THE IMPACT OF RISING OIL PRICES

Overview

The Trump Administration is poised to reimpose sanctions on Iran six months from its May decision to withdraw from the Iran nuclear deal. The agreement stated that Tehran would curb its nuclear activities in exchange for removing previous sanctions by the U.S. and Europe. Once the U.S. sanctions are back in play, they have the potential to disrupt oil shipments from Iran by as much as 1 million barrels a day.

This constraint in oil supply will likely send prices even higher. In fact, some analysts are predicting prices could rise as high as $100 a barrel — nearly a 300 percent increase from $26 a barrel just two years ago.

“Europe and China will not fight against the U.S. sanctions. They will grumble and accept it. There is no one who will realistically choose Iran over the U.S.”

Iran

Iran currently produces about 4 percent of global oil supplies. Although the U.S. sanctions have a 180-day grace period, the Department of the Treasury predicts other countries will begin reducing their Iranian oil purchases sooner, as this will increase their chances of obtaining a waiver from U.S. sanctions. The present assumption is that the U.S. will try to isolate Iran from global oil sales by potentially hundreds of thousands of barrels per day.

OPEC

The Organization of the Petroleum Exporting Countries (OPEC) is an intergovernmental organization of 14 nations founded in 1960. As of May 2018, OPEC member nations were Iran, Iraq, Kuwait, Saudi Arabia, Venezuela, Qatar, Libya, United Arab Emirates, Algeria, Nigeria, Ecuador, Angola, Gabon and Equatorial Guinea.

OPEC’s objectives are to: 

  • Coordinate and unify petroleum policies among member countries
  • Secure fair and stable prices for petroleum producers
  • Provide an efficient, economic and reliable supply of petroleum to consuming nations
  • Offer a profitable return to investors who help support the oil industry

Note that the intent of the OPEC agreement is to not have any one country dominate the market, controlling both prices and output. Should any one OPEC member step up its current distribution to replace all of the oil that Iran currently supplies, it would likely violate the spirit of the pact.

USA

The key to maintaining lower oil prices is to replace the Iranian supply line. There are several nations poised to do this. For example, the United States is now considered the fastest-growing energy superpower, largely due to the prevalence of the fracking process used to drill for oil domestically. In fact, the U.S. Energy Information Administration (EIA) recently raised its forecast for U.S. production to 12 million barrels per day by late next year. This level of output would catapult the United States to becoming the world’s largest producer, ahead of both Russia and Saudi Arabia.

However, the United States is not likely to bear the brunt of replacing Iranian oil supplies.

Russia and Saudi Arabia

Russia is the No. 1 producer of oil in the world, and it also stands poised to benefit from increased oil prices. Together, Russia and Saudi Arabia have been working to tighten the oil market for the express purpose of increasing prices.

In fact, the biggest beneficiary of Trump’s decision could be Saudi Arabia, which has the largest capability to meet demand once Iran’s oil is out of the market. Supplementing the market will help reduce the chance of further price hikes. Regardless, prices are expected to increase to some extent, and those countries picking up the slack in oil production will realize the most benefit.

Saudi Arabia is in favor of higher oil prices to help its flailing economy, with rumors circulating that it is targeting $80 to $100 per barrel. However, some analysts believe that the U.S. abandoned the Iran deal in an arrangement with Saudi Arabia to step up its volume of oil distribution but keep prices restrained.

Consumer Impact

As a general rule, consumers end up paying higher prices at the pump and for air travel, cruises, etc. when oil prices rise. However, thanks to the increase in U.S. oil production in recent years, we have become less reliant on petroleum imports. As a result, higher oil prices aren’t likely to have as significant an impact on the U.S. economy as in the past.

Unfortunately, Americans who’ve experienced little wage growth and maintain high debt may find even a marginal increase in gas prices hard to manage. According to AAA, the national average in May was about $2.81 a gallon, up from $2.34 a year ago. The Oil Price Information Service predicts that the typical American family will spend about $200 more on gas this summer. While this is a jump from what we’ve been paying over the last couple of years, so far no one is predicting the $3.50-gallon range from six or seven years ago.

Another caveat is that when a higher portion of the household budget is spent at the gas pump, less money is spent elsewhere. This lower consumer spending can have an impact on the country’s overall economic growth.

Investor Impact

On the flip side, higher gas prices tend to benefit oil producers, distributors, equipment manufacturers and related companies in the supply chain. Investments in big oil stocks have ramped up in expectation of higher profits and bigger share buybacks. In May, the price of oil reached $70 per barrel, leading the stock market to its best week in two months.

Both in the U.S. and all over the globe, higher oil prices are a positive for the highly volatile oil industry and its millions of workers.

Final Thoughts

Investors interested in the oil industry should recognize that it can be both lucrative and volatile. It is one of those sectors in which high risk teeters with the opportunity for high reward — but it’s difficult to capture that balance.

It’s important to work with an experienced financial advisor to find appropriate ways to invest in oil stocks, often by taking a balanced approach and diversifying appropriately across a wide range of assets — international and domestic — to help offset risk.

As always, consider your tolerance for high-risk volatility, your investment timeline and your ultimate financial objectives.