Investors Should Celebrate Falling Oil Prices

LONDON -- It's tough to make predictions, the saying goes, especially about the future. And it's particularly tough if you're predicting the future of the oil price.

Earlier this year, with a barrel of Brent crude nudging $128, analysts and traders were predicting it could soon hit $200 a barrel. Most people agreed the oil price could only go one way: up.

With hindsight, what happened next was predictable. Oil prices went into reverse at a near-record speed, dropping more than 20% this quarter. Next time you pop down the shops to buy a barrel of Brent crude, you can expect to pay less than $93. Suddenly everybody agrees the price can only go one way from here -- and that's down. Some traders and analysts even predict it could drop to $50 or $40 a barrel.

The mechanics of oil
The oil price plunge has been partly sparked by our constant, troublesome companion: the eurozone crisis. And let's not forget its slovenly siblings, weak U.S. jobs data and slowing Chinese manufacturing.

When global growth slows, demand for oil slips and the price falls. It has done this for years in what has always been seen as a self-correcting mechanism.

A falling oil price reduces industry costs and makes consumers feel richer, which helps to restart global growth. Recession over. Job done. But in recent years, many people feared this mechanism had broken down, because thirsty emerging markets kept oil demand high despite the Western slowdown.

It doesn't look so broken now.

Fracking heaven
Another reason for the oil price reversal is buried deep below the U.S. in fine-grained sedimentary rocks. The world's greatest gas guzzler is sitting on vast reserves of shale gas and oil that are now easier to access, more economical to produce, and could make the nation energy-self-sufficient in just a few years.

The U.S. isn't the only country sitting on a shale goldmine: So are Russia, Brazil, China, France, Germany, and -- somewhere below Blackpool -- the U.K. If shale fulfils its promise, the "peak oil" crew looks doomed, along with the $200-a-barrel merchants.

The West, however, will be saved. All hail Shale!

Arabian knights
Easing tensions between the U.S., Israel, and Iran have also forced the oil price down. So has Saudi Arabia, the world's swing producer, which has been pumping overtime to force the oil price to around $100 a barrel in a gift to the global economy.

At that price, Saudi Arabia can still fund the social programs it needs to head off a home-grown revolt, while its big regional rival Iran probably can't.

Russia, the world's largest gas and oil producer, also needs around $115 a barrel to break even. A falling oil price is bad news for investors in this single-issue economy.

Oil falls, markets rise
Falling oil prices are a boon for stock markets, as they reduce company input and transport costs thereby bolstering profits. That's good news for supermarkets such as Sainsbury's and Tesco and consumer goods companies such as Reckitt Benckiser and Unilever.

It is, of course, bad news for the oil majors. BP's  (LSE: BP.L  ) share price has dropped from 5 pounds to just more than 4 pounds since March. Royal Dutch Shell and Exxon Mobil have also hit the skids, although less dramatically.

Investors haven't lost interest in oil companies. I was looking at stockbroker TD Waterhouse's top 10 client buys for last week, and Gulf Keystone Petroleum  (ranked No. 2), BP (No. 7), and Max Petroleum (No. 9) were all in demand.

Tullow Oil (LSE: TLW.L  ) looks tempting to higher-risk investors, having enjoyed plenty of drilling success in West and East Africa, with further promising projects in French Guyana, Kenya, and Mauritania.

Oiling the wheels
Many investors will find recent share-price drops too tempting to resist.

If you're bold enough to go looking for the next oil takeover, you could strike a rich seam of merger-and-acquisition activity. One Fool couldn't believe his eyes when he discovered his largest oil holding is on a P/E of 5. You will also be delighted to discover there is a Foolish way to invest in oil and gas explorers.

As for future oil price movements, I'm making no predictions.

Oils, pharmaceuticals, banks, telecoms -- just where should you invest today? "Top Sectors for 2012" is The Motley Fool's latest guide to help Britain invest. Better. The report is free.

Further investment opportunities:

Harvey owns shares in BP and Royal Dutch Shell. He does not own shares in any of the other companies mentioned. The Motley Fool owns shares of Tesco and Exxon Mobil. Motley Fool newsletter services have recommended buying shares of Tesco and Unilever. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


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