The Real Price of Oil

Last week marked the two year anniversary of the March 9th, 2009 low for the S&P 500; it also was the 11th anniversary of the NASDAQ high of 5050 set back on March 10th, 2000. Is the cup half full or half empty? It all depends on your perspective.

The mood of the stock market has grown increasingly more downbeat over the last few weeks. It’s no wonder, as investors are facing widespread geopolitical turmoil in the Middle East and a catastrophe of yet unknown proportions in the world's third largest economy.

Almost defiantly, markets have displayed impressive resiliency. The combination of these events might have the ability to knock down any strong market. So far though it has absorbed these shocks, but markets remain vulnerable to a deeper correction.

Over the last couple of years governments have pumped money into their economies on a fast and furious basis to keep them propped up. This has resulted in a global increase of prices for food and energy. Higher food costs and lack of opportunity are the main factors causing much of the turmoil in Middle Eastern countries.

The problems over there are creating issues over here as we are seeing gas prices around $4 per gallon. Higher gas prices have the same effect as higher taxes only without any additional benefits. It leaves less money for consumers to spend on discretionary items, which could cause contraction for the overall economy.

In addition higher energy costs results in higher prices or fewer profits for most everything. Getting goods from the raw material stage through the manufacturing process to the end user will require additional cost. Already high food prices will surely continue to rise with the additional cost of shipping the goods from the farms to the grocery markets.

Unfortunately oil is the lifeblood of our society. Many daily activities require oil. From factories to farms, oil is needed as coolant or fuel. Heating homes, creating electricity; everything from lubricants to lipstick, and medicine to plastics, requires oil.

Americans consume more gasoline than South America, Europe, Africa, and Asia combined! We are gasoholics! We have an addiction with oil. Two thirds of all the oil used in America is for transportation.

With the earthquake that has devastated Japan; a huge problem for the country will be the restoration of power and water for many of their citizens. Electricity is out for millions and will take several weeks or months to restore. In the meantime, electricity would be rationed with rolling blackouts to several cities, including Tokyo.

A total of four nuclear plants in Japan have reported damaged and are offline – some permanently. There has to be a replacement for that energy shortfall. Nuclear power plants take years to build so it is not going to come from that source. Oil along with coal will be the most likely candidates as Japan will reopen some of their old non nuclear facilities. This will create an even higher demand for oil.

The battle in Libya as well as demonstrations in many other oil producing countries is a sign of instability. This could lead to supply issues and higher oil prices. There are several reasons to be concerned that our own economies fragile recovery could be derailed.

The United States Oil Fund (USO) is one of the most actively traded oil based funds on the market today. Through the use of the actively traded futures contracts, it tracks the price changes of light, sweet crude oil.

USO went up 21% in a recent three week period, only to pull back 4% last week. USO closed Monday at $40.91 and has big support in $38 per share range. With all the negative issues regarding potential supply disruptions and increased demand for oil, we could see price increases for the foreseeable future.

An investment in OIL could act as a personal hedge and help offset some of your increased costs at the pump. Use a stop of $37.70 and be hopeful that it drops to that level, because that will spell relief for American consumers. If the cost of oil continues to rise, you can expect the stock market to eventually capitulate and tumble due to the higher associated costs for almost everything else. That is the real price that we could pay for oil.