Broker Check

Oil Prices Surge

April 29, 2019

Just as the summer driving season is about to begin oil prices have once again become a popular topic of conversation. The higher prices at the gas pump may make a summer road trip more expensive in addition to increasing the cost of commuting and other forms of travel such as air travel. What is driving oil prices higher? Will the oil market soon find equilibrium or will prices reclaim the $100 per barrel level last seen in 2014?

Crude oil prices started the year at $42.77 per barrel. This was well up from the cyclical low of $26 in early 2016 but still represented a relatively low price compared to the average prices over the past decade. However, in just the first four months of 2019 the price of oil has surged 39% to $66.50 per barrel.

The increase in oil prices has been largely driven by supply constraints. The Organization of Petroleum Exporting Countries (OPEC) led by Saudi Arabia and supported by Russia (two of the world’s largest oil exporters) have coordinated to limit supply in an effort to push prices higher.

In addition, US sanctions against Iran have restricted the supply of Iranian oil. In April the US lifted the exemptions from sanctions that had been given to several countries which will in effect nearly completely cut off the export of Iranian oil. Taking a major oil producer offline by cutting off their access to foreign markets has tipped the supply and demand curve of oil in favor of oil producers rather than those of us who consume oil-based products at the gas pump.

With oil prices increasing so quickly in 2019 many analysts are asking whether this is a short-term supply shock which will moderate as other producers  increase  production  or  if  it  is  a  more structural issue which could cause oil prices to continue to rise, possibly even regaining the $100 per barrel level last seen in 2014 and before that in 2018.

One argument is that the recent increase in oil prices is due to a perfect combination of factors that allowed supply restrictions to have an out sized increase on price. When oil prices were in the $25-$45 range only the low-cost producers in the Middle East and Russia could sell oil at a reasonable profit margin. Therefore, when these producers restricted supply it had a large impact on the price. However, as oil prices increase many of the higher cost producers, such as those in the US, will have an incentive to restart or increase production as it will once again be profitable when oil prices are between $50-70. Therefore, while there may be a delay in the ability of domestic oil producers to respond to higher oil prices it is likely that new supply will be coming online to reduce the under supply of the market and possibly cause oil prices to settle in a more moderate range.

In the meantime, consumers may need to watch their budget carefully to manage the higher cost of gasoline. In some cases the higher prices cannot be avoided, such as fuel needed to commute to a job. In this case the only strategy may be to look at other budget categories that can be reduced so that the funds that are going to gasoline can be increased. In other cases, the increased prices may be offset by greater work schedule flexibility such as working from home one day in week. Increased gasoline prices can also be partially offset by behavioral changes. Coordinating trips away from home so that everything can be done in one trip can reduce the gallons consumed per week. Where a household has two vehicles is may be advisable to increase the utilization of the more fuel-efficient vehicle when possible.