During the summer of 2014, WTI oil traded at prices north of $105/bbl.
Around this time, Bloomberg had an article titled “Oil Topping $116 Seen Possible as Iraq Conflict Widens”while even Investopedia forecasted on June 19, 2014 that oil prices could “hit $118.75” in the coming weeks.
Forecasting is hard, and that’s why we don’t usually do it. In this case, oil prices stunned many investors by dropping off a cliff, tumbling to less than $50/bbl close to six months later.
As Warren Buffett says, many people were caught swimming naked when the tide of high oil prices went out.
UNDERSTANDING WHY OIL PRICES FLUCTUATE
To avoid being caught in a similar situation in the future, it helps to understand why and how oil prices fluctuate. Today’s infographic from Jones Oil is here to help us understand the many different issues that can impact global oil prices.
It covers supply and demand, weather, technology, geopolitics, as well as other factors that make oil prices fluctuate.
Ultimately, oil prices fluctuate because of changes to supply and demand, but the challenge for investors is that there are multiple factors at play that can affect those fundamentals. Many of them are interconnected.
These include weather events, supply interruptions (such as worker strikes or spills), broader demand trends such as the emergence of renewable energy, OPEC decisions, or other events that can have an immediate effect on supplies.
There are also meta factors, such as the “fear” that a future event may happen that could in turn affect supply and demand. This is where geopolitical risks get priced in, such as potential escalation of conflict in the Middle East or future election results of oil exporting nations.
Information and forecasts can also play a role. Imagine being an oil producer in early 2014, hearing some of the bullish reports above. Would you, or would you not invest in a project that had a breakeven of $60/bbl oil? Even a significant oil price fluctuation of +/- 30% would still have you come out on top.
However, as in the situation in 2014, this would have actually increased margin production, which would have only added to the glut in supply.