Why is the price of oil so high?

Brian Youngberg, CF Utility/Energy Analyst at Edward Jones, comments: We believe that, like most commodities, oil is priced primarily through supply and demand. However, other factors have helped propel oil prices to record levels recently.

Supply has remained relatively stretched with new production struggling to offset older, declining oil fields. As a result, spare production capacity has hit its lowest level in years. With a limited ability to make up for disruptions in global supply, the price of oil has become increasingly sensitive to changes in the outlook for oil production. Adding to this problem is the fact that a significant portion of new production is in remote or hostile areas, whilst costs to extract it are growing at a significant rate.

In recent years, global demand has accelerated. Whilst China and India receive the most attention, demand also has grown rapidly in much of Asia and the Middle East. A combination of large populations, expanding economies, improving standards of living and increasing automobile ownership will likely cause global demand for oil to continue growing.

Other factors helping to push oil prices higher include:

Ongoing global tensions that raise uncertainties
The weak US dollar
Speculators buying commodities, including oil, in hopes of offsetting lower returns from traditional investments
These issues are difficult to predict and have had an increasing influence on the direction of oil prices.

Where Does the Price Go from Here?

It is impossible to predict how oil prices will move. In the short term, we expect them to remain volatile, especially given the uncertain impact of the global economy on demand. More importantly we don't believe investors need to know where prices will go in the short term in order to make sound investment decisions. We believe investors should focus on principles and not predictions when making investment decisions. These principles include:

Maintaining a proper weighting in energy shares in a well-diversified portfolio
Looking past volatile day-to-day changes
Having a longer-term focus
Owning quality energy shares
Should You Own Energy Shares?

We believe you should consider owning energy shares primarily because they can help diversify your investment portfolio. Energy shares also include the potential for rising income. We recommend investors own 13% of their equity portfolio in energy shares.

We recommend building your energy share ownership with integrated energy companies for the following reasons:

They historically have tended to be less volatile than energy companies that are focused on only one segment of the industry. This lesser volatility is due to integrated energy companies' diversified operations.
They generally offer greater dividend income relative to the overall energy sector.2
Is Now a Good Time to Buy Energy Shares?

Overall, we believe shares of some integrated oil companies are attractively priced relative to past levels because we expect good earnings and dividend growth. Our analysis shows that some integrated companies are priced based on an average long-term price for oil of only $65 per barrel. However, we currently expect the average price of oil to be above that in the longer term. Risks to buying oil shares include a significant drop in commodity prices, geopolitical problems, operational delays and adverse legal or regulatory decisions.

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