Lower oil prices │ Risks and opportunities

Recently, the Organization of Petroleum Exporting Countries (or “OPEC”) decided against cutting its production. This sent the price of oil down further.

OPEC could have cut back its production to raise the price of oil. But doing so would have encouraged non-OPEC countries to raise their production. The fact is, countries like the U.S., Russia and Canada, among others, account for an increasing share of the world’s oil production. OPEC’s decision to keep up its production is meant to maintain—or at least slow the shrinkage of—its market share.

Some OPEC members likely see lower oil prices as a good thing. Lower prices can curtail production by oil companies elsewhere. It will also constrain exploration, drilling and capital investment budgets. This can work to OPEC’s long-term interests.

More supply + less demand = lower prices

Another factor weighing on the price of oil is weaker economic growth: most of Europe is struggling to stay out of recession; Japan is in recession; and China’s economic growth will keep falling as it gets bigger and catches up with developed countries. Weaker economic growth reduces the demand for oil. While the U.S. is now growing more swiftly, it imports less and less oil as its own production soars.

Climate change and the internal combustion engine

There are growing worries about the environmental impact of oil production and consumption. Most scientists believe that greenhouse gas emissions are contributing to global warming. This could lead to more extreme weather events. The melting of the polar ice caps would raise the sea levels and threaten cities such as Venice or New York City’s Manhattan Island. Higher sea levels would also threaten low-lying countries such as Holland or Bangladesh.

One response has been to find alternatives to the internal-combustion engine. These include vehicles powered by electricity, natural gas, hydrogen and so forth. Then, too, vehicles have become increasingly fuel efficient. This reduces oil consumption.

If prices remain this low for long, oil producers will suffer. On the other hand, if prices recover, those brave enough to buy today will earn handsome profits.

Should you want to buy an oil stock, we would advise you to opt for an integrated oil company. That’s because their operations are more diversified—including refining facilities and large networks of filling stations. Two conservative stock candidates that we have “buy” recommendations for are Imperial Oil Ltd. (TSX–IMO; NYSEMKT–IMO) and Suncor Energy Inc. (TSX—SU; NYSE–SU).

 

The MoneyLetter, MPL Communications Inc.
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