The Hidden Cost of Volatility Drag

The energy market has been in a state of turmoil since the start of 2010. Despite expectations of a rebound in global oil demand, supply outpaced forecasts, leading to an increase in prices. In fact, U.S. production is poised to post a 6.4% rise in 2009, with Gulf of Mexico output accounting for the majority of this growth.

That said, the overall outlook remains cautious due to high levels of unemployment that are likely to persist throughout 2010. Unemployment rates in the United States and Europe have been steadily declining since the start of the year, but a slowdown is expected as consumers become more cautious about spending. This could temper discretionary spending habits, which in turn could slow down economic growth.

A New Reality for Crude Oil Supply

The increase in supply will be largely driven by production in the Gulf of Mexico, with U.S. oil production averaging 5.268 million barrels per day through October 2009. In percentage terms, this would be the largest increase since 1970, according to Platts’ estimates.

That said, it is essential to note that supply will always be adjusted by producing countries in response to global economic conditions, prices, and shifts in stocks. The energy ministry’s Central Dispatching Unit has reported a record-high crude output for December 2009, with Russian crude production jumping 4% on the year to 10.01 million barrels.

What Does This Mean for Investors?

For investors, the slow and steady increase in oil prices may not be as alarming as it seems. While prices have risen steadily over the past few years, they remain relatively low compared to historical norms. However, a continued rise in supply could lead to a decline in demand, which could eventually cause prices to drop.

That said, high levels of unemployment will continue to temper discretionary spending habits, and investors should be cautious not to overinvest in energy-related stocks. A stronger U.S. dollar could also impact oil prices, making lower prices more acceptable since terms of trade would be more favorable for oil producers.

What's Interesting Is

What’s interesting is that the increase in supply will eventually lead to a decline in demand, which could cause prices to drop. However, investors should be cautious not to overinvest in energy-related stocks and should consider diversifying their portfolios to mitigate potential losses.

The Bottom Line

In conclusion, while the energy market may appear to be in a state of turmoil, it is essential to keep a level head and look for opportunities. A slow and steady increase in supply will eventually lead to a decline in demand, which could cause prices to drop. However, investors should be cautious not to overinvest in energy-related stocks and should consider diversifying their portfolios to mitigate potential losses.