Year to date the market is up 11.10% as measured by the S&P 500 and the bond market is up just over 1.33% as measured by the Barclays Global Aggregate Bond Index.
Crude oil prices have fallen more than 30% from their highs earlier this year. While people have attributed this tumble to many things, one factor cannot be ignored: U.S. crude oil production has been exploding. In a recent email, Deutsche Bank economist Torsten Slok sent around a chart, showing the explosion in U.S. crude oil production over the past few years from roughly 5 million barrels per day (mmb/d) to around 9 mmb/d. Slok wrote: “The most important reason why oil prices are falling is because of the dramatic increase in recent years in U.S. crude oil production… and U.S. oil production is expected to increase further by 1 mmb/d in 2015 and 0.6-0.7 mmb/d per year in the years to 2020. In other words, expect a continued increase in oil supply going forward.”
The low price of oil is good news for the United States economy, because it implies higher real incomes for American consumers. Within the U.S., the lower price is transferring real income from oil producers to households, which raises short-term demand because households spend a higher proportion of their incomes than oil firms do. For the same reason, the lower price also gives a boost to aggregate demand in Europe, Asia, and other oil-importing regions.
The big losers from falling oil prices include several countries that are not friends of the U.S. and its allies, such as Venezuela, Iran, and Russia. These countries are heavily dependent on their oil revenue to support their governments’ spending – especially massive transfer programs. Even at $75 or $80 a barrel, these governments will have a difficult time financing the populist programs that they need to maintain public support.
Although Saudi Arabia and several of the Gulf States are also major oil exporters, they differ from other producers in two important ways. First, their cost of extracting oil is extremely low, which means they will be able to produce profitably at the current price – or even at a much lower price. Second, their enormous financial reserves allow them to finance their domestic and international activities for an extended period of time, as they seek to transform their economies to reduce their dependence on oil revenue.
Harold Hamm, chief executive of Continental Resources Inc (CLR.N), stunned a bearish crude market by scrapping all of the North Dakota energy producer’s oil hedges, betting that prices will recover soon after sinking 25 percent in recent months. The sale of all of its crude oil hedge positions from October through 2016 netted Continental a $433 million one-time gain for the current quarter. With the move, Continental is effectively declaring a premature victory over OPEC. The company did not consult with credit-rating agencies before pulling contracts, and board members are confident about the move, Hamm said. “We believe the recent pullback in oil prices will ultimately prove to be beneficial to Continental,” he said, adding he believes prices will rebound to at least $85 per barrel in the near term.