Declining Oil Prices and their Impact on the Economy and Investor

Declining Oil Prices and their Impact on the Economy
and Investor Portfolios
By: Salvatore J. Ricco, CLU, ChFC, AIF
“Formula for success: rise early, work hard, strike oil!”
- J. Paul Getty
What does the decline in the price of oil mean to the economy and your portfolio?
Oil has dropped almost 50% from a high of over $100 per barrel in early 2014 to under $53!
Correspondingly, the average cost per gallon for regular gasoline has dropped from a recent high of
$3.60, to a current price of $2.17.
What is causing the current decline in price?
The reasons for the current decline in price lie on both the supply and demand side. World oil demand is
still growing, but rather weakly. Demand for oil by China and other emerging markets is no longer a
major driving factor. In addition, U.S. oil production is up 80% since 2008, due in large part to the
American “shale revolution.” Improving technologies have allowed U.S. producers to extract oil from
previously difficult to reach deposits. These factors, along with OPEC’s decision not to cut production
targets, have created a panic in the market that has led to a significant decline in price.
What does the decline in energy costs mean for the economy?
Research shows that every penny decline in the price of a gallon of gasoline translates to about $1 billion
in additional disposable income for American households. Add up all the price reductions of the most
recent decline and you have a multi-billion dollar stimulus to the economy. Already low inflation rates
could go lower as oil and its by-products represent a significant component in the cost of many goods and
services.
Winners and Losers- The Losers:
Small to mid cap energy exploration companies will see a significant effect on their bottom line as
declining prices will render many existing and future projects unprofitable. Most major economies are oil
importers, not exporters, with the exception of Canada, Russia, Mexico and Nigeria. This has already had
a negative effect on all emerging market equities and local currency emerging market bonds as market
participants tends to shoot first and ask questions later. Energy has the highest sector representation in the
high-yield junk bond market so there will be negative volatility in this asset class as well.
Winners and Losers- The Winners:
Consumers get the equivalent of a multi-billion dollar tax cut. Airlines, whose energy cost can be 30% of
revenues, will be big beneficiaries as well. In addition, certain industrial and manufacturing businesses
that consume oil will reap the benefits as well. If the decline in prices persists, Goldman Sachs estimates
that cumulative savings for the American consumer could be in excess of $125 billion over the next year.
What will it take to stabilize the market?
Jerry Webman, senior economist for Oppenheimer Funds put it best by saying that ”the cure for low oil
prices is low oil prices.” Low prices will lead to increased demand which will reduce supply and
ultimately help to stabilize prices. Low prices could also force oil producers to shelve certain projects
that would not be profitable, especially in the U.S. where many shale related fields have higher
production costs. Oil companies like Royal Dutch Shell, Chevron and BP have already slashed their
production budgets by billions which will dampen supply down the road. All of these factors should
continue to help reduce supply.
Where does Ricco Wealth Partners stand on changes to portfolio allocations in light of these
developments?
We do not anticipate making any changes at this time. Our investment policy of maintaining broad
diversification among all asset classes remains steadfast. We retain some exposure to energy production
companies, high yield corporate bonds and emerging market stocks and bonds. Energy continues to be
just one of many sectors we invest in to get a proper representation of the global economy within our
portfolios.
The views expressed are those of the author only and should not be construed as investment or tax advice. Registered Representative Securities
offered through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative Cambridge
Investment Research Advisors, Inc., a Registered Investment Advisor. Cambridge and Ricco Wealth Partners, LLC are not affiliated. The above
information is for summary purposes only and should not be construed as tax advice; please consult your tax advisor for a more comprehensive
analysis of your specific situation prior to implementing any financial or tax planning strategies.