As the old saying goes – what goes up must come down. Recently oil prices have been coming down quite spectacularly. This has naturally raised the question of how investors can benefit from this. To answer this question, we need to understand why oil prices have fallen. There are essentially three theories on this.
Oil prices are being deliberately kept low
High oil prices encourage people to look for lower-cost alternatives. These include shale gas and coal. As oil prices drop, it becomes less attractive to extract other kinds of fuels. This is particularly true of shale gas as fracking is still highly controversial. One school of thought holds that oil-producing countries are prepared to take a short-term hit in terms of oil prices to stop alternative industries, such as shale gas, from gaining acceptance. Consequently as soon as the oil-producing countries are happy that they have eliminated the threat (for now at least), oil prices will rise again.
There is an excess supply of oil
High oil prices encourage oil production. If, however, there is an over-supply of oil, prices will fall. When this happens production is reduced until prices rise again. In an ideal world a continual cycle of rising and falling prices would be replaced by a balance between supply and demand. In the real world, however, demand for oil can vary hugely for a number of reasons. This makes it very difficult to strike this perfect balance.
There is reduced demand for oil
Another explanation is that weakened economies have a lower demand for oil. To put it another way, oil is essential for many purposes, but not all purposes are essential for daily life. For example oil prices feed into petrol prices. Petrol is used by the emergency services, which have to keep going day in day out and therefore have to buy petrol regardless of the cost. Petrol is also used for leisure travel, but people can reduce or cut out leisure travel if the cost of it becomes too high.
Energy costs are a matter of long-term strategy
The truth is that any or all of these explanations could explain the drop in oil prices. What some consumers may find harder to understand is why lower oil prices take so long to become lower petrol prices or heating bills or air tickets. In fact, some people may even see this delay as an example of “fat cat” profiteering. However very few oil-dependant companies are buying fuel now to use now. Large companies value stability as it enables them to create long-term business plans. They therefore engage in long-term supply contracts, which can result in them paying well above market prices for the fuel they need. (Of course, the reverse is also true). They may also choose to invest in oil-related companies so that they can benefit, in some way, from rising prices.
So how can individuals benefit from the oil market?
This is the key question and it is one which deserves serious consideration. It could also be worth thinking about the question of energy in more general terms. Regardless of what oil prices do in the short term, the reality is that oil is a finite resource (as are other fossil fuels). Because of this, we need to look at alternative sources of energy for the future. We also need to look at ways to use the resources we still have more effectively. Therefore investments which relate to either of the above could be well worth taking some time for to get professional advice from a qualified financial adviser.