As we write, crude oil continues its decline, with WTI trading down more than 20 percent from the year’s highs.
While some analysts are calling this a bottom, others — including some we respect — believe that prices could continue to fall into the $70s.
The decline can only be described as dramatic, and has had an equally dramatic effect on the stocks of oil companies, as represented by the Energy Select Sector SPDR ETF ($XLE) in the graph below.
What’s Driving Falling Prices?
There are consistent seasonal effects — we have left the driving season and have not yet entered the heating season in the northern hemisphere. There are also global macroeconomic and geopolitical forces behind the trend, which is why many analysts believe that it may continue for some time.
First, as we noted two weeks ago, the U.S. Dollar is appreciating against many world currencies. Since oil prices are denominated in Dollars, this acts to reduce demand, since oil becomes more expensive for non-U.S. economies. Bull markets in the Dollar tend to be multi-year affairs — which may help keep oil prices under pressure.
Second, the economic news outside the U.S. (and perhaps China) has been pretty relentlessly poor over the past weeks. Global economic growth targets are being revised downward from their already low levels by organizations such as the International Monetary Fund. News from Europe is bad, with even Germany looking like it might slip into recession, and ongoing policy paralysis. Japan’s hopeful uptick under Shinzo Abe seems to be losing steam as long hoped-for structural reforms prove difficult to implement.
Therefore, the oil markets, looking forward, seem to be pricing in a low growth future, in which oil demand will be low.
Third, geopolitics are a factor. The Saudis are raising production and cutting prices, perhaps in an effort to preserve market share — or to put a dent in the upstart U.S. shale oil producers, some of whom are highly levered and require a high break-even oil price to survive. Further, many countries in the world – including Saudi Arabia itself — rely heavily on oil revenues to support the social spending that helps them maintain order.
Among these, Russia is key; we have seen estimates from $95 to $107 as the price per barrel that Russia needs.
Although many other countries — including Libya, Venezuela, and Nigeria — will be hurt by falling oil, some suggest that the price decline is being encouraged in part specifically to punish Russia for its aggression in eastern Europe.
And let’s not forget that the Saudis would love for Americans to enjoy cheap gasoline for long enough that they start buying more Ford F150s and fewer Toyota Priuses.
Who Is Hurt, and Who Benefitted?
Besides Vladimir Putin and his cronies, who else will be hurt by falling oil prices?
As we noted above, the first to feel the pain have been oil companies. If this trend continues — and we note that the forces driving it do not seem to be transient — we would be cautious at any claim that energy stocks represent a bargain at current prices.
And of course, to many of our readers, the first apparent beneficiary is their own wallet — with U.S. gasoline retail prices falling about 15 percent from this year’s highs.
The Bureau of Labor Statistics calculates that gasoline comprises about 6 percent of a consumer’s basket of expenses. By that calculation, the current decline in gasoline prices would feel like about a $500 annual bonus to an average American family. So the continuing pressure on oil prices translates into the potential for increased consumer spending, especially as we head into the holiday season.
Many U.S. companies will have a similar feeling — particularly those that rely on crude as a manufacturing input, or that consume it in transportation. Each industry has numerous idiosyncrasies and complexities, but transport (including shipping and airlines), refiners, and chemical companies are all logical beneficiaries of lower oil prices.
The Flies in the Ointment
The central problem with locating specific beneficiaries of low oil prices is simply the market psychology that these falling prices represent. If anticipations of recession risk and global growth slowdown are major factors in oil’s decline, those same sentiments are currently weighing heavily on global markets as a whole.
Further, one of the other main factors in oil’s fall — the rising U.S. Dollar — will ultimately begin to cost the U.S. economy by hurting exports.
That may happen eventually — but we note that historically, sharp oil price declines, when they happen, as now, outside a recession, have often correlated with stock rallies.
Investment implications: Falling oil prices are being driven by significant macroeconomic and geopolitical factors, which may be multi-year developments. If the pressure on oil prices is not transient, energy stocks may have further to fall. U.S. companies and U.S. consumers may feel like they’ve been given a tax break — and the latter may show some increased willingness to spend. Eventually, the stronger Dollar that’s behind oil’s fall may weigh more heavily on U.S. exporters. But in the meantime, the sharp decline in oil reinforces our view that after the current correction, the U.S. bull market in stocks will resume.
