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Trickle-down effects of oil prices

The forces of supply and demand have combined for months to lower oil prices. In a Money Talk Video, Brian Kilb explains what that price drop means for consumers, producers and, on balance, for investors. He spoke with Joel Dresang.

Joel Dresang: Brian, the price of oil is at a four-year low. It’s gone down about 25% since June. I’m thinking that’s a good thing, but there’s probably more to the story than that.

Brian Kilb: There always is, Joel. Yeah, the situation with oil is two-sided, like all things. There’s a good news and bad news, depending on whether you’re on the producer side or the consumption side.

Joel: So, oil prices affect consumers and producers in different ways.  Talk a little bit about the consumers.

Brian: On the consumer side, Joel, where we’ll feel it the most is at the gas pump. Every typical family in America since June, is saving roughly about 50 bucks a month, because of their savings at the gas pump. Where does that $50 a month go? It goes into another visit to a restaurant or another pair of blue jeans. And, that reinvestment back into the economy is what keeps this thing going strong.

Joel: What about producers?

Brian: Producers are going to get hurt with the margin. The oil industry is heavily built on debt, so as margins shrink, more of that money goes to covering their debt costs. So, it can be a challenge for oil companies. At some point in time, oil prices will get low enough, where they’ll change the way they produce.

Joel: We’re becoming bigger producers of oil, so how does that affect the U.S. economy?

Brian: Well, let’s go back to why oil prices are dropping to begin with. In classic economic terms, we always talk supply and demand. In this case, supply and demand both are being significantly impacted by undergoing changes.

So since 2004, oil production in this country is up 56%. In that same time period, demand for oil is down around 8%. Well, at some point in time, if oil is cheap enough, it won’t be profitable for the oil companies to continue to manufacture it.

So, at some point in time, as oil prices are reduced low enough, you’ll drop producers from the market. That’ll change the available supply of oil, which will then change prices and you get a re-balancing, in effect, of the oil market.

Joel: So, Brian, with lower oil prices, it’s also reflecting a lower demand for oil worldwide, which signifies that there’s a global slowdown in the economy. How should we feel about that?

Brian: Oil prices have declined because we have more supply and less demand. One of those variables may change, or both may change. You’re talking about global growth. If global growth re-accelerates – China’s been a huge consumer of oil, for instance. If their economy begins to re-accelerate at a level above where it is now, that could increase demand for oil, which could have an effect on prices.

Joel: How should investors be looking at this right now where, on balance we see consumers benefiting a little bit more than producers with the lower oil prices?

Brian: Well, obviously, if you’re focused as an investor, on oil-producing companies, oil-producing stocks, then you know higher prices typically lead to higher margins, which typically lead to higher profits. That’s good for the energy companies.

In this case, we’re talking about a reduction in oil prices, which means you and I have more money to spend in other places. So, I think the impact of lowered oil prices and increased Gross Domestic Product, at the disposal of the consumer, may benefit a range of companies across the spectrum of the market.

Brian Kilb is executive vice president and chief operating officer of Landaas & Company.

Joel Dresang is vice president-communications at Landaas & Company.

Money Talk Video by Peter May
(initially posted Nov. 14, 2014)

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