Opinion / Politics

What Are Oil Prices Doing? What Does it Mean?

oilOkay, what is up with oil? The price has been bouncing like a yo-yo, futures dipping below zero, jumping back up, now predictions of a repeat? What does this yo-yo mean? How might it affect retirement accounts and economies like ours?

In short, several factors are buffeting oil, whipping it like a tall ship’s sails in a storm. These factors are important but will fade. How they will affect retirement and the US economy is worth exploring.

From the top, some analysis. A barrel of oil in November 2019, cost roughly $40 dollars. America was the world’s top producer, OPEC cohesive, and no one had heard of coronavirus – except some Chinese doctors, who were shut up.

At the same time, oil futures were behaving as they always do, buyers and sellers banking on – or hedging with – future deliveries. Then crosswinds started to build. China’s economy started slowing, nothing to do with coronavirus, just too much debt, competitive pressures, and regional overextension.

As the US economy roared, weakness surfaced in Europe and Russia. Then came COVID-19, proliferating from Wuhan, first case November 17th, likely from a virology institute. The virus jumped from bats to humans, then human to human. The institute studies bat viruses.

China’s story got stranger. Taiwan reported human-to-human transmission to the World Health Organization (W.H.O.), which promptly minimized the report – under Chinese influence. China shut down domestic air travel but not international travel.

In China, testing was minimal, case and death numbers incomplete until April 2020, when the overall death rate shot up by 50 percent. Back in early January, questions abounded, truth remained hidden.

Nevertheless, President Trump stopped incoming flights from China late January, set up his Coronavirus Task Force, and then stopped flights from Europe. But the virus had made landfall in the United States.

From that point forward, medical and policy leaders tried to stop its spread – using contact tracing, expanded testing, treatment and “social distancing.”  Unfortunately, this Chinese virus was on a tear. The Far East, Europe and soon the United States struggled to defend against the novel pathogen.

To do so, economies shut down. While they will reopen, oil demand plummeted. Industrialized economies stopped producing things, commuters stopped driving, and oil prices crashed.

That was only part of the collapse in oil futures. A nasty trade war erupted inside OPEC – between producers Russia and Saudi Arabia. In March 2020, Russia refused to reduce production, which could have helped oil stay above $30 a barrel. Saudi leaders responded. On March 8, Saudis ramped up production.

Oversupply further reduced oil prices. US oil prices dropped by 34 percent, global crude by 24 percent. OPEC’s cohesion vanished. As US oil prices fell, so did prices in Kuwait which needed $49 dollars a barrel to break even, Nigeria which needs $139, and across the globe. Producer economies shrank. Meantime, Russia’s currency fell 30 percent, and Saudi Arabia raised its debt ceiling by 50 percent.

You can see where this story is going. Two bad things were about to collide. The world was awash in oil above ground through overproduction – more supply than anyone needed. Now came the onrushing pandemic shutdown. Things just got worse.

Oversupply accelerated, demand continued retreating, and the price of oil collapsed. The world had too much oil, and no one needed it. In the real world, oil became a burden. Those pumping could not sell, except at lower and lower prices. Those buying had less and less need, and nowhere to even store it.

In the futures market, which gambles on future prices of commodities and settles contracts on a set date, things got wilder. Not only did institutional purchasers place poor bets, so did individuals thinking prices would soon pop up. Assumptions were wrong, and decisions were poorly timed.

The world economy stalled, then stopped. By mid-April, as reality became clear, the rush was in the other direction. So much oil had been pulled up with nowhere to go, that nobody wanted it. In effect, oversupply and collapsing demand meant no storage space. Companies were stuck and had to pay others to take oil off their hands. They effectively sold it at negative prices.

The economics of supply and demand worked, markets cleared as contracts came due, but with a premium on oil storage the world was upside down. Overabundance and lack of demand meant previously held value had less than neutral value – it had negative value and had to settle at a loss.

The big question now: What happens ahead – with what effect on things like retirement and the US economy? We can make a few predictions. Producers – Russia, Saudi Arabia, the United States, Canada, and others – will stop pumping. They will leave oil in the ground. God does not charge for storage.

They will cap old wells, those far from refineries and shorelines, as they are least efficient, most costly, usually older, and economical to cap. They will store oil wherever they can, stacking tankers in ports around the world, since above ground storage is now full.

On the demand side, what do we know? Once the pandemic tapers, manufacturing and retail will reopen, and people will drive again. Demand for oil will return. Will it roar back? Not likely.

The glut will take time to drain, and economies hard hit may pump more again, trying to out-produce competitors. Other factors could weigh on oil’s price, including solar, wind, electric cars, hydroelectric and geothermal power.

As for retirement accounts, news is good and bad. This moment is probably once in a generation. The 2020 crash of oil to “below zero” will be talked about for years. Alternative energy is coming but will not soon replace oil. Nor are we likely to be unprepared for the next pandemic.

Net-net, while staying diversified is wise, oil prices will recover. The world – once we restart – tends to use lots of oil. When volatility subsides is anyone’s guess, but we will eventually wrap string around this yo-yo and set it aside. Until then, patience – and a good mask – may be your best bet!

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