Oil and gas investors are looking for economic indicators to help them understand the future movements of the oil industry. Like any commodity market, oil and gas companies and oil futures are sensitive to inventory levels, production, global demand, interest rate policies and overall economic numbers such as gross domestic product.
Key points to remember
- As produced commodities, oil and gas markets are driven by supply and demand as well as the cost of extracting, producing and refining these natural resources.
- Investors should look at inventory and refining capacity to see if supply is growing faster than demand, which could put downward pressure on prices (or vice versa).
- In addition to supply metrics, oil demand can be tracked by looking at trends in economic growth, transportation, and gasoline consumption.
- Government policies on taxes, tariffs, interest rates and regulations can also affect oil and gas prices.
Oil is an economically and strategically crucial resource for many countries. Countries like the United States keep large reserves of crude oil for future use. The measurement of these oil reserves acts as an indicator for investors; changes in oil inventory levels reflect trends in production and consumption.
The Energy Information Administration provides a weekly oil and other liquids supply estimate. When the trend line increases over time, suppliers are likely to lower prices to induce more purchases. The reverse is also true: lower production levels push buyers to push up the prices of petroleum products.
Use and production of the refinery
The crude inventories release is accompanied by a long list of data focused on crude oil production, covering domestic production, refinery inputs and use, and other inventory levels (motor gasoline) as well as import/export data. All of this data is taken into account in an attempt to get a sense of the fundamentals of the crude oil market. For example, traders will look at refinery usage to determine the extra capacity available to get additional supply into the market. If refinery utilization is high, it would be difficult to move additional oil through refineries, leading to lower supply and higher prices.
Investors should keep an eye on the relationship between refinery utilization and refining capacity. Refineries are expensive and it can take a long time to significantly increase production capacity beyond current levels. If demand increases to the point that the refinery is maxed out, this can lead to higher prices until capacity can be increased.
Global demand and economic performance
Economic development in highly populated countries, such as India and China, can lead to a sharp increase in global demand for oil and gas products. Alternatively, economic struggles tend to reduce demand for oil as businesses scale back operations and households reduce gas consumption to save money. A clear example of this was the Great Recession in 2007-2009 when oil and gas prices fell more than 70% in less than six months.
Aggregate indicators of general economic performance can inform investors of expected changes in demand for oil and gas. Gross domestic product (GDP) is a measure of the total levels of expenditure and production in a given economy, and increases in GDP are assumed to lead to increased demand for oil.
Government policy: interest rates, taxes and regulations
Interest rates are important economic indicators for industries related to goods or finance. Changes in interest rates affect inventory storage costs, affect the borrowing and spending patterns of producers and consumers, and change capital costs and the structure of oil producers with respect to land, buildings, machinery and equipment.
Government tax policies have an impact on business performance and profitability. Increased taxation of petroleum products or oil and gas companies limits production and can lead to higher prices; the reverse is true for lower taxes.
Regulations are also an important aspect to consider. Since burning fossil fuels raises environmental concerns, governments may feel the need to increase their taxes or regulations on oil and gas companies to intentionally reduce consumption levels; it affects supply and demand and therefore the price.