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What’s Going on With Oil Prices?

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No one can consistently and accurately predict where oil prices will be—it’s a commodity, subject to changes in supply and demand, to the psychology of buyers and sellers, and to global happenings. Put five economists in a room and you’ll get five opinions (or, as the old joke goes, six, if one of them went to Harvard).

Why do oil prices matter?

At the risk of sounding simplistic, oil is important because it fuels the global economy, impacting everything from manufacturing and transportation costs to currency and interest rates. It’s been blamed for much of the recent volatility in financial markets.

It also impacts the apparel industry in the form of fiber and other production costs, and helps drive retail and consumer spending.

2015 was the second year in a row that saw a significant decline in world oil prices. After being cut in half in 2014 to $50 a barrel, the price of Brent crude, the global benchmark, plunged another 35 percent in 2015 to just over $37. In January this year, prices dropped yet another 13 percent.

Persistent oversupply

Oversupply is the primary reason for the plunge in oil prices. The decade-long investment by U.S. shale-oil producers, also called frackers, intended to reduce U.S. dependency on foreign oil, began bearing fruit starting in late 2014, and turned out to be so productive that it started an oil glut that persists to this day and shows no sign of letting up. The International Energy Agency estimates that global oil production increased from 93.7 million barrels per day in 2012 to almost 97 million barrels per day by the end of 2015, or more than 2 million barrels per day above estimated global demand, according to the agency.

The Organization of Petroleum Exporting Countries (OPEC), which includes Saudi Arabia, Kuwait, Venezuela and 10 other countries, has often curtailed production when supply outpaces demand. This time, however, it kept the spigots on, presumably to preserve their market share. Inventories of crude oil finished 2015 at their highest levels in decades. Iran has also started to export more oil as sanctions against them get lifted, which will add to the oversupply.

Impact on economies and markets

In the U.S., energy companies have suffered steep earnings losses, cut expenses and laid off people. These cutbacks have reverberated into other industries and cast a pall over financial markets. Tepid stock markets in 2015, impacted everything from pension funds to 401Ks to college savings accounts.

The World Bank estimated that global economic growth was a disappointing 2.5% in 2015, a figure it expects to rise only slightly in the coming year. Manufacturing activity in China has slowed significantly over the past several months, resulting in lower global demand for energy, and putting tremendous pressure on global economic growth. Key developing countries, which many expected would help jump-start global economic growth, have instead fallen into recession. Oil exporting countries have seen their tax revenues drop and currencies weaken.

Apparel raw materials prices have been significantly impacted by the oil glut. Global manmade fiber prices dropped 17 percent in 2015, helped by lower petrochemical intermediates prices that were passed along by fiber producers. However, a slowdown in global fiber demand also pressured prices.

Less pain at the pump

Some of the decline in oil prices has shown up as a windfall for consumers. Between the middle of 2014 and the end of 2015, the average price of a gallon of gas in the U.S. had dropped 47 percent to $2 per gallon. The U.S. Energy Information Administration (EIA) expects the average price of $2.29 in 2016.

However, lower gas prices are not quite the bright spot for consumers that they used to be. Because of demographics and urbanization, automobile usage in developed countries is decelerating. Millennials are choosing to live in urban areas where they can use public transportation or travel shorter distances to their destinations. Retiring baby boomers are no longer commuting to work.

The weekly retail sales by refiners to U.S. gas stations fell from 28,000 gallons per day in January 2012 to 25,000 gallons per day in October 2015.

What about the gas bonus? In late 2014, retail economists were hoping consumers would spend the money they saved on gas and fuel oil on discretionary categories like apparel, footwear and accessories. But such a spike in spending never happened.

In fact, U.S. Department of Commerce data released Monday showed that disposable income in the U.S. increased by 3.8% in 2015, but that personal consumption expenditures rose by only 3.4%. The personal savings rate, however, rose by 12.5%, indicating Americans are using their rising incomes to pay off debt and invest for the future. At the end of 2015, the U.S. personal savings rate was 5.5%, its highest rate in three years.

What will 2016 bring?  

The predictions on where oil prices will be in 2016 are all over the map. U.S. EIA estimates have oil rising to $40 per barrel by the end of 2016. The World Bank estimates put the average price at $37 in 2016.

Other forecasts are more bearish. Both Goldman Sachs and Morgan Stanley have released reports that put oil potentially falling to levels between $20 and $25 per gallon, up to double the decline predicted by the U.S. EIA. Whereas Morgan Stanley believes the continued decline will be due to the strong U.S. dollar, Goldman cites other factors.

In light of these estimates, which put oil between a fairly wide band of price predictions, it is safe to assume that the volatility and oversupply will continue for at least another year.

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