InvestmentsMar 30 2015

Canny investors to cash in on oil slump

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The decline in the price of oil in the past nine months has had a diverse effect on markets and investors looking into the commodities space.

In the 12 months to March 18 2015, the S&P GSCI Brent Crude Spot index has plunged 39.63 per cent. However, the FTSE All-Share Oil and Gas index has dropped just 9.2 per cent in the same period and the S&P 500 Oil & Gas Exploration and Production index has fallen 6.39 per cent, data from FE Analytics shows.

So while the oil price itself has had a dramatic fall, with Brent Crude currently sitting at roughly $54 a barrel, and WTI (West Texas Intermediate) Crude oil even lower at $43 a barrel, investors that have taken indirect exposure to the commodity have had a slightly better ride.

Meanwhile, the wider indices have performed strongly in the past 12 months, in spite of reasonably large exposures to the oil sector. The S&P 500 has gained 26.3 per cent in the 12 months to March 18, while the FTSE All-Share has risen 8.71 per cent.

Daniel Murray, chief economist at EFG Asset Management, notes: “The clear market delineation has been between the energy producers whose stocks and shares have suffered quite a lot in the past nine months versus the sectors that benefit from a lower oil price.

“Consumer discretionary in particular is the sector that has done relatively much better, in part because the lower oil price acts like a bit of a tax cut, so consumers have more spending power.”

Other beneficiaries of the falling price of oil include any industrial sectors that are energy intensive, while on a country basis the obvious impact is that oil importers such as India have done better, while oil exporters such as Russia have suffered.

As a whole the uplift to the global economy from the lower price of oil can roughly be calculated as a 0.1-0.2 percentage point increase in global GDP for every $10 decline in the price. Therefore, a $50 fall could equate to a boost of 0.5-1 percentage point to global GDP.

Mr Murray adds: “It is not massive but it is meaningful, and it is certainly a tailwind for the global economy through 2015 and hopefully into 2016.”

One of the drivers in the decline of the price of oil was the unusually sharp increase in supply. Mr Murray explains: “That was in part down to shale, but also down to some of the Libyan oil coming back online, so there was a sharp increase from that source. That threw all the existing demand-based models out of sync.”

Although many are now re-evaluating the supply-demand dynamics of the oil market, it seems unlikely that the price of oil will recover too rapidly, with Carmignac commodities fund manager Michael Hulme highlighting a pick-up in supply volumes from south Iraq and Kurdistan.

“But the biggest surprise that really triggered the fall in the oil price was the production spike in Libya, which no one expected because of the ongoing fighting there,” Mr Hulme explains.

“Needless to say there remains a big shale overhang in the market, which has pushed up oil and gas production in the US. Shale has been the greatest driver of change in the oil markets in the past five years, leading the resurgence of US onshore oil production. Shale fields in the Bakken and Eagleford have gone from zero to 1 million barrels of production a day each.”

With such a large boost to global output, and with Saudi Arabia seemingly more focused on gaining market share than cutting production, a return to $100 a barrel looks doubtful any time soon.

Mr Hulme says: “US data shows the country’s storage capacity is quickly reaching its limit, so there’s nowhere to put [the oil] and this will hit production. Most US shale producers need $70 a barrel to justify new drilling. However, we doubt that supply can correct any earlier because of the lags in the system.

“We believe oil prices will remain under pressure until natural declines assert themselves and exploration and production companies curtail drilling activity. Turning off US shale production takes time – as much as 18 months.

“I am optimistic oil prices will recover – possibly to around $75 – in the first half of 2016 as shale volumes begin to fall. This year will be tough, but also replete with opportunities for canny investors.”

Nyree Stewart is features editor at Investment Adviser

Impact of low oil price on environmental markets

Bruce Jenkyn-Jones, head of listed equities at Impax Asset Management, explains the wider effects of a declining oil price:

“The lower oil price has created considerable negative sentiment around environmental markets, but it has not led to material underperformance. Understanding the influence of a lower oil price on each sector is complex and requires a detailed analysis of the underlying drivers of companies and the business models involved.

“In the water sector, we have witnessed both positive and negative impacts, with the lower cost of oil proving positive for many water treatment companies where oil is an input cost for many chemicals.”

Dividends under threat?

Michael Hulme, fund manager at Carmignac, explains the impact lower oil prices could have on oil company dividend payouts:

“European integrated oil companies face an unpleasant choice between a dividend cut and shrinking volumes. Big oil companies have been effectively bailed out by low interest rates in the past five years.

“The question now is – what is their long-term story? The big oil companies are overindebted and don’t have a lot of free cashflow to pay dividends. Their business models are not sustainable at the current oil price. If prices do not recover above $100, then we will start to see dividends cut.”