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Falling Oil and Gas Prices

Sigma Investment Counselors

December 17, 2014

As of December 15th  the average price of a gallon of gas in Michigan had fallen to $2.43 and crude oil prices fell to less than $60 a barrel (over a 37% decline this year) for the first time since July 2009.  The Organization of the Petroleum Exporting Countries (OPEC) announced last week that it will not slow production to raise the global price of oil; there had been speculation that the organization would cut production in an attempt to bring the price back up.

For quite some time, Sigma’s Investment Committee has been discussing that North America was well on its way to energy independence.  Domestic production of crude oil and natural gas is on the rise and there is a surplus of oil in the market, primarily from shale oil production in the United States.  As investment advisors, the short and long term affects of falling oil prices and increased production is monitored and analyzed to determine how markets and the economy will be affected.

In the near term, falling prices at the gas pump provides an increase in disposable income for most consumers; the low prices provide a stimulus to the economy unlike any of the tax breaks we have seen in recent years.  This is good news for retailers as recovering consumer confidence and increased spending should boost the economy.  Other positive effects of low energy prices can be found on the bottom line of many companies whose cost of production or cost to transport their goods to market have decreased.

But what are the negative effects of lower oil prices?  The S&P 500 Energy Index has had a negative 17.03% year to date total return, while the S&P 500 has enjoyed a positive return of over 8%.  Energy stock investors have seen significant declines in their wealth this year.

More importantly, retirees have been negatively impacted.  The cost of living (COLA) increase for social security recipients is 1.7 percent for 2015. COLA is tied to the Consumer Price Index, the government’s inflation measure, which assumes 9% of total expenditures are on energy. Meanwhile, since seniors likely do not commute to work each day, they may be less likely to enjoy the benefits of a decrease in gas prices. And, according to the October 2014 report, the index for all items less food and energy has risen 1.8 percent over the last 12 months.

The CPI assumes 7.6% of expenditures are on medical care, a percentage which is likely higher for seniors. This year the cost of outpatient services has increased 3.95% and inpatient hospital services has increased 4.9%.  The lower price of oil and gas has skewed the true cost of living increase for seniors who rely on their social security benefits, and now who likely will experience a lower standard of living next year despite the 1.7% increase in their social security payments.

Many were assuming that OPEC would cut production, however maintaining lower oil prices ultimately benefits OPEC because lower prices discourage exploration and expansion of production here in the United States and globally.  What is the equilibrium price of oil? That is difficult to estimate, but the nature of the oil business has changed and will continue to change. OPEC no longer holds sway over the market and likely gas and oil prices will remain lower long into 2015 and beyond.

Enjoy your holidays with family and friends!

Suzanne M. Antonelli, CFP®

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