PETRÓLEO The oil price slump – historical view

Redacción - Miercoles, 03 de Febrero

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• With a decline of around 30% since end-October and around 50% since end-June to less than $30 p/b recently, the severity of the oil price slump has taken many observers by surprise.
• As recently as October 2014, the World Bank¹ was forecasting an average oil price of $96 p/b in 2015 – almost 50% higher than what actually transpired.
• As shown below, the current oil price slump has been notably brutal by almost any historical basis of comparison.

Current oil price cycle vs prior cycles

Source: Bloomberg, January 2016, Chart depicts WTI indexed to 100 for each cycle;

¹ World Bank Commodity Markets Outlook, October 2014

 

The oil price slump – supply side view

• With oil prices averaging a high $95p/b in the 2011-14 period, this encouraged strong investment in oil exploration and production, including in higher cost oil sources.
• In particular, the sustained period of strong oil prices coincided with the US shale energy revolution, which was the main reason behind a cumulative 3.9 m b/d surge in US crude oil and liquid fuels supply in the three years to end-2015 (see chart below).
• To put the scale of the US shale oil surge over 2012-15 into perspective, it is worth noting that the world’s fourth biggest oil producer, Iraq, produced 4.1m b/d in 2015.

 

Non-OPEC crude oil and liquid fuels supply growth, 2013-15

Data: EIA  Short-Term Energy Outlook, January 2016

 

The oil price slump – demand side view

• While global oil supply has been growing as outlined, at the same time, global demand for oil has weakened, in large part due to slowing economic growth in China.
• The slowdown in China has been detrimental for oil demand because it is the world’s biggest importer of oil and because in the past few years it has also been a key source of incremental demand for oil. According to the EIA data, in the 2011-15 period, China accounted for over 40% of  global liquid fuels consumption growth but in 2016-17 its share of global liquid fuels consumption growth is forecast to average 22%.
• In addition to slowing overall growth, China’s economy is in the process of rebalancing towards  private consumption, meaning less reliance on oil intensive fixed investment and manufacturing exports. The chart below suggests that this process has some way to run

 

China’s GDP composition normalisation still has some way to go

Source: Goldman Sachs, January 2016

 

Economic implications

•       In broad economic terms, lower oil prices are disinflationary and functionally very similar to a wealth transfer from oil exporting nations to oil importing nations. 

•       In theory then, big oil importers benefit from low oil prices while big exporters lose. This is a general statement. A fuller analysis requires consideration of the impact of lower oil prices on all the components of aggregate demand for each country in question , including the existence and extent of energy subsidies which effectively determine the split of the benefit from lower oil prices between government and the private sector.

•       In practice however, for many oil importing countries, lower import costs are balanced to varying degrees by: 1) reduced energy sector investment; 2) the propensity of reduced fuel bills to be saved by consumers; and 3) potential exacerbation of deflationary risks.

•       The US is a prime good example of the interplay of all the above factors owing to sharply declining shale sector investment, inflation very close to zero and signs that consumers have so far been largely saving the bulk of the oil benefit as shown below

 

US consumers’ energy windfall appears to have been largely saved so far…

Source: BEA, Federal Reserve, Evercore ISI December 2015

 

The $ benefit of sharp declines in energy prices is around $358 billion. 

 

But, personal savings in the US have increased by around $333 billion, suggesting that most of the benefit has been saved up until now. 

 

Investment implications

Given oil’s key role in powering the the global economy, low oil prices have many sector and stock level implications. Generally, areas for which oil is a key input cost, benefit, while areas for which revenues are positively linked to oil prices, lose out.

Examples of oil price winners include:

•       Autos – low oil prices support demand for motor vehicles, particularly gas-heavy vehicles such as SUVs. Stock example: GM

•       Agriculture – lower oil prices tend to bring down farm operating costs, including farm machinery, fertiliser and transports costs. Stock example: Kubota Corp

•       Chemicals – crude oil can account for the bulk of many chemical companies’ raw materials costs, so lower oil prices help. Stock example: Akzo Nobel

Examples of oil price losers include:

•       Oil exploration and production (E&P) – lower oil prices are clearly negative for oil E&P firms, particular those with higher break even costs. Stock example: Occidental Petroleum

•       Energy capital goods – lower oil prices mean lower investment in E&P, which means reduced demand for energy capital goods. Stock example: Diamond Offshore Drilling 

•       Alternative/clean energy – low oil prices effectively reduce the economic appeal of many renewable/clean energy focused products. Stock example: Tesla Motors 

 

Source: Evercore ISI December 2015

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