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The Oil Price Drop Effect on Stocks and The Economy

The Oil Price Drop | How Much Has Oil Fallen?

Oil PricesThe oil price drop has been one of the biggest economic stories of the fall of 2014. Brent crude oil, which is the crude oil benchmark that sets most gasoline and heating oil prices in the United States, has dropped from approximately $110 to $70 from July 2014 to December 2014, or an approximately 36% drop.   That is a huge drop for such an economically important commodity that affects pricing and business conditions for practically the entire economy. With such a significant drop in the price of crude oil and similar price decreases in oil’s derivatives products that consumers and businesses use to fuel their vehicles and operations, there are very real effects on stocks and the economy that traders and investors need to consider.

The Oil Price Drop Effect on Stocks

The oil price drop effect on stocks is somewhat complicated by the fact that many stock sectors will benefit from lower oil prices, while some specific sectors will be hurt by lower oil prices. While the broader economy and the stock market as a whole benefit from lower oil prices as consumers have more money to spend and many businesses will be more profitable, there are certain sectors of the stock market that are hurt economically when oil prices fall, as significantly as they have during late 2014.

Oil Rig

The stock sectors that benefit the most from lower oil prices are ones that have cost structures that are tied into the cost of motor fuel. This includes trucking companies, airlines, and automobile manufactures. Indirectly, stock sectors such as restaurants and retailers benefit from lower oil prices.

The benefit of lower oil prices to transportation stocks is obvious. Just take a look at the performance of the Dow Jones Transportation Average (NYSE:   ^DJT), which is up approximately 10 percent since the summer of 2014, when fuel prices started their decent.   Although transportation companies can take long-term measures to make their fleets more efficient or to run on alternative fuels, they are still so reliant on motor fuels made from crude out that significant changes in the price transportation fuels go right to their bottom line, because they have a cost structure that requires a great amount of transportation fuels to operate.

Consider transportation stocks, including airlines, trucking companies, shippers, and automobile companies, since they all should benefit from lower oil prices during the last quarter of 2014 and during 2015. Automobile companies might seem like a curious group of stocks to include in an investment strategy that takes advantage of lower oil prices, but there are good reasons to include them. For one thing, lower oil prices mean more people can afford to buy automobiles.   For another thing, when consumers come in to buy an automobile, they are more likely to opt for the more expensive larger models that have higher profit margins, since gasoline prices have come down so much. Another tailwind for automobile companies during 2015 is the fact that they average automobile on the roads of the United States is 11 years old. That is a very high average age for automobiles, which will help prod consumers into automobile showrooms to buy new cars.

The Oil Price Drop Effect on The Economy

Oil Price DropThe oil price drop effect will have a positive effect on the United States economy. A significant drop in oil prices not only puts a lot more money into consumer’s pocket that fuels consumer spending (which drives 70% of economic growth in the United States), it also provides lower costs for many industrial and commercial sectors of the economy that use oil products.   Everything from food production to automobile manufacturing uses a significant amount of oil to bring finished products to consumers. A drop in oil prices provides these industries, as well as many others, additional money for them to reinvest in their businesses or to apply to their bottom line profits, which boosts the economy and stock prices. Dropping oil prices also cause a deflationary effect on prices, since so much of the United States economy uses oil in some way or another, which will not only relieve consumers from rising prices, but will also prevent the Federal Reserve from raising interest rates sooner than they plan to during 2015.

The one complicating effect from falling oil prices for the United States economy is that as oil prices fall, they will likely cut into the recent growth in the oil drilling sector, especially in North Dakota and Texas. While the rest of the country stands to benefit from lower oil prices, regions that are tied to the production of oil, which have seen tremendous economic growth in recent years, should experience diminished economic activity. At some point, drilling for oil just becomes uneconomical, and for many of the new oil wells that point is in the $70 to $80 per barrel range. As oil wells are closed and oil exploration and drilling activity is curtailed, jobs will be lost and specific oil drilling regions will suffer. However, on balance, the United States economy will benefit from lower oil prices.

If oil prices fall low enough, for example, below $50 per barrel, there could be massive job losses and bankruptcies in the oil producing regions of the United States. At that point, restaurants and companies connected to leisure will benefit greatly, since oil prices that low will make going out to eat and traveling to leisure destinations much more palpable for average consumers.

Such a steep drop in oil prices will reshape the oil industry and depress local economies, but overall the United States economy will benefit from much cheaper oil as it adds to quarterly Gross Domestic Product (GDP). Any shake out in the oil industry that is caused by falling oil prices should be viewed as a buying opportunity for long-term investors. The key is to buy oil companies that are well capitalized and will survive the oil price drop and thrive once oil recovers in price. Some oil companies will benefit tremendously, as they buy competitors at fire sale prices.

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