Oil Prices Won't Sink the Dow

Both the Dow Jones Industrial Average and S&P 500 dropped early this week on fear of conflict in Syria and rapidly rising oil prices. You may think the rise in oil prices is bad for stocks, but in the long term that's actually not the case. The chart below shows that oil and stocks often move together, benefiting from good times in the economy and dropping when things go bad.

WTI Crude Oil Spot Price data by YCharts.

Oil and the Dow have a lot in common
When talking about the price of oil, the first thing we need to look at is what affects the price of oil in the long term. As with most commodities in the global market, supply and demand drive the price of oil. Supply can be complex, with OPEC regularly increasing or decreasing production, but demand is a little easier to understand. The bottom line is that what's good for stocks is good for the price of oil.

Overall, stock markets like to see rising GDP, a growing labor force, and increasing auto sales. All of those things are positive for oil producers, and they lead to increased demand.

On the flip side, recessions are bad for both stocks and oil. You can see above that between about 2000 and 2002, stocks dropped along with the price of oil. They have more in common than you might think.

More oil is coming from home
The biggest development in the energy business over the past decade has been improved efficiency in shale drilling. Land that was once nearly worthless in western North Dakota is now full of productive wells -- something that's been replicated around the country.

In 2005, the U.S. produced just 8.25 million barrels of oil per day. This July, production was up to 12.04 million barrels per day, largely because of the expansion of shale drilling. That has helped drive imports down: Just 35.9% of our net imports come from overseas versus 60.3% in 2005.  

When the price of oil rises, it may have a negative impact on consumers' bank accounts, but it's also creating jobs that help the economy. The good thing is that we're not sending as much money overseas as we once did, which makes the rising price of oil less concerning for the overall market.

There's a cap on the price of oil
The final reason I don't think investors need to be worried about the price of oil is consumers' ability to change their behavior. As the price of gasoline has risen over the past decade, we've begun driving more efficient vehicles, and recently alternatives like natural-gas and electric vehicles have become viable options. You can see below that consumption is dropping sharply as the price of oil has risen.

US Oil Consumption data by YCharts.

That trend will continue as consumers become more comfortable buying alternative vehicles. In effect, the threat of alternatives and the willingness of consumers to buy more efficient vehicles creates a cap on the price of oil. There's only so much we can take before we just stop driving.

Foolish bottom line
Unless all-out war breaks out in the Middle East and multiple major oil-suppliers are involved, I don't think there's a lot for investors to worry about. After all, we've been through two wars with Iraq and conflicts in Libya and Iran without much long-term impact on oil or stocks. That will likely be the case again this time around.