OPEC and Your Investments — The Effects of High Oil Prices

By Matthew Schmidt
Analyst, mPower

Are you spending so much at the gas station that it seems extravagant to pay for a car-wash, too? Does it feel like a splurge to heat your home on Friday night and order pizza? If so, you are experiencing some of the not-so-subtle effects of increasing oil prices.

Commuters and consumers alike might want to continue socking away the week's change to pay for gas and Friday night take-out, because the recent upward trend in oil prices may not be over yet.

Last year was a scorcher for oil prices. From a December 1998 low of $10.35, crude oil futures hit $32.15 a barrel on the New York Mercantile Exchange on March 2, 2000. This was the highest oil price since January 1991 -- when the United States entered the Gulf War. The nearly threefold jump in prices is largely the result of agreement within OPEC.

OPEC, the Organization of Petroleum Exporting Countries, is group of 11 oil producing and exporting countries from around the world. The organization meets twice a year to discuss and coordinate ideas and policies that attempt to stabilize oil prices and promote profits for the member countries.

OPEC countries include Algeria, the Socialist People's Libyan Arab Jamahiriya, Nigeria, Indonesia, the Islamic Republic of Iran, Iraq, Kuwait, Qatar, Saudi Arabia, the United Arab Emirates, and Venezuela.

Source: The Organization of Petroleum Exporting Countries. Used with permission.

These nations own about 75% of the world's oil reserves and account for about 40% of total production. Because they control such a large segment of the market, member countries wield a lot of influence in how much oil other countries have and, therefore, how much non-member countries pay for oil.

In response to oil prices reaching their lowest level in 12 years, the organization decided last year, at their March 1999 meeting, to lower the world's supply of crude oil by approximately 7% (which is about 2 billion barrels a day).

These export cuts dramatically reduced the supply of oil available to countries around the world, and the result was a steady increase in oil prices over the past year.

Source: Energy Information Administration, Form EIA-182.

Oil prices are largely the product of the balance of supply and demand: when producers are pumping and delivering large amounts of oil, there is enough for everyone and prices are lower.

When oil-producing countries agree to limit or stop their exports, non-oil producing countries, such as the United States, receive less than enough to meet their needs, making prices go up. Other international factors, such as war, bad weather, strikes, and taxes can also affect prices if oil production or delivery is jeopardized.

The oil industry is an integral part of the global economy, and price fluctuations within the industry can affect everyone.

Oil prices can impact transport prices, costs of goods and services, and the availability of many life-sustaining products like food, water, heating, and housing. One of the most obvious effects is on gasoline. Higher oil prices will be passed on to the consumer by higher gas prices.

Whether you are an individual or a corporation, higher gas prices can sting if you own a car, truck, airplane, ship, or any other vehicle that uses oil as an energy source.

According to the Energy Information Administration, the averge price for a gallon of gasoline, as of March 13, 2000, was $1.57, as compared with the spring 1999 price of $1.00.

Over time, if oil prices continue to rise, individuals and corporations alike could begin to see signs of the dreaded "I" word: inflation.

Inflation, the sustained rise in the general level of prices, is generally viewed as harmful because it causes the real value of income to decrease and can distort investment and consumption decisions.

Few can forget the oil shocks of the 1970s -- the first in 1973 caused prices to quadruple, and the second in 1979 saw prices that nearly tripled. Both produced surging inflation and global recession.

The question on the minds of many investors today is, will the recent surge in oil prices deal us the same fate?

Fortunately, many developed countries are less prone now to the effects of oil shocks that characterized the 1970s.

Spending on oil is a smaller percentage of the economy than it was 20 years ago. Computers, telecom, and other less energy-intensive industries are becoming increasingly important to global economies. Increased attention to alternate forms of energy and overall greater energy efficiency also have insulated the economy more from the effects of rising oil prices.

The price of crude oil also makes up a smaller percentage of gasoline prices than in the 1970s. Today, taxes on gasoline comprise as much as 70% of the final price paid by consumers in some countries. Overall, we are not in the same economic environment as the shocks of the 1970s, and we are reminded often of the strength of our economy.

Indeed, a poll of leading economists last month by Reuters suggested that the Consumer Price Index (a primary measure of inflation) would actually fall in 2000 to 2.4%, vs. the 1999 rise to 2.7%.

So what does this mean for the average investor? Well first of all, watch for the next biannual meeting of OPEC on March 27, 2000. The price of a barrel of oil will depend on whether OPEC agrees to maintain or expand production at that meeting.

An OPEC decision to open the spigots is likely to sate some pent-up demand, depending on how much more oil will be made available. This would likely cause prices to decline, reducing the likelihood of inflationary pressures from oil. The International Energy Agency estimates that the world needs a 2.4% increase in 2000 (about 2.3 million barrels of crude oil per day) just to return to a seven-year production average (1990-1996). If exports are increased, OPEC will determine the amount at its March 27 meeting.

If OPEC decides to keep current export quotas, oil prices may continue their rise and we could see signs of public enemy number one: inflation. Overall, this could result in volatile markets, continued rising interest rates, and slower growth in the economy. The effects will also be felt in specific industries as well. Sectors that depend on oil in their operations will face higher costs. This includes airlines, automobile makers, shipping companies, and chemical companies.

Even if oil prices do continue their upward trend, the effects on the economy are likely to be less pronounced than in the past. But consumers will definitely be hit with higher gas prices. You can ease the sting by looking for alternate means of commuting: bike, train, ferry… anything but your SUV.

The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.

