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Oil and you

Personal Finance | It's all about supply and demand

Issue: "Two-ring circus," Sept. 6, 2008

Dominating the causes of the trouble in the stock market over the last year has been the rising cost of oil. Though the price per barrel has come down in recent weeks (the price was at an all-time high of $147 per barrel in early July), the fact remains that the price has virtually doubled in the last year. While many speculate on the root causes of the price increase, fewer suggest practical applications to your own situation.

Prices are directly set by supply and demand forces, no less for oil than any other commodity. The media have been fond of indicting "oil speculators" in recent times for "artificially moving the price of oil up," but the truth is that the price of oil is not set by speculators. They are simply trying to make a profit in predicting what the price will be.

For every dollar placed on a trade betting that oil will increase in price, there is another dollar placed betting the opposite. The futures market in our country is an even-sum game--there are two sides to every trade. It is poor economics to suggest that sideline investors are superseding fundamental principles of supply and demand. The price of oil has moved up because demand for it has dramatically increased, while supply has not increased to meet demand. The massive industrialization of China, India, and many of the world's emerging economies has created a worldwide demand for energy that oil is counted on to fulfill. In the meantime, daily pumping from known reserves has stayed flat, if not actually decreased. Economics 101 tells us this creates higher prices.

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Much has been made of our country's failure to increase supply. Many blame the moratorium on offshore drilling. Advocates of drilling in ANWR (the Arctic National Wildlife Refuge, a massive source of oil on 19 million acres of land in northeast Alaska) are quick to point out the possibilities that exist there while others see eventual solutions in alternative sources of energy, such as nuclear power, solar power, or bio-fuels.

My interest is not in joining the political fray on this topic, but to make the obvious economic assertion that demand decrease, and/or supply increase, regardless of how those things are created, represent the only chance of decreasing the price of oil. If less people need oil, prices should come down. If more oil is available, we can expect a downward pressure on prices.

High prices always do what they are intended to do, and that is decrease demand. With clients I often use the example of a really nice steak. Many of us love a good filet mignon, and many of us would pay a hefty premium to enjoy one every now and then. But if $20 is deemed reasonable for a nice steak, and $50 is considered to be hefty, but affordable, surely $1,000 is a ridiculous price to pay for a piece of beef. That same principle applies to consumption of oil-at some price, demand decreases.

My belief is that we face a conflict in the coming decade that will have a huge effect on both supply and demand. Political pressure is likely to force a more intelligent and aggressive pursuit of increased supply (regardless of which party occupies the White House). On the other side of the supply/demand coin, the use of gasoline-fueled cars is very likely to decrease (perhaps dramatically).

The practical application of all this is simple: Make sure your portfolio has addressed the changing cost of world energy. Discuss with your financial advisor whether your investments stand to benefit from the era we are entering, or will be suffering through these new realities. Curtail your own behavior as a consumer of energy to within your personal monthly budget. And most importantly, never presume that the way things are, is the way they always will be. God's world is far more dynamic: A world of $20 per barrel oil (as it was in 2002!) can become a world of $145 per barrel oil. And can change again. But God is in control of all things.

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