Reactions to the Sudden Drop in Oil Prices

Bruce Birkett
February 27, 2015
Unless you’ve been living in a cave (without an internet connection) you are probably aware that the price of gasoline has dropped well below $3.00 per gallon which is where Americans had become accustomed to paying at the pump. Why has the price of gasoline dropped and what can you as a small business do to ensure your business is not adversely affected?

Why has the Price of Gasoline Dropped Suddenly?

As you probably know, gasoline is a produced from crude oil. The stuff that leaked into the sea for several months in the Gulf. Crude oil is a commodity in every part of the world – it has no real competitive advantage regardless of who supplies it. Therefore, the price for a barrel of this stuff cost about the same throughout the world (adjusted for different currencies). When the price of this commodity changes, the price of a gallon of gasoline changes just the same. But, why has the price of a barrel of crude oil dropped recently? Is it a result of supply and demand or just speculation? Supply and demand phenomenon is the increase or decrease in the price a good based on the demand for that good. For example. You hear these car salesmen yelling at you through the TV that they have over-stocked their 2014 supply of cars so they have dropped the price in order to make room for the newer cars. They supposedly have more cars than have been demanded by buyers so the only way to move them is to lower the price. Whenever one has more of a product than the customers want it sits on the shelf until the price is lowered. The seller has a sale, then the product starts to move. On the other hand, speculation is when unrelated events happen is causes a couple of people to panic and sell this good at fire-side prices. Someone else sees this happening then they panic and sell at an even lower price before the price plummets or so they can maintain their market share. This snowball effect continues – constantly lowering the price of the good. The drop in the price of gasoline is mostly due to supply and demand effects. Since we know this, we can start to evaluate it from this perspective and then devise a strategy that ensures our businesses remain on course during this period.

Three Strategies to Consider to Ensure Your Business is Not Adversely Affected by the Drop in Oil Prices.

Always Hedge

Hedging is sort of like having a plan B. Just in case your primary thing doesn’t work out according to your expectation, there will be a go-around or another way out so that you don’t lose everything. Hedging make good sense in any situation in which you are dealing in volatile commodities. For example, if your business is in the business of providing pipe to the oil extracting industry for oil rigs, make sure you have customers in other industries unrelated to the oil extracting industry. It reminds me of a 4th generation manufacturer of textile products in the U.S. They were the number 2 supplier in the world of this particular product. As a result they put all their resources into supplying textile customers only because that was what they were very good at and that’s where the money was. But, when the textile industry suddenly left the U.S., this manufacturer had no other customers, very high over-head costs and eventually filed for bankruptcy. Don’t let this happen to you. Hedge.

Benchmark

Find out what others in your industry are doing to offset potential losses due to falling oil prices. This is a form of benchmarking. How do you know where you stand in relation to your competition? Are you paying attention to changes your competition is making or are you simply stuck on drinking your own kool-aid? Businesses that don’t make changes to their strategies typically don’t stay around very long or they remain at the bottom of their industry in terms of market-share, revenue or profits. Find out what others are doing.

Be in a business that is counter-intuitive to the oil Industry

What do I mean by this? Lower oil prices eventually means lower prices at the pump. When drivers spend less filling up their vehicles, we generally spend more on other goods. Larger automobiles are a good seller during periods of low gas prices. Being a supplier to the automotive industry is a good business to be in whether its manufacturing floor mats or key chains. So yes. There are some ways to protect your business from dropping oil prices and even a couple of ways to make a profit from this phenomenon. The main thing is to realize that something different needs to happen as early as possible, but better late than never.

About the Author

Bruce Birkett

Bruce Birkett divides his time between the US and Europe, where he has a number of both large and small business clients for whom he provides a range of consulting services with a small expert team. In the past, he has worked with major institutional investors, particularly in real estate, and he has also helped individual investors looking at private equity. He has been involved in a number of African business ventures and currently also contributes to an English trend following group out of Beijing, China.

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