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7 reasons to worry about cheap oil

January 21, 2015

By Richard Barrington | MoneyRates.com Senior Financial Analyst, CFA

rise of speculation

It was not long ago that people were fretting about the possibility of $5-a-gallon gasoline. Now, seeing gas prices steadily backtrack toward $2 a gallon may seem like a dream come true for many consumers.

However, that trend is going to such an extreme that the dream could turn into a nightmare. Here are seven reasons to worry about plummeting oil prices.

1. Geopolitical tensions

Iran and Russia are two of the world's most dangerous nations, and their economies are both very dependent on oil. Many Americans might take some added pleasure in knowing that falling oil prices hurt those countries, but the plunge has been so steep that those countries might feel threatened enough to lash out in retaliation. A milder price decline would have had the effect of slowing those countries down economically without potentially destabilizing them.

2. The indication of global economic weakness

Rapidly falling oil prices may cause some new problems, but what worries many investors is that they are a symptom of an existing problem. Not too long ago, some analysts warned that the appetite for oil on the part of the world's large, developing economies would soon become insatiable. Now there is concern about what the slowing of this demand growth says about the overall growth rate in those economies.

3. U.S. jobs at risk

Foreign economies are not the only concern. There are more than 170,000 U.S. jobs directly involved with oil drilling and extraction, and that does not include all the other businesses that support that industry or provide services to oil-producing areas.

4. Financial sector exposure

The oil price boom sparked heavy investment in new exploration and extraction. With the drop in prices now making many of those investments unprofitable, banks that lent heavily to finance oil sector investments might start to see an upturn in defaults.

5. The rise of speculation

To some extent, the downturn in oil prices was probably a correction of natural market forces, but now speculation seems to be playing a lead role in exacerbating the price collapse. Short-term oil futures are now trading at nearly 30 percent below long-term futures, suggesting that the current price is being artificially depressed by speculators looking for a quick profit by betting on oil continuing to fall. Overly speculative markets are neither stable nor healthy.

6. The setback to conservation and sustainability efforts

One of the stocks that has been hurt as oil prices have come down is electric car maker Tesla Motors. This is indicative of how cheaper oil dulls enthusiasm for energy conservation and sustainability efforts, but without those efforts the world will just become more dependent on oil in the long run.

7. The impact on future price cycles

When oil prices fall, exploration and production projects are curtailed. This ultimately slows supply and sets the stage for the next upturn in prices. The concern is that a drastic drop in prices could exacerbate both capacity cuts and the ultimate rebound in prices.

Oil may well be the single most important commodity in the world. It says something disturbing, then, that something so important could be priced so inefficiently as to range from over $100 dollars a barrel to under $50 in the space of less than a year.

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