Ballooning Supply Fueling Reduced Prices At Pumps

OCEAN CITY — Oil prices have remained low in the last few weeks, even as equity markets have risen from their recent pullback to an all-time high.

West Texas Intermediate (WTI) crude is hovering around $80 per barrel, down by roughly 18% this year. We attribute this to a growing supply along with anticipation of weaker demand as forecasts for global growth have come down.

The range of outcomes for oil prices has widened with the economic outlook more uncertain, geopolitical risks such as ISIS unabated and Ebola potentially impacting travel plans, according to BofA Merrill Lynch (BofAML) Global Commodity Research strategist Francisco Blanch. The weak outlook for economic growth outside the U.S. and the strengthening dollar can be expected to put downward pressure on prices of crude. However, one can never rule out a short-term reversal given the nearly 25% drop just since June.

A rising supply has exacerbated the recent weakness in oil prices. U.S. energy producers have been exploiting developments in horizontal drilling and hydraulic fracturing, or fracking. As a result, America’s supply of crude is forecast to reach the highest level since 1986 this month, according to the U.S. Energy Information Administration (EIA). Drillers are becoming more efficient as technological innovations increase the output of wells, producing more oil per dollar spent on exploration and production.

Meanwhile, Libya has started to ramp up output and the largest OPEC producer by volume, Saudi Arabia, has maintained it at high levels and even cut prices in an effort to protect its global market share. This is a departure from its traditional practice of supporting prices by reducing supply. The International Energy Agency (IEA) reported that OPEC crude oil output surged to a 13-month high in September, even as the IEA reduced its forecast for oil demand for October.

Let’s look at who benefits and who suffers if oil prices drop further or remain low. Clearly, lower prices generally hurt companies that explore, produce and sell crude oil by cutting into their revenues and also diminishing their growth prospects by

discouraging investment in future projects.

Lower prices also hurt governments of oil-producing and exporting nations, especially those whose state finances depend on higher prices. Russia comes to mind, as do certain Latin American nations where oil is a key export, like Venezuela.

On the flip side, lower prices are a boon to countries like the U.S., which remains a large net importer of crude oil despite growing domestic production. Lower energy costs benefit the bottom line of manufacturing companies, and on a larger scale, cheaper and lower oil imports improve the trade balance — a benefit to gross domestic product (GDP).

The U.S. consumer is a big beneficiary too. An improving jobs outlook and low interest rates already have created a decent backdrop for spending. Lower prices at the pump add a little extra to funds for discretionary purchases. The national

average price for a gallon of regular unleaded gas is now $2.97, down 19% since June.

Consumer spending accounts for almost 70% of U.S GDP, and an improving outlook in that area should provide a boost to the economy. On balance, we believe that oil prices at their current depressed levels should be a net positive for the economy, although certain areas will benefit more than others.

(A Merrill Lynch Wealth Management Advisor who can be reached at 410-213-8520.)