This month we write about an area that has declined enough to enter bear market territory. The area of the market that has been hurt the most in the recent market turmoil has been the energy sector. Oil has a significant impact on several key sectors of the economy:
Consumer spending.Consumers spend, on average, 4% of their income on energy (including oil, natural gas, refined gasoline, etc.). As a result, a sharp drop in energy costs can help provide a boost to consumer spending, particularly important as holiday shopping and the winter heating season approach.
Capital spending.Energy accounts for one-quarter of all capital spending globally, more than any other sector. Oil and gas exploration and production are very capital intensive, and significant infrastructure investments are needed to support the U.S. energy boom.
Transport sector.Oil influences transports as a cost (fuel for airlines, shippers, trucks, etc.), but it also provides growth opportunities as an increasing amount of oil and petroleum products are transported by truck and rail due to the boom in U.S. energy production.
After falling 25% from its summer 2014 highs, West Texas Intermediate (WTI) crude oil, a long accepted benchmark for U.S. oil prices, has begun to find a footing in the $81-82 range. Slower global growth is being reflected in oil demand forecasts. The International Energy Agency (IEA) cut its outlook for 2014 oil demand growth by 200,000 barrels per day, or 22%, from its prior forecast of 900,000. Global oil demand is around 92 million barrels a day. Compounding the slowdown in global economic growth, Saudi Arabia has engaged in a price war to drive down non-OPEC supply and to defend its market share against U.S. shale production. It may also be trying to put economic pressure on its rival and neighbor Iran.
The pressure on domestic producers may be temporary because many have cited profitability with prices as low as $60. The IEA has stated that just 4% of U.S. shale output needs prices above the $80 level to be profitable.
There are several risks to the downside for oil to suggest its recovery from recent lows may be bumpy. Additional pipeline development, export friendly policies, and stronger demand are needed to help clear out excess inventories in the United States. Though it will take time, more U.S. exports could put downward pressure on domestic inventories and support prices. Globally, the oil market is expected to be slightly oversupplied in 2015. We do not have much confidence that growth in Europe will improve. A prolonged recession in Europe would further reduce global demand.
We believe booming U.S. production and a global price war present manageable risks. We would expect the market to find its supply-demand equilibrium – and in turn, more solid footing – within a reasonable time frame.
John Hess 
Falgun Jariwala 
Managing Principal Managing Director
jhess@nsinvestors.com fjariwala@nsinvestors.com
www.nsinvestors.com www.nsinvestors.com
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