Oil Price Declines – What should investors do?

Investors and human beings certainly have short memories.  The recent steep decline in oil prices has car buyers and investors’ believing this decline is a long-term phenomenon.  It seems that we’ve all forgotten that the oil and real estate sectors follow boom and bust cycles.  A trip down my personal memory lane will bring perspective to these two cycles.

My father was transferred by MetLife from his New York office to the Tulsa Oklahoma office in 1982.  The oil prices were high causing a mild recession in the United States.  Unfortunately for my parents, the move required them to sell their home on Long Island in a depressed real estate market.  To make matters worse, Tulsa was benefiting from high real estate prices due to the high oil prices and thus the home they purchased in Tulsa was at a peak price.

Oil well pump jacksHowever, by the time my father was transferred back to New York in 1986, the oil situation had changed.  Oil prices had fallen causing the Tulsa real estate market to decline, just as my parents needed to sell their home.  In addition, the move back to New York occurred during the rising NY real estate market due to the improved economic condition in the country as a result in part from the decline in oil prices.

The world price of oil, which had peaked in 1980 at over USD $35 per barrel ($101 per barrel today), fell in 1986 from $27 to below $10 ($58 to $22 today).   The oil glut began in the early 1980’s as a result of slowed economic activity in industrial countries (due to the oil crisis in 1973 and 1979) and the energy conservation spurred by high fuel prices.   Sound familiar?

It seems in recent times people have been purchasing less fuel-efficient automobiles presumably due to the lower gas prices at the pump.  Assuming they’re going to have these cars for more than a year or two, they may come to regret that SUV decision.

Even though the production and extraction of oil is a global and international endeavor, the production of oil follows the same economic law – supply and demand – as other materials and products. With the cost of a barrel of oil decreasing to $30, the supply of oil will begin to decrease as it is not cost efficient for producers to extract the oil at those low levels. The global economic slowdown has also reduced the demand for the product resulting in reduced global prices.

Real estate prices also follow the same boom and bust cycle. The last real estate boom ended with the recession of 2008-2009. Right before that time, I heard of people wanting to purchase homes and flip them for great profits with the understanding that real estate only goes in one direction – up.  I would occasionally remind them that one of my job assignments at Chase Manhattan Bank was working in the commercial real estate division in New York City.

I joined the bank real estate team in 1992 to help in what the bank called the “workout” division.  The former commercial real estate team had been re-positioned to determine how best to reduce the losses from the significant loans that they gave to real estate developers.  At that time, many of the real estate projects were failing and the borrowers were unable to repay the bank on the loans.  Banks lost millions on these loans.

So as we are in another cycle, I wanted to remind investors that oil prices will rebound sooner than most people predict.  It would be wise to understand the boom and bust cycles so that you do not make changes to your investment portfolio with the mistaken belief that this is a permanent condition.  And while you are at it, you may want to consider purchasing a more fuel-efficient automobile.

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About Dan Crimmins

Dan Crimmins, co-founder of Crimmins Wealth Management, is a financial coach and fee only financial planner. Have a financial question? ASK DAN

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