By David Coleman
During this past month oil has flirted around $30/barrel. Thankfully, this week, a Russian official reported that Saudi Arabia has proposed a 5% decrease in production for all OPEC members. Under the proposed production decrease, countries outside of OPEC would also reduce their output of oil.
No changes have been made yet, so don’t get too excited, but this is a step in the right direction. After a solid month of continuous oil decreases and equity plummets, this news is refreshing to investors. We’ve started on the road to production negotiations and hopefully an agreement to reduce production worldwide. But why did the oil glut burden our economy so heavily, and what will this potential increase in oil prices do?
Why do low oil prices hurt the economy?
When oil prices are low the energy sector suffers. The energy sector is a large part of the economy and as such greatly affects sectors tied to it. When energy companies are low on revenue they cut jobs, capital improvements, and dividends for investors. Workers, industry, and investors suffer from those cuts.
Those same workers, industry companies, and investors then spend less. The energy sector ripples throughout the economy quickly. Everyone is feeling the pain from an over-saturated oil supply.
You would think that as gas prices go down, consumers would spend or save more, which would actually help the economy. It takes some time for that to start happening though. Most consumers have a hard time adapting to low gas prices and phrases like “it’ll be back up to $4.00 a gallon soon” reduce willingness to spend more.
What will an increase in oil prices do?
There are a couple of factors that change as oil prices rise. The first is investor confidence. Recently investors have closely eyed oil prices. Equity prices have almost identically mirrored oil in the past month, and the energy sector has weighed.
With a boost in energy sector revenue, we could find ourselves out of the cyclical oil/equity storm. Like we talked about in Don’t Follow the Crowd, as investors notice oil rising an exponential flood of buying could occur. This would boost large energy companies which would in turn reinvigorate the service and industry that support them.
What should I do differently?
If a deal is made, and accepted by a large portion of the oil producing countries, we will see a rise in gas prices. Investors young and old should keep a close eye on OPEC. If an agreement is made or any kind of big news comes out of Saudi Arabia, I’d fill up my tank immediately. It might save you a couple bucks.
For investors, look at the big energy companies (Exxon, Chevron, BP) and do some research. Find out what has the most attractive equity for your risk window, and invest a couple dollars. They’ve taken a massive hit recently and some of them are in good value territory. Naturally, read our guides on Investment Research and Diversification before you do so.
My site CollegeInvestr.com covers topics ranging from basic budgeting to market research and commentary. My main focus is to provide information for young investors trying to build wealth and reduce student loans. If you’ve liked this article, come check out more of my material!