One of the biggest stories in investing over the past few months has been falling oil prices and their effects on a whole range of investments. As critical as oil is to powering our everyday lives, most people are uncertain about how the rapid decline in oil prices impacts their investments.
The fact is that most U.S. investors have some of their money in the big oil companies and in equipment companies, distribution companies and other industries that support oil. The S&P 500, probably the best-recognized index of U.S. public corporations, lists 43 energy companies, the majority of which are dedicated to extracting and distributing petroleum (Exxon Mobile is the second largest corporation on the index by market capitalization). The sheer size of the oil industry means that it is a cornerstone of mutual funds, hedge funds, pension plans, 401k plans, trust & endowments and individual investing. Unless you’ve done something to opt out, you should assume that you are “in” oil.
So what is all of the market concern about? A few years ago, the big discussion was “peak oil,” the observation that oil is a limited resource, and we will hit a point at which supplies are dwindling. We will still hit that someday, of course, but contraversial advancements in oil extraction (from tar sands bitumen and shale, in particular) flooded the market, increasing supplies. This development means cheaper fuel prices, but there is a catch.
The cost to extract oil varies tremendously depending on local geology, method and things like labor costs. Most North American shale fields probably lose money at anything below $60-$70 a barrel. Tar sands oil has even less margin because of the difficulty of refining it. Saudi Arabian oil, on the other hand, is significantly cheaper to extract. And this is what OPEC is counting on. Under Saudi leadership, OPEC has taken the position that letting prices crash in the short term will run some of the competition out of business.
Will it work? No one is sure, yet. But we can say that as long as the oil industry is focused on its price wars, we will be seeing a bit of a damper on the performance of U.S.’s oil-soaked investments.