The global financial marketplace is a dynamic environment that can change direction rapidly. While smaller pieces of the puzzle, such as individual stocks, can have complete reversals of fortune within a single trading day, asset classes as a whole tend to move at a slow enough rate that investors are able to prepare ahead of time for expected booms and busts. Oil however, is the one asset that proves to be the exception to the rule.
Unlike most assets that operate by the standard laws of supply and demand, oil has its own unique economic behavior. Thanks to heavy political influence by OPEC, oil’s international supply availability can change on the whims of a single organization rather than by fundamental market forces. That means that regardless of the actual energy demands of the global economy, the amount of oil that is produced doesn’t necessarily move in correlation.
The Oil Paradigm
OPEC has long been the single largest force impacting the oil market. The relatively small collection of oil producing countries, primarily located in the Middle East, has been able to single-handedly change oil’s value by controlling its supply. If they want oil to rise in value, they simply restrict access to generate a higher price, and if they want oil to fall, they simply allow more of it to be released.
The reign of the Middle Eastern stranglehold on global oil has been challenged though. New production of oil by other regions has threatened to take away OPEC’s market share of oil, thereby lessening their control. Most notable among these new sources of oil has been the U.S. shale oil industry.
As new players emerge on to the global scene, OPEC has less influence on oil prices. In the long run, this is a positive development as oil will be able to trade more in line with supply and demand and less on the direction of a single organization. However, until there is some balance in the industry, oil’s future is fraught with volatility and complications.
In order to combat the growing influence of other oil producers, OPEC has decided to let the production of oil remain high despite lowered global demand for energy. This has the effect of dragging down oil prices to lows that haven’t been seen in more than seven years. The logic behind the move is simple.
The War on U.S. Shale Oil
The idea is to let oil values sink as far as possible for as long as possible in the hopes that U.S. shale oil companies will go under as their cost of production falls into the red. Despite the oil oversupply glut though, U.S. shale oil isn’t likely to collapse in the face of OPEC’s challenge.
Deep cutbacks have been made as oil’s price has fallen from more than $115 per barrel in the summer of 2014 to close to $40 per barrel today. Still, there’s a large push for energy independence and that mindset is even more resolute now as the world sees why leaving control of an essential commodity in the hands of such a small group is problematic.
The U.S. shale oil revolution isn’t done yet, though. The country is still a net importer of oil, although the amount has greatly decreased thanks to domestic production. This success will drive the industry going forward and provide a backdrop on which the shale oil industry will continue to grow.
The Bottom Line
Right now, oil is a volatile place to be. As OPEC throws its tantrum against U.S. shale oil, the financial marketplace will suffer the blows and react accordingly. Investors need not be too concerned however. The effect should only be a temporary one, keeping oil prices low for the short term, but won’t affect the long-term viability of the global economy.
2016 will likely be a year of oil supply gluts and low energy prices but could also present some opportunities for other energy sources, such as natural gas, to thrive. Gas prices too should remain low, helping out small businesses and ironically giving a boost to the economy as it struggles to recover from the loss of China’s global influence. The final picture on oil isn’t quite known though, with sanctions on Iran oil still unclear, though that will likely be lifted in early 2016. It will most likely be a political battle in the next year that will determine oil’s fate.