The oil market has seen dramatic volatility throughout the more than century-long history of trading crude oil. Even in the past several years, crude oil prices have moved dramatically, and although oil prices today are relatively inexpensive, there's no telling whether West Texas Intermediate, Brent, and other benchmarks for crude will regain their lost ground or go still lower in the near future. Regardless of which way oil prices move, though, their past fluctuations contain some lessons for energy stock investors.
A short history of oil prices
Throughout most of the 1950s and 1960s, crude oil stayed at single-digit prices per barrel. Even when you make allowances for inflation, crude prices remained within a range of about $20 to $30 per barrel on an adjusted basis.
However, in the 1970s, a couple of events had a dramatic impact on crude oil prices. First, due to war between Israel and Arab states in the Middle East, the Arab members of the Organization of Petroleum Exporting Countries chose in 1973 to impose an embargo against the U.S. for its support of Israel. That sent crude prices up to the $10- to $15-per-barrel range. Then, when the Iranian revolution occurred in the late 1970s, the resulting loss of supply sent crude prices soaring to $40 per barrel -- or about $120 when you adjust for inflation.
Oil prices stayed high until the mid-1980s, when measures to increase fuel efficiency finally started to hit demand. A period of low prices persisted into the mid-2000s, with a single minor spike upward during the first Gulf War in the early 1990s.
The latest boom-and-bust cycle occurred beginning in the mid-2000s. The rise of emerging market economies like China boosted demand for energy, but low prices had led to stagnant efforts to explore and produce more crude. Prices jumped to nearly $150 per barrel briefly before the financial crisis led to a sudden and short-lived drop. In the recovery in the early 2010s, oil once again reached triple digits. Only in the past couple of years has the price of oil fallen back, with current prices in mid-2017 of just under $50 per barrel.
What investors can learn from crude oil's price history
Movements in the oil markets have educated those investors who paid attention along the way. In particular, the following lessons should stand out as essential for energy investors:
- Experts are routinely wrong. In 2015, many prominent investors predicted that the decline below $100 per barrel would prove to be short-lived. Two and a half years later, they've been proven wrong.
- During tough times, a healthy balance sheet is essential. Exploration and production companies that are viable at higher oil prices can suddenly become extremely unprofitable when crude falls. By contrast, periods of low oil prices offer opportunities for financially strong energy industry players that have the long-term vision to buy strategically important assets on the cheap.
- Various sectors of the energy market have different exposure to crude oil prices. Midstream pipeline companies profit based on volume, and while there's sometimes a link between amount of oil produced and its price, that isn't always the case. Even within the exploration and production subsector, companies that depend on high-cost production methods like offshore drilling or oil sands suffer to a greater extent than relatively cheaper producers of land-based energy assets.
- It takes a while for energy consumers to adapt to changing prices, but they do so eventually. The ups and downs of crude prices reflect the periods of several years that it takes most users of energy to find more efficient ways of doing the work they need to do.
Finally, when you look at the stock price histories of some of the largest players in the energy market, you'll notice one key thing: Although their short-term share prices typically move up and down with the price of oil, their longer-term trajectory points upward more dramatically than the price of crude. That demonstrates the value of an active business, and it shows why investing in oil stocks rather than directly in the commodity can produce much better results for investors over the long haul.
Crude oil prices will inevitably remain volatile in the years to come, and energy investors will have to navigate an ever-changing market. By understanding both the short- and long-term impacts of crude oil price movements, oil stock investors can make more informed decisions that will improve their investing results in the long run.