A fantastic thing for us individuals in 2014 was that gas prices were lower than we have all seen in years. It was more than $100 in June and now it has dropped to close to $50 in December.
But it’s not all as positive as we think though. If it gets as low as $40 per barrel, it could spell disaster for America’s economy. The major falls and rises of value of crude oil have correlated strongly with major global political and economic crisis across the world.
See, if oil prices are too low, then the oil companies can collapse since they will lose money and not gain enough of a profit to stay afloat. The average break-even oil price for these U.S. ends up being about $75-$77 per barrel. If the price of oil can’t cover production expenses, then you could expect spending to drop, jobs to get cut, and many more problems.
If oil prices are too low, the U.S. will be forced to stop fracking (digging into our own land to get oil), which is an entirely different story, but that could hurt Russia, who relies heavily on oil export income, and it can benefit oil kingdoms like Saudi Arabia.
But, to stop all of this from happening, many major American oil companies are buying “insurance” (hedging) on oil futures (oil that does not exist yet) to bet that prices will stay low. The companies are buying a certain amount of oil barrels at a certain price (usually a bit lower than the current oil prices to make it look enticing to possible buyers) and a fee (just like normal insurances require- it ain’t free) to insure that if oil prices continue to drop, they won’t lose out big time and their company won’t collapse. They can’t increase the prices on those barrels that they bought already with the hedge, so if they predicted wrong and oil prices rise instead of fall, they lose money on those hedged barrels.
Hedging isn’t new news though. Companies are ALWAYS hedging, it’s a huge business practice that is always being used consistently to prevent loss, but they don’t hedge every barrel because they do want to sell it for more. North Dakota, an oil-rich state, only has hedged 3,000 barrels per day (bpd) in 2015, which amounts to a total of only 4% of their oil production. Now, they are in trouble they hedged so little and the oil prices are still falling. Which is why the company’s stock has fallen almost 65 percent from all-time highs in late August. Hedging can be a life-saving measure for oil companies and that’s why many are heavy-hedgers. An example of a smart hedge move was with Southwest Airlines. They saw oil prices looked like they were going to go up, so they took a risk and bought their oil at a lower price to lock it in and still be able to offer cheap flights (they hedged it).
So, while we are all loving to fill our cars up for so cheap, just remember that lower prices doesn’t mean it’s better for us in the long run.