Commentaries

PMC Weekly Review - May 11, 2018

A Macro View: Do higher gas and oil prices signal a “nuclear fallout” of slower future growth?

Memorial Day weekend typically marks a high point in gas prices every year—summer is near, and many of us will be hitting the open roads. Over the last few years, we have enjoyed low prices at the pump, which have provided us with more disposable income—but all this may be ending. As gas and oil prices continue to rise, we may be forced to alter how we drive, spend, and live. 

The recent tax cuts have put more money in our pockets, but higher gas prices facing us this summer will affect our ability to spend that surplus on other goods and services. Although the prices are still nowhere near the peaks we saw in June 2008, when prices averaged $4.00 per gallon, or in May 2011, when average prices were $3.90, we might be headed in that direction. In 2017, the average price per gallon of gas across the country was $2.34 compared with today’s average of $2.82, an increase of more than 20%.1 Over this same period, West Texas Intermediate Oil (WTI) also increased from an average of $51 per barrel to nearly $70 per barrel.2

Geopolitical worries are a significant factor in rising gas and oil prices, as the United States has withdrawn from the Joint Comprehensive Plan of Action (more commonly known as the Iran nuclear deal), and plans on restoring sanctions that target Iran’s energy, financial, and industrial sectors. President Trump’s decision to pull out of the deal can have far-reaching consequences for the oil market, gas prices, and overall relations in the Middle East. Iran is the third-largest oil producer within the Organization of Petroleum Exporting Countries (OPEC), and the sanctions should cause tighter supply by removing as much as one million barrels of Iranian oil per day.3 Furthermore, oil-rich Venezuela’s dramatic cut in production also has impacted prices as the country’s oil output recently fell to its lowest levels in almost 30 years. Venezuela is facing an economic crisis that is getting worse, with no cash for maintenance or investment, a debt crisis, and U.S. sanctions that will only continue to place pressure on their output.4 

Oil supply also has been driven lower due to an OPEC agreement, established in January 2017, to cut oil production. OPEC’s goal in this agreement was to reduce the amount of surplus oil stored around the world, thus increasing the global price of oil. Talks suggest that OPEC may continue with the agreement through 2019, thereby continuing to place pressure on the oil supply and consequently increasing gas prices. OPEC is scheduled to meet on June 20 to decide whether to keep in place the agreement to cut oil production.5 

If it were not for the US shale oil industry’s increased production, we already would likely be facing gasoline and oil prices that are significantly higher than we see today. However, demand has recently outpaced supply, as solid world-wide economic growth has put even more pressure on gas and oil prices. It remains to be seen if these prices will continue on their current upward trajectory, or whether they will fall back to the lower levels that we have grown accustomed to for the last few years. What we do know is that oil price fluctuations have considerable consequences on economic and capital markets activity. In fact, ten of the last eleven post-World War II recessions occurred on the heels of oil price spikes.6 Will rising oil prices be the impetus that finally brings the long-running stock market to its knees? 

1 https://www.cnbc.com/2018/05/03/gas-prices-hit-three-year-high-and-are-expected-to-keep-rising.html

2 http://www.macrotrends.net/1369/crude-oil-price-history-chart

http://www.opec.org/opec_web/en/data_graphs/330.htm​

4 http://money.cnn.com/2018/02/12/news/economy/venezuela-oil-production/index.html

https://www.forbes.com/sites/ellenrwald/2018/04/19/oil-prices-are-going-up-and-so-is-your-gasoline-bill/#4351a3d65a3f

http://econweb.ucsd.edu/~jhamilton/oil_history.pdf​

Michael Pajak, CAIA
Investment Analyst

Download the full PDF

The information, analysis, and opinions expressed herein are for general and educational purposes only. Nothing contained in this weekly review is intended to constitute legal, tax, accounting, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. All investments carry a certain risk, and there is no assurance that an investment will provide positive performance over any period of time. An investor may experience loss of principal. Investment decisions should always be made based on the investor’s specific financial needs and objectives, goals, time horizon, and risk tolerance. The asset classes and/or investment strategies described may not be suitable for all investors and investors should consult with an investment advisor to determine the appropriate investment strategy. Past performance is not indicative of future results.

Information obtained from third party sources are believed to be reliable but not guaranteed. Envestnet|PMC™ makes no representation regarding the accuracy or completeness of information provided herein. All opinions and views constitute our judgments as of the date of writing and are subject to change at any time without notice.

Investments in smaller companies carry greater risk than is customarily associated with larger companies for various reasons such as volatility of earnings and prospects, higher failure rates, and limited markets, product lines or financial resources. Investing overseas involves special risks, including the volatility of currency exchange rates and, in some cases, limited geographic focus, political and economic instability, and relatively illiquid markets. Income (bond) securities are subject to interest rate risk, which is the risk that debt securities in a portfolio will decline in value because of increases in market interest rates. Exchange Traded Funds (ETFs) are subject to risks similar to those of stocks, such as market risk. Investing in ETFs may bear indirect fees and expenses charged by ETFs in addition to its direct fees and expenses, as well as indirectly bearing the principal risks of those ETFs. ETFs may trade at a discount to their net asset value and are subject to the market fluctuations of their underlying investments. Investing in commodities can be volatile and can suffer from periods of prolonged decline in value and may not be suitable for all investors. Index Performance is presented for illustrative purposes only and does not represent the performance of any specific investment product or portfolio. An investment cannot be made directly into an index.

Alternative Investments may have complex terms and features that are not easily understood and are not suitable for all investors. You should conduct your own due diligence to ensure you understand the features of the product before investing. Alternative investment strategies may employ a variety of hedging techniques and non-traditional instruments such as inverse and leveraged products. Certain hedging techniques include matched combinations that neutralize or offset individual risks such as merger arbitrage, long/short equity, convertible bond arbitrage and fixed-income arbitrage. Leveraged products are those that employ financial derivatives and debt to try to achieve a multiple (for example two or three times) of the return or inverse return of a stated index or benchmark over the course of a single day. Inverse products utilize short selling, derivatives trading, and other leveraged investment techniques, such as futures trading to achieve their objectives, mainly to track the inverse of their benchmarks. As with all investments, there is no assurance that any investment strategies will achieve their objectives or protect against losses.

Neither Envestnet, Envestnet|PMC™ nor its representatives render tax, accounting or legal advice. Any tax statements contained herein are not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal, state, or local tax penalties. Taxpayers should always seek advice based on their own particular circumstances from an independent tax advisor.

© 2018 Envestnet. All rights reserved.