OPEC and Your Investments — The Effects of High Oil Prices

By Matthew Schmidt
Analyst, mPower

Are you spending so much at the gas station that it seems extravagant to pay for a car-wash, too? Does it feel like a splurge to heat your home on Friday night and order pizza? If so, you are experiencing some of the not-so-subtle effects of increasing oil prices.

Commuters and consumers alike might want to continue socking away the week's change to pay for gas and Friday night take-out, because the recent upward trend in oil prices may not be over yet.

Last year was a scorcher for oil prices. From a December 1998 low of $10.35, crude oil futures hit $32.15 a barrel on the New York Mercantile Exchange on March 2, 2000. This was the highest oil price since January 1991 -- when the United States entered the Gulf War. The nearly threefold jump in prices is largely the result of agreement within OPEC.

OPEC, the Organization of Petroleum Exporting Countries, is group of 11 oil producing and exporting countries from around the world. The organization meets twice a year to discuss and coordinate ideas and policies that attempt to stabilize oil prices and promote profits for the member countries.

OPEC countries include Algeria, the Socialist People's Libyan Arab Jamahiriya, Nigeria, Indonesia, the Islamic Republic of Iran, Iraq, Kuwait, Qatar, Saudi Arabia, the United Arab Emirates, and Venezuela.

Source: The Organization of Petroleum Exporting Countries. Used with permission.

These nations own about 75% of the world's oil reserves and account for about 40% of total production. Because they control such a large segment of the market, member countries wield a lot of influence in how much oil other countries have and, therefore, how much non-member countries pay for oil.

In response to oil prices reaching their lowest level in 12 years, the organization decided last year, at their March 1999 meeting, to lower the world's supply of crude oil by approximately 7% (which is about 2 billion barrels a day).

These export cuts dramatically reduced the supply of oil available to countries around the world, and the result was a steady increase in oil prices over the past year.

Source: Energy Information Administration, Form EIA-182.

Oil prices are largely the product of the balance of supply and demand: when producers are pumping and delivering large amounts of oil, there is enough for everyone and prices are lower.

When oil-producing countries agree to limit or stop their exports, non-oil producing countries, such as the United States, receive less than enough to meet their needs, making prices go up. Other international factors, such as war, bad weather, strikes, and taxes can also affect prices if oil production or delivery is jeopardized.

The oil industry is an integral part of the global economy, and price fluctuations within the industry can affect everyone.

Oil prices can impact transport prices, costs of goods and services, and the availability of many life-sustaining products like food, water, heating, and housing. One of the most obvious effects is on gasoline. Higher oil prices will be passed on to the consumer by higher gas prices.

Whether you are an individual or a corporation, higher gas prices can sting if you own a car, truck, airplane, ship, or any other vehicle that uses oil as an energy source.

According to the Energy Information Administration, the averge price for a gallon of gasoline, as of March 13, 2000, was $1.57, as compared with the spring 1999 price of $1.00.

Over time, if oil prices continue to rise, individuals and corporations alike could begin to see signs of the dreaded "I" word: inflation.

Inflation, the sustained rise in the general level of prices, is generally viewed as harmful because it causes the real value of income to decrease and can distort investment and consumption decisions.

Few can forget the oil shocks of the 1970s -- the first in 1973 caused prices to quadruple, and the second in 1979 saw prices that nearly tripled. Both produced surging inflation and global recession.

The question on the minds of many investors today is, will the recent surge in oil prices deal us the same fate?

Fortunately, many developed countries are less prone now to the effects of oil shocks that characterized the 1970s.

Spending on oil is a smaller percentage of the economy than it was 20 years ago. Computers, telecom, and other less energy-intensive industries are becoming increasingly important to global economies. Increased attention to alternate forms of energy and overall greater energy efficiency also have insulated the economy more from the effects of rising oil prices.

The price of crude oil also makes up a smaller percentage of gasoline prices than in the 1970s. Today, taxes on gasoline comprise as much as 70% of the final price paid by consumers in some countries. Overall, we are not in the same economic environment as the shocks of the 1970s, and we are reminded often of the strength of our economy.

Indeed, a poll of leading economists last month by Reuters suggested that the Consumer Price Index (a primary measure of inflation) would actually fall in 2000 to 2.4%, vs. the 1999 rise to 2.7%.

So what does this mean for the average investor? Well first of all, watch for the next biannual meeting of OPEC on March 27, 2000. The price of a barrel of oil will depend on whether OPEC agrees to maintain or expand production at that meeting.

An OPEC decision to open the spigots is likely to sate some pent-up demand, depending on how much more oil will be made available. This would likely cause prices to decline, reducing the likelihood of inflationary pressures from oil. The International Energy Agency estimates that the world needs a 2.4% increase in 2000 (about 2.3 million barrels of crude oil per day) just to return to a seven-year production average (1990-1996). If exports are increased, OPEC will determine the amount at its March 27 meeting.

If OPEC decides to keep current export quotas, oil prices may continue their rise and we could see signs of public enemy number one: inflation. Overall, this could result in volatile markets, continued rising interest rates, and slower growth in the economy. The effects will also be felt in specific industries as well. Sectors that depend on oil in their operations will face higher costs. This includes airlines, automobile makers, shipping companies, and chemical companies.

Even if oil prices do continue their upward trend, the effects on the economy are likely to be less pronounced than in the past. But consumers will definitely be hit with higher gas prices. You can ease the sting by looking for alternate means of commuting: bike, train, ferry… anything but your SUV.

The information provided here is intended to help you understand the general issue and does not constitute any tax, investment or legal advice. Consult your financial, tax or legal advisor regarding your own unique situation and your company's benefits representative for rules specific to your plan.