Most experts would agree that our economy is out of danger, if not on the road to recovery. From 2013-2014 we saw the broad market move upwards due to the easy money policies of the Federal Reserve. Now with the market recovering well, most believe that the Fed will start raising interest rates mid-2015 and the market has responded accordingly. We must recognize that investment in the stock market must be done much more strategically because this year—every sector will behave differently. The sector that has suffered the most severely in the past 12 months and consequently most poised for a rebound is the energy sector.
Understanding the Movement
The energy sector consists of all players in the various sectors of crude oil, solar, wind and water. As more than 60% of this sector is dominated by crude oil related companies, our analyses refer to energy and oil interchangeably. It won’t come as a surprise that gas prices are and have been going down for the past 12 months. This is because the price per barrel of oil has gone from around $95 per barrel in January 2014 to $60 per barrel in one year—a 37% drop! It is a common adage in investing circles to “buy low-sell high”—the art is in recognizing when the bottom is. To put things in perspective at the height of the last market peak in September 2007, Brent Crude (a major oil price index) was at $76 per barrel. Based on market and historical behavior, energy is poised for a revival—it’s just a matter of time.
Energy prices play a large part in the international political arena. As mentioned before, crude oil being the majority of this sector makes it a hot commodity on the world scene. The price of every single thing in this world is derived from the simple economic principle of supply and demand. The oil industry is no different, deriving most if its price movement from the supply side of the equation.
The Organization of Petroleum Exporting Countries (OPEC) draws significant political and economic influence from the fact that the hegemony controls the majority of the world’s oil supply.
The oil prices recent downward movement suggests that OPEC is allowing a much larger supply of oil into the world market. The prevailing (yet unproven) theory is that the United States established a backdoor deal with OPEC countries to reduce oil prices in an indirect method to combat Russia’s aggressive political and military decisions in the last 18 months. The theory conjectures that the United States doesn’t want to directly engage Russia in its latest moves into Ukraine and has indirectly placed sanctions on the nation (oil being Russia’s #1 export). With oil prices severely depressed, Russia’s already failing economy is put under further pressure as it receives significantly less for its exports. It remains to be seen whether this theory is just pure speculation, coincidence, or the truth.
Moving on Up
All this being said, the energy sector is poised for a revival. While increased supply from OPEC is temporarily lowering prices, there are both supply and demand effects that will eventually raise energy prices again.
First, with oil prices lower, oil production is going to reduce. Oil drillers are receiving less for the oil they sell so they will adjust by drilling less till it rebounds. Less oil worldwide means higher prices, which will lead to more oil production. As such oil prices continue to move up and down in cycles. As it is currently in the trough of a cycle, it is expected that eventually it will rise up again.
The second effect at play in this discussion is the consumer demand aspect of oil (through gas for cars etc.). With gas prices down, individuals like you and me are more likely to buy and use gas.
For example, the trip from San Francisco to Los Angeles is one hour by plane and approximately six hours by car. The biggest factors in comparing the modes of transportation against one another is time and fuel cost. In the past, individuals would have chosen to fly because gas prices are high. Now, with low gas prices, people are more likely to make the drive.
Obviously there is a point when time spent traveling becomes the more important factor—one is not going to drive from New York to Los Angeles just because gas prices are down. As individuals are more likely to consume gas, demand on oil increases leading to a rise in its price.
The average investor at this stage can explore different companies that would benefit from increasing oil prices—oil companies such as Exxon-Mobil, oil and gas drilling companies, and energy efficient car companies like Toyota.
This article is the opinion of the author and is not shared by India Currents or any of its staff. All investors should conduct their independent analysis before taking any actions and should not make any decisions on the information provided in this article alone.
Rahul Varshneya graduated from the Leavey School of Business at Santa Clara University with a degree in finance and works in the tech industry as a financial analyst. If you have feedback or have a topic you would like addressed please contact Rahul at [email protected]