How the Oil Market Affects Us Every Day

By Jason Flores, CFA, CAIA – Executive Vice President & Chief Investment Officer

Oil makes the world go around, or at least helps vehicles that go around the world.

The oil market has always been as volatile as it has been important to economies across the globe. Many economists point to the petrodollar as the reason for U.S. economic dominance. The fact that countries such as India, Russia, China, Saudia Arabia, and the United Arab Emirates are all trying to figure out how to trade oil without the dollar gives some credence to this reasoning. Renewable energy continues to eat away at the dominance of fossil fuels, oil, and coal in particular, but still makes up only 13% of the energy consumed in 2022 according to the most recent data from the U.S. Energy Information Administration (EIA).

It is reasonable to assume that renewable usage has grown in the past year but not enough to replace the 36% of energy consumption that oil provided in 2022. The role oil has in the economy is hard to overstate. High oil prices, and by extension, high gas prices, have a direct impact on consumer sentiment. Elections have been won and lost due to the price of gas, and wars have been fought over oil. It’s that important.

Oil may seem insignificant if you’re judging by U.S. Market Cap.

If someone were to judge the importance of a particular economic sector in the U.S. by market capitalization (cap), oil would seem insignificant. Market cap is the value of all outstanding shares of stock for a company multiplied by the current price of a share of stock. As of January 22, 2024, the market cap of Microsoft is $2.963 trillion, Apple is $2.961 trillion, Nvidia, a semiconductor manufacturer, has a market cap of $1.469 trillion, and Tesla clocks in with $674 billion in market cap, all according to Finviz.com. By comparison, the entire S&P 500 Energy sector, with 23 companies including Exxon, Chevron, and Conoco Phillips, has a market cap of $1.527 trillion.

To put this in simple terms, if a person owned Apple or Microsoft and could sell them for their current market cap, that person could then turn around and buy every company in the S&P 500 energy sector and have just over $1.4 trillion left over. Tesla, an electric car manufacturer, is worth the same amount as the 19 smallest companies in the S&P 500 energy sector combined. Keep in mind that Tesla sold 1.8 million cars globally last year, or roughly 11% of the vehicles sold in just the U.S.

Metrics such as price-to-earnings ratio, price-to-sales, and price-to-book value show that oil companies are undervalued relative to the rest of the stock market. Oil companies also provide some of the higher dividend yields in the S&P 500, with companies such as Exxon and Chevron providing yields of 3.81% and 4.24%, respectively, based on data from Finviz.com.

The volatility of the oil market is not for the faint of heart.

Since 2008, there have been three significant busts. Initially shale drilling in the US was not as productive as conventional wells, and it cost a lot more. Oil companies found that getting financed by banks was difficult after the bust in 2015-2016 and became even more difficult after 2020. The number of companies in the oil and gas sector has been reduced significantly due to these issues. Technological advances and new processes have reduced the cost of shale drilling, and productivity has increased. This has provided more pricing power to the remaining companies, but this is still a global market.

Last year, the U.S. produced the most oil in our history.

But OPEC still carries weight in the oil market, and their decisions to cut or increase production certainly have ramifications for US producers. Energy production fell during COVID, as did prices. Post-COVID, as consumption ramped up, energy production lagged demand, and oil futures prices responded by shooting up from a low of $32.12 per barrel for Brent Crude on April 24, 2020, to $112.24 on June 10, 2022, according to data from the NYMEX futures exchange. Since that high, oil has retreated to $75.01 per barrel as of January 22, 2024.

As oil prices have fallen from increased production, inflation has also receded. Slowing growth in China and sanctions on Russia stemming from the war in Ukraine helped push prices down globally. More supply is coming online due to the U.S. temporarily lifting sanctions on Venezuela, reintroducing a major oil supplier to the global stage.

As of November 2023, Venezuela was producing 850,000 barrels per day and steadily increasing production. With the largest reserves in the world of close to 304 billion barrels, according to Statista data, there is significantly more they can produce. Guyana has also discovered roughly 11 billion barrels of their coast in the last decade, which has led to a dispute with Venezuela. Angola is also increasing production which was the reason for its recent split from OPEC. All this supply increasing at a time when global growth is slowing provides context for the stock price of US oil companies.

Supply and demand can change quickly in the oil market.

Hurricanes in the Gulf of Mexico can increase prices rapidly, for example. But nothing can change the price trajectory of oil like a war in the Middle East. The war between Israel and Hamas continues to threaten a larger spillover. Should Iran become more involved, it is conceivable that oil prices could spike. If sustained, a spike in oil prices would impact inflation and the potential for the interest rate cuts investors are expecting here in the U.S.. Russia is also one of the world’s largest oil producers, and changes in their war with Ukraine could also impact oil prices, as could the dispute between Venezuela and Guyana if it continues to escalate.

The rig count in the US is declining, meaning there will be fewer rigs producing oil, and due to the consolidation in the industry the remaining players will continue to enjoy more control over production and pricing. Add in rumors of a large stimulus package to revive China’s ailing economy, and it is plausible to see several scenarios where oil prices jump, increasing the price of oil company stocks.

In conclusion…

The oil market affects us economically every day, from the gas pump to the cost of the goods and services we purchase. While oil company stocks may look like a buy based on certain metrics, there are reasons the market prices as it does. The dynamics can and do change in an instant.

At Central Trust Company, we continuously assess the rapidly changing investment landscape for both risks and opportunities. If you are wondering how your assets translate into securing your future, a financial plan is a great place to start. Please reach out to your team here at Central Trust Company to create or update a financial plan.

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