A:

Oil and gas investors look for specific economic indicators to help them understand future movements in the petroleum industry. Like any commodity market, oil and gas companies and petroleum futures are sensitive to inventory levels, production, global demand, interest rate policies and aggregate economic figures such as gross domestic product.

Oil Inventories

Oil is an economically and strategically crucial resource for many nations. Countries like the United States maintain large reserves of crude oil for future use. The measure of these oil reserves acts as an indicator for investors; changes in the stock levels of oil are reflections of trends in production and consumption.

The Energy Information Administration provides a weekly supply estimate of petroleum and other liquids. When the trendline increases over time, suppliers are likely to lower prices to entice more purchases. The opposite is also true; decreasing levels of production cause buyers to bid up the price of petroleum commodities.

Refinery Use and Production

Investors should keep an eye on the ratio between refinery use and refinery capacity. Refineries are expensive, and it can take a long time to significantly increase production capacity beyond current levels. If demand grows to the point that the refinery is maximized, it may lead to higher prices until capacity can be increased.

Global Demand and Economic Performance

Economic development in highly populated nations, such as India and China, may lead to a large rise in global demand for oil and gas products. Alternatively, economic struggles tend to reduce the demand for petroleum as businesses scale back their operations and individual households cut back on gasoline use to save money. A clear example of this was the Great Recession in 2007-2009, when oil and gas prices dropped approximately 40% in less than six months.

Aggregate indicators of general economic performance can inform investors about expected shifts in the demand for oil and gas. Gross domestic product (GDP) is a measure of the total levels of spending and production in a given economy, and it is assumed that increases in GDP lead to increases in demand for oil.

Government Policy: Interest Rates, Taxes and Regulation

Interest rates are important economic indicators for sectors related to commodities or finance. Changes in interest rates affect the costs of inventory storage, affect the borrowing and spending habits of both producers and consumers, and change the capital costs and structure for petroleum producers with regards to land, buildings, machinery and equipment.

Government tax policies impact business performance and profitability. Increased taxation on petroleum products or oil and gas companies restrict output and may lead to rising prices; the opposite is true for lower taxes.

Regulation is also an important aspect to take into consideration. Since the burning of fossil fuels leads to environmental concerns, governments may feel the need to increase their taxes or regulations on oil and gas companies to lower consumption levels intentionally; this affects supply and demand and consequently the price.

(For related reading, see "Key Ratios for Analyzing Oil and Gas Stocks.")

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