Download 2015-01-20 Winners and losers from the oil

Market Perspective
January 2015
Winners and losers from the
oil price slump
Arguably the most important economic development of 2014 was the
slump in global oil prices in the second half of the year. As prices
continue to plummet in early 2015, this perspective looks at the causes of
the decline and the likely impact on selected countries, sectors and
individual companies.
While the decline in oil prices should benefit the global economy as a
whole, it will also create specific winners and losers, underscoring the
importance of an active investment approach.
DECLINING OIL PRICES – WHAT’S BEHIND THE SLUMP?
As Chart 1 below shows, the price of a barrel of Brent crude and West Texas Intermediate
(WTI) crude has slumped by 58% and 55%, respectively, since the start of the second half
of 2014. As with all commodities, prices are determined by the interaction of supply and
demand and to a smaller extent by expectations of future supply and demand.
Weakness in the eurozone economy and the structural slowdown in Chinese economic
growth have weighed on demand. However, by far the single most important factor
behind slumping oil prices has been the surge in US shale oil production.
Chart 2 below shows that US oil production has accounted for the vast majority of nonOPEC supply growth. The US Energy Information Administration (EIA) estimates that, in
the three years to 2015, US crude oil production will have increased by 2.8m barrels a
day (b/d) to 9.3m b/d, a figure comparable to Iraq’s 2013 total production of 3.2 m b/d.
130
$ per barrel
120
110
100
90
80
70
60
50
40
Jan-12
WTI
Jul-12
Brent
Jan-13
Source: Datastream, January 2015
Jul-13
Jan-14
Jul-14
Chart 2: Surging US shale oil production boosting supply
4.0
2015
2014
2013
3.5
3.0
2.5
The US has been by far the biggest
2.0
contributor to non-OPEC supply growth 1.5
adding 1.2m b/d and 1.5m b/d
1.0
(respectively) in 2013 and 2014 alone
0.5
0.0
-0.5
United States
Canada
Brazil
China
Sudan/S. Sudan
Russia
Kazakhstan
Oman
Colombia
Malaysia
India
Gabon
Vietnam
Other North Sea
Australia
Egypt
Norway
Mexico
Syria
Azerbaijan
United Kingdom
Since June,
crude oil prices
have more than
halved
140
The remarkable slump in global oil
prices since mid-2014 creates
specific winners and losers.
Oil importing countries benefit from
reduced import costs and higher
consumption. Major oil producers
lose out but the overall global
economic impact should be
distinctly positive.
In the US, higher consumption and
a lower energy import bill are only
partly offset by reduced energy
sector investment, with a significant
boost to overall economic growth.
Sector winners include autos,
airlines, chemicals and agriculture.
Sector losers include oil E&Ps,
energy capital goods, clean energy
and energy high yield.
This means that effective stock
selection is critical, underscoring
the value of active investing.
millions b/d
Chart 1: The global oil price slump
AT A GLANCE
Source: EIA Short-Term Energy Outlook, December 2014; Chart shows non-OPEC
supply growth only
THE SAUDI FACTOR
In the past, the OPEC cartel of major oil-exporting countries has played a critical role
in controlling oil prices through supply management. With the dramatic recent price
collapse, OPEC oil revenues have plunged, creating severe budgetary pressures for
many major oil-exporting countries. In such conditions in the past, OPEC’s typical
response would have been to cut its oil production with most of the burden for this
falling on ‘swing producer’ Saudi Arabia. However, in its last meeting in late November
2014, OPEC surprised many observers by retaining its previous oil production target.
This highly atypical response appears part of a Saudi-led strategy to choke future oil
supply from higher-cost sources notably US shale. Given its own ultra-low-cost
1
production of as little as $5-6 p/b, Saudi Arabia is betting that lower prices will
progressively eliminate the viability of shale producers and reduce overall supply, which
would increase its own market share, support longer-term prices and ultimately maximise
the net present value (NPV) of its oil reserves.
MACRO IMPACT: COUNTRY WINNERS AND LOSERS
From a country perspective, lower oil prices effectively entail a transfer from oil
producers to oil importers. This transfer is growth-enhancing overall because the
direction of flow is from generally high-savings countries to lower-saving ones, i.e. to
consumers with higher propensities to spend.
“It is not in the interest of OPEC
producers to cut their
production, whatever the price
...whether it goes down to $20,
$40, $50, $60, it is irrelevant.”
Ali Al Naimi
Saudi Arabian Oil Minister
Lower oil prices benefit major oil-importing countries through two channels: increased
domestic consumption as expenditure on fuel and energy items declines; and an
improving net exports position reflected in a strengthening current account position. The
higher a country’s share of energy in total consumption, the more it stands to gain,
2
although taxes and fuel subsidies lessen the impact. Chart 3 below captures both
economic channels by plotting oil imports as a percentage of GDP versus energy
weightings in the CPI baskets of selected countries (as a proxy for energy consumption).
Chart 3: Selected country winners and losers
Thailand
10%
India
Net Oil Imports, % GDP
Rep. of Korea
Greece
5%
South Africa
Japan
Philippines
Sweden
Chile
Italy
France
USA
Australia
United Kingdom
China
0%
4%
6%
8%
10%
Canada
Mexico
-5%
Hungary
Poland
Czech Rep.
