Headlines proclaiming last year's 46% decline in the price of oil are designed to provoke fear while goosing readership and ratings. Professional commodity traders are having a ball and making tons of money as amateurs pay them big bucks to speculate on each day’s fluctuation.
The Wall Street Journal noted that crude was at its lowest level since 2008. That sounded familiar to their headline after the DJIA declined 316 points on December 12, 2014. Buyers that fateful afternoon are feeling richer today than the traders who panic-dumped shares that day.
Those who got long oil contracts, or oil-based equities, in late 2008 experienced similar results. From the final bottom, the price of WTI jumped more than 240% over the next couple of years.
The 10-year chart of WTI (West Texas Intermediate) shows the volatility, or relative stability of crude pricing, over the entire past decade. Based on the wild swings you might think that big changes in global supply and demand for crude were big contributors to the movements.
In fact, worldwide demand increased during nine of the previous ten years.
It took The Great Recession to cut absolute usage, and even then it dropped less than 1.5% year-over-year. Boom times led to 2% - 3% in extra demand. Most years revolved around 1% increases.
Americans believe in the “oil glut” theory because domestic production has surged due to the shale revolution. The U.S. share of global oil output has risen dramatically since the end of 2006.
Headlines announcing that America has become a net exporter of energy have colored perceptions here at home. It is relatively meaningless when evaluated on a worldwide basis.
Over the past five years total supply and demand have moved in parallel directions, albeit with some noticeable near-term variations.
The chart belies the idea that supply is now swamping demand, justifying last year’s huge plunge in crude prices.
After the 2008-09 decline crude pricing went from about $40 to above $140. Price per barrel then dropped to near $35 on the way back to $120. In late December, 2014, WTI dipped into the $52 range.
It is more likely that the present weakness will be temporary, rather than becoming the "new normal."
Do you really believe that $2 per gallon gasoline is right around the corner? If not, you should be buying some oil-related stocks while the quotes are depressed.
Over the long term the price of crude will revert to a number that reflects the average cost of production adjusted for all the traditional variables.
Supply and demand were not responsible for the 46% drop in oil prices. The magnitude of that move reflected a speculative mood change more than a fundamental one.
At their last meeting OPEC did nothing to alter supply. People hoping for production cutbacks were disappointed but supply-demand was not affected one bit from the pre-meeting level.
To get a bargain you need to be willing to buy what others are fearfully selling. Buying during panics always feels uncomfortable while you are doing it. That’s why it will end up being so profitable.
Disclosure: Long an assortment of oil-related shares. Short puts on a number of oil-related stocks.
