Oil Prices have fallen significantly over the past year. The reason is summed up in a recent report from the International Energy Agency – the oil market is drowning in over supply. The magnitude of the decline in prices has surprised market participants and sparked a host of fears about domestic and global economic growth. In a market full of negative headlines, it is important to remember that while lower oil prices are a threat to energy companies and oil exporting countries, there are other areas of the market that may benefit.
Low oil prices translate into lower fuel and energy costs for companies and more income for consumers, but not necessarily for stock gains. A few sectors have managed gains in a difficult market environment. Other areas of the market have been punished, as market sentiment remains fragile due to concerns about future demand offsetting the benefit of lower energy costs.
Airlines stand to benefit from both cost savings and increased consumer demand. As of the 3rd quarter of 2014, prior to the steep drop in oil prices, fuel accounted for approximately 31% of costs. As of the 3rd quarter of 2015 (latest data available), that number had fallen to 18%. In 2015, U.S. carriers used 541 million more gallons of fuel than they did in 2014, as revenue passenger miles increased approximately 6%. Even with the higher fuel usage, airlines saved almost 33% as the average price per gallon fell from $2.86 to $1.86. Many airlines have yet to take full advantage of the lower prices because they had hedged their fuel costs. Hedging helped during periods of rising prices, but it prevented them from fully realizing the benefits of lower oil prices. Nonetheless, the airline sector has outperformed the S&P 500 index.
Refiners, who take crude oil and turn it into gasoline and other refined products, represent the only bright spot in the energy industry. Because the price of gasoline has not dropped as much as the price of oil, profit margins improved. Refiners have been able to increase earnings by 50% over the last 19 months. Performance for the industry has been hurt recently, as markets fear the lifting of the U.S. crude oil export ban may lead to increased costs. However, markets have been kinder to refiners than other areas of the energy sector.
For the trucking industry, fuel costs have rivaled labor costs, typically a company’s largest expense. In 2014, fuel and oil costs averaged 34%, topped only by driver wages and benefits at 35%. Low oil prices have resulted in improved profitability over the past 18 months, with earnings per share increasing by 53%. The market, however, has yet to reward these improvements. China’s economic slowdown, the strong U.S. dollar’s impact on trade, and a reduced need for domestic transportation equipment, have caused investors to avoid transports. Additionally, market fears of a continued economic slowdown around the globe have pressured the sector.
Autos have experienced consecutive years of record sales, with total sales at or near all-time highs since 2013, and miles traveled reached a new record in 2015. Autos are a big ticket item and have historically been economically sensitive. Rising recession fears have begun to impact the sector, despite improving financial results. An additional headwind has been that consumers have increased their savings. An estimate of personal savings has risen from 4.8%in the 2nd quarter of 2014 to 5.5% in the 4th quarter of 2015.
Internationally, India is an example of an oil importing country that stands to benefit significantly from low oil prices. India’s growth has been strong in recent years. In 2015, India - with an official gross domestic product (GDP) growth rate of 7.5% - actually surpassed China’s growth, making it the fastest growing economy for the year. As India’s infrastructure develops (electric and transportation), energy use per capita is likely to rise. While India is a big beneficiary now, it could see even more positive effects in the future should oil prices remain low. Lower oil prices have yet to translate into higher stock market prices.
Although we all remember high oil prices, a number of factors suggest oil prices may remain low.
Short-term:
- U.S. production has proven resilient in the face of lower prices. Supply is down only modestly, surprising markets.
- OPEC has shown a reluctance to cut supply, driven by fear over losing market share.
- Russia and other nations are dependent on oil revenue to maintain cash flow for national budgets.
- Iran may add more than 1 million barrels a day of oil in the absence of sanctions.
Long-term:
- Improving technology and higher fuel mandates may reduce demand.
- Environmental concerns increase the demand for alternative energy.
- Continued improvements to battery technology and electric car capabilities may expand the use of electric vehicles.
The U.S. Energy Information Administration (EIA) tracks proven reserves and technically recoverable resources. Proven reserves refer to the amount of oil that is able to be recovered economically at current prices and with current technology. Technically recoverable resources are broader and refer to “tight” oil, which includes shale oil among other unconventional resources. Proven reserves have increased steadily over the past few years, partly due to increased oil prices, making it economically feasible to extract oil that may have been too expensive to recover previously. However, the EIA’s estimate of technically recoverable resources related to tight oil have increased at a much faster rate. Estimates have increased from 32 billion barrels in 2011 to 345 billion in 2013, and have since been updated to nearly 413 billion barrels. To put this in perspective, the 313 billion barrel increase between 2011 and 2013 is larger than the entire proven reserves of Saudi Arabia (280 billion barrels). As technology continues to evolve, access to previously unknown reserves will likely expand, meaning we are not apt to run out of oil anytime soon.
Outside of a significant surprise, such as a cut in supply from OPEC or a pickup in demand from economic growth, low oil prices may be with us for some time. Long-term factors such as conservation and alternative energy may mean that $100 oil, not today’s current price, will be considered the anomaly. While continued low prices will be a headwind for the energy industry and oil exporting countries, consumers and oil importing countries, such as India, benefit.
- The views expressed are provided for information only and are not to be used or considered as an offer or solicitation to buy or sell securities or investment products. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you consult your financial advisor.
- The economic forecast set forth in this presentation may not develop as predicted, and there can be no guarantee that strategies promoted will be successful.
- Because of its narrow focus, specialty sector investing will be subject to greater volatility than investing more broadly across many sectors and companies.
- Data provided by LPL Financial.
- All investing involves risk including loss of principal.