your financial future

Innovation is having a tremendous impact on capping the future price of oil and gas, which is very positive for the economy and your financial future.

The national average of gas is around $2.40 per gallon. A large increase in the price of gas would have a significant negative financial and psychological effect on US consumers and the US economy.

However, due to technological innovations, we do not think there will be permanent or long term significant increase in the price of gas.

Throughout the economy and world, we continue to stress the importance of innovation, and the resilience and abilities of companies and industries to adapt and change. We are rational optimists. What has occurred within the oil industry is another positive example of this.

The recent range of around $45-55 per barrel of oil is likely to remain or be capped on the upside. There may be temporary periods above this range, but technological innovation and cost cutting in hydraulic fracking, horizontal drilling and other techniques continue to make US producers more profitable, even at lower oil prices. If the price of oil increases suddenly, then US producers will increase their production and prices would fall.

What does this mean to you and your financial future?

  • If the price of oil and gas are not likely to increase significantly, that limits a major potential factor of future inflation. Gasoline is a major cost for most individuals. Oil and related products are key raw materials for many industrial and consumer products.
    • This is all positive for your financial future in the long and short term.
  • When we invest in stocks, we recommend broad diversification. We do not recommend placing major bets on specific industries or sectors.
    • The significant innovations in the oil industry and the resulting reduction in oil prices increase the risk, or limit the relative upside, of many oil and gas-related stocks and master limited partnerships.
    • While oil and gas companies may be profitable, stocks in other industries may outperform oil related stocks over the long term, as other industries may have greater pricing power or growth potential.

The background

In past decades, OPEC countries could dictate and control the price of oil, and thus the price of gasoline. This caused major inflation and very negative economic impacts in the 1970s. This may no longer be feasible, as US producers are part of a free market economy.

The price of oil has been in a range around $50 per barrel since August, 2015, almost 2 years. OPEC countries want to gradually raise oil prices. They have been trying to cut back production to raise oil prices in recent months, but their efforts have been mitigated by US producers.

US technological innovation in fracking and shale production are offsetting the OPEC countries efforts to increase the price of oil. The major benefit of this to the economy and you is a “cap” on oil and gasoline prices has developed. If correct, this limits future inflation, as oil and gas are key components of inflation.

US oil production has been increasing in recent years and has surged to a record of almost 10 million barrels per day. If OPEC tries to cut their production to cause oil prices to rise, then US producers will pump more oil, as it becomes more profitable for them to do so. As oil prices are based on supply and demand, if OPEC cuts and the US producers pump more, then oil prices are likely to stay within a range or even go down.

From an investment perspective, rapid technological innovation has drastically changed the nature of the energy sector and investing in this area. Rapid change and innovation are impacting so many other industries. Trying to predict these changes and which companies will succeed or face challenges is difficult or many times impossible, especially over the longer term.

The rapid pace of change makes our investment philosophy of asset class investing and broad, global diversification all the more applicable and appropriate.

Change and innovation will continue. Our investment style is consistent with your goal of having a successful investment experience and meeting your financial priorities.

We want to wish each of you a happy and peaceful Memorial Day weekend. We hope that you take time to consider the sacrifices of current and past service members, who enable us to have so many of the freedoms that the United States uniquely enjoys. 

For further reading on this topic, I highly recommend the following articles (paywall may be in place):

 “OPEC, Fighting Market Forces, Extends Productions Cuts” The New York Times, May 25, 2017 Stanley Reed

“How American Shale Drillers Flipped OPEC’s Script” The Wall Street Journal, May 24, 2017

Lynn Cook and Benoit Faucon
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