Image: Linn Energy.
I hope you didn't expect $2 gasoline to last, because it's long gone throughout the country and some states are already well over $3 per gallon again.
Oil prices in general have climbed 25% since mid-January, and retail gasoline prices are up 33% over the same time frame. What's going on, and will the rise in oil prices continue?
WTI Crude Oil Spot Price data by YCharts.
Why oil prices can't stay low forever
The oil market might be a wild and crazy place day to day, but in the long term it still must answer to the laws of supply and demand. When the price of oil plunged in late 2014 (indicating supply had exceeded demand) the industry responded by cutting back on oil drilling. In the last six months, over half of the rigs that were drilling for oil have been idled.
US Rotary Rigs data by YCharts.
Over time, this will decrease the supply of oil in the market. But this reduction in drilling has also helped define something of a soft floor in the price of oil. Clearly, below $50 per barrel U.S. shale drillers can no longer drill profitably, so they'll reduce supplies at that price. Naturally, prices rose as a result.
Demand is picking up with lower prices
The other side of the equation is demand, which seems to be increasing while gasoline prices are low. In the first four months of 2015, demand for oil was up 2% compared to a 0.9% rise in the same year-ago period and a decline in consumption from 2005 to 2012. Strong SUV sales in the U.S. have reversed a decade-long move toward smaller, more fuel efficient vehicles, and an improving economy has pushed demand higher as well.
We've been here before
You might remember that just a few years ago oil and gasoline prices similarly plunged rapidly only to slowly rise to over $100 per barrel and $4 per gallon of gasoline. The first chart above could easily be mistaken for the chart below of what happened to prices in 2008 and 2009.
WTI Crude Oil Spot Price data by YCharts.
History tends to repeat itself; if that proves the case here, we're in for higher prices going forward.
Higher oil and gasoline prices might be looming
The rise in oil prices over the past few months has been slow and steady, but it also might not be over. Oil companies have yet to open the coffers by increasing capital budgets for 2015, which could increase supply. And after the collapse in oil prices both equity and debt investors, who fueled the fracking boom, have become more cautious about further investing in the industry.
This dynamic could mean that supply will be suppressed for at least the next year, if not longer, until oil companies and investors are certain a rise in prices is sustainable. By then, oil could be at $70 or $80 per barrel or even higher.
As we saw in 2008 and 2009, the market tends to overshoot the downside when it comes to oil prices. Then suppliers get worried and customers go out and buy SUVs, which tends to push prices higher. It's a dance oil prices have been playing for decades and it's not going to end anytime soon. Whether you're an investor in oil or a consumer of it, it's time to accept that $60 per barrel is just the beginning of oil's latest rise.
