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Answer:
Dear BuyandHolder,
You're
smart to understand why prices fluctuate because there
is a greater risk factor in investing in the oil industry
than in many other sectors. Nevertheless, if you understand
what drives prices and select well run companies,
they may have a place in your portfolio. Keep in mind
the old adage, however -- never put all your eggs
in one basket. Remember not the Alamo, but Enron!
As
with most commodities, price is based on supply and
demand. Although with oil, you can add another ingredient
to the recipe and that is politics, especially in
the oil-rich Middle East. Let's look at the political
factor first.
Politics
One
of the most obvious examples of the role of politics
in the pricing of oil took place back in 1973. At
that time, some of the Arab OPEC nations cut off selling
oil to the U.S. (and to other countries as well) as
a protest toward their support of Israel during the
Arab-Israeli Yom Kippur War. Production was actually
slashed by about 25% and subsequently the cost of
crude oil prices almost tripled.
Another
political situation that directly affected oil prices
took place in 1990, when Iraq invaded Kuwait. Prices
rose almost immediately.
Seven
years later we witnessed the Asian political and financial
crisis. This lead to a worldwide decrease in the need
for oil and prices dropped.
Weather
Weather
is also a factor to keep in mind. You may recall that
in August of 2005, when Hurricane Katrina hit the
Gulf Coast, many of our refineries and other oil facilities
had to be shut down. Soon after, the area was hit
by Hurricane Rita. Officials estimated that between
the two storms, almost 25% of this country's oil producing
capacity was immobilized. And, as a matter of fact,
in September of that year, the price of gasoline at
pumps across America reached $3 per gallon. American
drivers were shocked. Nonetheless, they kept filling
up their tanks.
Demand
As
economies around the globe have gained strength, overall
demand for oil has gone up. There was a time in China's
major cities, for example, when everyone rode bicycles
and a car was a luxury reserved for politicians and
the very rich. Today, there are long lines at gas
stations in Beijing and other metropolitan areas.
Demand is also up in the Middle East.
You
should also be aware of the fact that in 1993, for
the first time, we actually imported more oil from
other countries than we produced. Our dependency on
imports remains in place because of declining U.S.
production.
Supply
As
we discussed in an earlier column, OPEC cut production
in 2006 and in the early months of 2007. Then the
cartel slowly increased production during the final
months of last year. Nevertheless, overall demand
remains greater than the supply, or more accurately,
the supply released by OPEC. Of course, this could
change at any time and largely hangs on the whims
of the oil cartel.
The
U.S. Dollar
Oil
is traded in dollars. As you know, the dollar recently
has fallen dramatically against the Euro and other
foreign currencies. This means consumers in countries
whose currencies have appreciated against the dollar
find any increases in oil prices not as difficult
to handle as we do here at home. Thus demand for oil
in those countries remains strong.
Investing
We
cannot advise you regarding what stocks you should
own. But we can advise you to keep track of what is
happening with oil producers and distributors around
the world through the Energy Information Administration.
This agency posts late breaking news, pricing data
and a wide range of related information at: www.eia.doe.gov.
Some
of the facts I outlined above -- about politics and
prices -- were obtained from the agency's historical
time line at: www.eia.doe.gov/kids/history/timelines/petroleum.html.
Never mind that someone put it in the "kids" information
section. The information is accurate, useful and not
at all child like!
I
also urge you to read the sections in Value Line
Investment Survey on the petroleum industry. Individual
companies are evaluated by independent financial analysts
and economists and then given rankings for safety
and timeliness. Your public library most likely subscribes
to this weekly research service.
INFO:
www.valueline.com
Good
luck!
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