Zaks Investment Advisory Service

On Oil Availability and Historical Oil Prices

I have long wanted to devote one of the programs to oil. We hear about it constantly, with information about oil price changes airing as regularly as that about the S&P 500. Of course, this is no accident: we import about two-thirds of all consumed oil, and spend about $300 billion a year doing so. Rand Corporation calculated that a $10 rise in the price of oil costs an American family $700 a year. Alarmists (of which there are many) warn that it will soon run out, or that it will soon cost more than $100 per barrel. On the other hand, we read that more oil is buried in the shales of Colorado and Utah than has been discovered in all the OPEC states. Or that there is so much oil in the sands of Canada (at least 175 billion barrels), that in terms of world reserves, Canada is second only to Saudi Arabia. Or even that turning coal into liquid fuel is the panacea for all our energy troubles.

Let us try to make sense of what is really happening to oil, and energy sources in general. It is no surprise that we, investors, should be interested in this: the largest companies in the world produce oil. Look at the list of the so-called integrated oil companies, whose shares are traded on the New York Stock Exchange, and you will see the names of some of the world’s biggest companies: ExxonMobil, BP, France’s Total, the Anglo-Dutch Shell, Chevron, etc. In recent years, these companies have been very successful: Dow Jones has an index for integrated oil and gas companies; over the past three years, this index rose by about 90 percent, while the S&P 500 grew by slightly more than 30 percent. In other words, investors who in recent years devoted a large percentage of their portfolios to oil and energy stocks had better returns than the market average. However, this was far from always the case: for example, in the preceding 20 years, between 1980 and 2000, oil companies’ returns were smaller than the market averages.

Let us take a look at what has happened to energy source prices in a historical perspective. Oil prices have not always been charged with as much emotion as they are today. For example, between 1946 and October 1973, the price of oil grew – without much wavering – by less than five percent a year, i.e. near the inflation level of the time. But in October 1973, after the Yom Kippur War between Israel and the Arab states, OPEC announced an embargo on oil deliveries to countries supporting Israel, and the oil price skyrocketed 2.5-fold in a matter of a month. In 1946, in today’s dollar terms, a barrel of oil cost about $14. In 1973, before the war – about $17. In January 1974, after the embargo was placed, it already cost $45 in today’s terms. Unfortunately, the Nixon Administration of the time exacerbated the situation by introducing price controls on gasoline. Lines formed at gas stations. For the first time since World War II, the United States experienced an energy shortage. Inflation grew and the economy fell into recession. Even a new economic term appeared – “stagflation,” i.e. stagnation plus inflation.

The high prices held until 1979, although not growing quite as quickly. But in 1979, a revolution erupted in Iran and hostages were taken at the US embassy there. The United States annulled all contracts for oil deliveries from Iran while Saudi Arabia – taking advantage of the situation – raised its prices, which then climbed even higher in the run-up to the Iran-Iraq war. As a result, in April 1980, the price of oil had soared in today’s dollar terms to $101 per barrel! This was the oil price peak. From then on it started to fall, and even the first war with Iraq (the Persian Gulf War) had only a brief price effect. In December 1998, oil prices fell to $11.30 per barrel or $14 in today’s dollars. From $101 in 1980 to $14 in 1998 – that is how the price of oil fluctuated on the world market. It started growing again at the start of 1999, reaching $76 per barrel by mid-2006, but has fallen back to about $60-$65 per barrel since. For the large part, this rise is being attributed to the constantly growing energy demands of China.

We spent this whole time talking about oil. But, as we know, it is not the only energy source. Every year, besides oil, we consume billions of cubic meters of natural gas and millions of tons of coal. Next time, we will talk about how prices changed on natural gas and coal – two extremely important energy sources – and why do we fail to react to their growth as strongly as that of oil. We will also discuss how prices of oil and other energy sources affect our economy. And we will examine whether there is a real alternative to oil. We will further try to sneak a peak into the future and assess what might happen to oil, gas and coal prices.

But now we will have to conclude the program. I would like to remind our listeners that on the Portfolios page of our site www.zaksinvest.com, we provide information about three model portfolios, and compare their performance to that of the market. Compare the return of your investments to our model portfolios. If you do not know what the return of your portfolio is, contact us and we will calculate it for you. This was Sergey Zaks. Thank you for your attention and until next time.