Like most other markets, the price of oil or gas is largely determined by supply and demand. The price may lower if there is a sudden spike in availability or a drop in demand. Of course, those two determinants behave differently.
For instance, if retailers ship fewer items to stores due to slowing demand, the demand for gas can also fall—and the price for gas would then, too, decline. This could indicate a slowing economy as fewer shoppers are buying retail items. However, an increase in supply might also cause oil or gas prices to slide. If there is more supply of any good than is desired, the price of that item goes down. However, this does not necessarily mean that an economy is slowing down.
Let’s look closely at both supply and demand and examine how your behavior as an investor might change based on what we know.
The recent plummet in oil prices is driven both by a reduction in demand and the outcome of a meeting last week between OPEC and other oil producing nations. The goal of the meeting was to get all parties to agree to reduce demand by 1.5 billion barrels of oil per day. However, Russia said that they were not going to reduce their supply. Then, the Saudis said that they would actually INCREASE their supply!
OPEC and the other nations were discussing reducing their supply because of the decrease in demand that we are currently experiencing. This is a historic decrease. COVID19 is actually causing the suspension of travel to and from many parts of the world. As people travel less there is less need for fuel. Manufacturing in China (another large consumer of oil) is also sharply reduced because of COVID19. These are just two examples of why demand for oil has sharply decreased.
So, how should an investor respond to this news? In reality, cheaper fuel is good for many parts of the economy. Your local retailer just reduced their shipping costs. Chinese manufacturers just saw one of their key manufacturing components drop dramatically. If everything else were to hold constant, then these factors alone would lead to increased profits. Of course, everything else is not holding constant, though, so it’s important to stay aware of long-term trends within industries. For instance, while the retailers and manufacturers might benefit from lower oil prices, oil companies will suffer from lower oil prices.
As a long-term investor, it is important to let others panic at the overnight headlines while you maintain your focus on your long-term objectives.