4 Benefits Of Rising Oil Prices

By Stephen D. Simpson, CFA | March 14, 2011 AAA

No, that title is not a misprint. While everybody likes cheap energy and most economists believe that economic growth is predicated at least in part on cheap access to energy, it does not automatically follow that there is no good that can come from higher energy prices. Markets are made up of multiple independent agents and what constitutes a challenge for one can be an opportunity for others. (Learn a little more about the "non" part of this nonrenewable resource. Check out Peak Oil: Problems And Possibilities.)

TUTORIAL: Exchange-Traded Funds

1. Some Sectors Thrive
It probably counts as obvious that there are sectors that thrive when oil prices march upward. High prices for oil fuel the same sort of process as in any other sector; suppliers look for ways to provide more of the product and take advantage of those higher prices. For energy, then, that means opportunities for companies involved in exploration (seismic survey, for instance), drilling, production and servicing.

Ultimately boom times in the energy sector filter into the economy. After all, a dollar in wages from an oil company spends the same at Wal-Mart (NYSE:WMT) as a dollar from a solar energy company. When oil prices are high, companies spend more on equipment, supplies, salaries and the like - money that enters the economy in much the same fashion as a boom in any other sector.

2. New Technologies Become Viable
Cheap oil is problematic for companies and industries looking to supplant oil. While most people can agree that there are vague and nebulous costs associated with accessing and utilizing oil (pollution, for starters), the United States has been reticent to translate those costs into higher energy taxes. What's more, it is not clear that higher taxes on fossil fuels in Europe and much of Asia really do anything to mitigate environmental damage beyond reducing consumption. All in all, then, when oil prices are low it is very hard for cleaner energy technologies to compete effectively on price.

With higher oil prices, though, suddenly a lot of new ideas get a hearing. Increased fuel mileage for passenger cars seemed pointlessly expensive in the U.S. prior the 1970s energy crisis, and it likewise seems probable that hybrids today owe any acceptance outside of the environmental crowd to the high price of gasoline (the number one derivative of oil these days). Along similar lines, the path towards viable mass market all-electric cars is predicated on persistently high oil prices.

It is not just passenger vehicles where high oil prices lead to innovation. Quite a lot of plastics and other synthetic materials are derived from oil and higher prices ripple through the economy. With high oil prices, then, comes increased interest and R&D into non-oil alternative feedstocks for these materials. (Find out more in 6 Surprising Ways Oil Prices Affect You.)

This process has a lot of fringe benefits for the economy as a whole. Research into oil substitutes creates jobs for scientists and engineers. When successful, these efforts also result in product alternatives that allow consumers to spend less of their income on energy (whether directly or indirectly). Oil-free technologies also typically offer less environmental degradation and related externalities, though they are never entirely free rides themselves (the batteries in hybrids, for instance, require metals that have to be mined, refined and processed).

3. Changes in Behavior
For those who believe that burning oil (and other hydrocarbons) is generally a bad thing, higher prices that lead to lower use has to be counted as a benefit. When people are faced with higher prices and no obvious substitutes, they will consume less assuming that their demand is relatively elastic.

With high oil prices (and high gasoline prices), people will drive less - staying closer to home for shopping, combining various errands to be more efficient, and so on. Likewise, they will spend less on oil-derived products whose prices rise with higher oil prices. Clearly there will be some loss; if there are no easy substitutes available, people will simply have to spend more on energy and spend less on other things.

Over time, though, more and more options become viable and greater changes in behavior are possible. Given time, people will drive less, take better care of their cars (to increase mileage), switch to more fuel efficient car models and/or use more public transportation. Likewise, companies will find limits on just how much they can pass on higher input costs and will seek to reduce their usage of oil and oil byproducts as well. (This organization's decisions can influence oil prices, but there is a limit to its power. Check out Meet OPEC, Manager Of Oil Wealth.)

4. Alternatives Come to the Fore
If increased exploration and production is a normal byproduct of higher oil prices, so too is substitution. When Nazi Germany faced oil shortages in World War II, methods of producing oil, diesel and gasoline substitutes from vegetable oils, animal fats and coal were thoroughly explored. Likewise, the oil crisis of the 1970s gave the development of ethanol in Brazil a major boost.

In the United States there really are few short-term alternatives to oil. Technology exists to supplant oil with natural gas in many applications, but those switchovers only make economic sense in the face of persistently higher oil prices. Likewise, coal and biomaterials (switchgrass, etc.) can be pressed into service, but again only make sense as alternatives if oil prices are quite high and seem likely to stay there.

TUTORIAL: The Industry Handbook

The Bottom Line
On the whole, higher oil prices are not going to have most people in the United States celebrating. If nothing else, there is a psychological impact to driving by those gas stations every day and seeing the prices tick higher. That said, free markets offer plenty of options for economic agents to respond to higher prices and oil prices are no exception. While painful in the short-term, higher prices may ultimately open the door to cleaner, more efficient and ultimately cheaper energy sources that benefit us all for years down the road.

You May Also Like

Related Articles
  1. Stock Analysis

    Breaking Down the Halliburton Baker ...

  2. Economics

    How Weak Oil Prices Affect Airline Profits

  3. VelocityShares 3x Long Crude Oil ETN has the potential for huge returns, but there are several reasons why you might want to steer clear for now.
    Mutual Funds & ETFs

    A Leveraged Oil ETN For The Future (Just ...

  4. Stock Analysis

    ConocoPhillips's Well-Oiled Profit Machine

  5. Gasoline prices have been dropping lately after holding fairly steady for a year or so, following world oil prices.
    Personal Finance

    How Long Will Lower Energy Prices Last?

Trading Center