Spain
Germany
Brazil
Indonesia
2%
Turkey
Biggest
winners
from lower
oil price
12%
14%
16%
18%
Energy CPI Weight
Biggest losers from lower oil
price
Colombia
Russian Federation
Norway
-10%
Source: Fidelity Solutions Group, December 2014
Based on the analysis in Chart 3, major oil importers such as Turkey, Thailand, India,
Spain and Germany are among the biggest winners from the oil price slump.
Unsurprisingly, major oil exporters including Russia, Colombia and Norway are the
biggest losers.
WHY THE US ECONOMIC IMPACT SHOULD BE POSITIVE DESPITE SHALE
As the world’s largest economy the US merits closer consideration. As a major oil
importer, it benefits from lower oil prices through both higher consumption and reduced
net imports. However, despite still being a major net oil importer, the country’s energy
sector has been the beneficiary of a remarkable boom in shale energy in the past few
years and this has supported strong growth in exploration and production investment.
With the current oil price dipping below the headline break-even level of many US
shale oil-producing regions, shale-related investment will drop significantly.
A key issue is which of these two effects dominates. Based on EIA data, we estimate a
reduction in US gasoline expenditure of $115bn, equivalent to around 0.6% of US
GDP in 2015.3. However, we know that gasoline is only about half of total US liquid fuel
consumption; factoring in lower prices for other items such as such as jet fuel and
diesel (a ‘distillate fuel’) pushes the estimate of savings in total liquid fuel consumption
higher to about 0.9% of GDP. On the negative side, based on our analysts’ industry
forecasts, we estimate a reduction in US exploration and production (E&P) investment
of $65bn, which would be equivalent to 0.4% of GDP.4
“Falling oil prices create
winners and losers. On a
country level, oil-importing
countries such as China and
India stand to gain.
“For some emerging markets
with inflationary tendencies, a
secondary benefit could be the
deflationary stimulus being
provided by lower oil prices.
This should allow their central
banks to ease monetary policy
more easily than they would
have otherwise done.”
Sudipto Banerji
Portfolio Manager
Global Equities
Figure 1: US liquid fuels v E&P investment impact of lower oil prices
Source: Fidelity Worldwide Investment, January 2015
Figure 1 above illustrates that our estimates of the total liquid fuels savings of around
0.9% of GDP should comfortably exceed the negative impact from reduced exploration
and production investment of around 0.4% of GDP. However, as noted earlier, the US
economy should also get a boost from reduced net imports.5 Factoring this in, we
estimate that the overall US GDP boost from the global oil price collapse could be as
much as 0.8% of GDP of in 2015. In summary, although clearly highly region
dependent, the US economy should get a distinct boost overall from lower oil prices.
GLOBAL ECONOMY BOOST
In December 2014 (when oil prices were around 20% higher than now) the IMF said
the sharp reduction in oil prices should act as a “shot in the arm” for the global
economy, with a forecast boost to world GDP of up to 0.7 of a percentage point in
6
2015. In the case of China, the world’s second largest net importer of the commodity,
every $1 drop in the oil price is estimated to lead to annual savings of $2.1bn, so the
7
50% oil price decline amounts to a saving of over $100bn.
With its total energy import bill exceeding $500bn in 2013, lower oil prices are likely to
provide significant support to the flagging European economy. In the case or France,
for example, the INSEE econometric model calculates an oil price-related real GDP
boost of 0.3% by the summer of 2015. 8
However, the positive consumption impact will be less than in the US due to the
dominance of duties and tax in retail prices – in Germany and the UK, for example,
these account for around 60-70% of retail gasoline prices compared to just 20% on
average in the US. When oil prices fall, national governments often increase the tax
take and reap some of the benefits.
In Japan, the other major driver of the global economy, the overall economic impact
should be similarly positive to Europe with a negative deflationary impact more than
offset by the consumption and net trade impact of lower oil prices.
SECTOR IMPACT
Given its key role in powering the global economy, it is unsurprising that lower oil prices
have widespread ramifications not just across countries but across global sectors.
Energy and related sectors stand to lose out while many global consumer discretionary
and energy-intensive sectors stand to benefit, especially certain industrials sectors.
SELECTED SECTOR WINNERS
Autos – Continuing low gasoline prices should support the outlook for many global
automakers. In the US, for example, the slump in oil prices in the second half of the
year contributed to 16.4 million car sales in 2014, the highest level since 2006. Low
gasoline prices (see Chart 4 on next page) spurred increased sales of larger vehicles
such as SUVs and crossover vehicles, which outpaced sedan sales for the first time in
three years.
“A collapse in oil and
commodity prices more
generally implies a redistribution of wealth from
commodity-producing to
commodity-consuming
countries.
“Therefore we should consider
this to be a material tax cut for
both the US and European
economies. Equity markets will
soon refocus their attention on
the benefits of falling oil
prices.”
Dominic Rossi, CIO Equities
Chart 4: US gasoline prices have closely tracked the oil
price lower
4.50
$ per gallon
4.00
US retail gasoline prices track
crude oil prices closely and are
down by over 30% since mid
June
EIA
Forecast
3.50
3.00
2.50
35
% of total cost of
production
5.00
Chart 5: Fuel related costs * as % of total production costs
for major US crops in 2013
2.00
1.50
31.7
28.7
30
25.6
25
18.8
20
15
10
5
Retail regular gasoline
Crude oil
0
1.00
Jan 2010 Jan 2011 Jan 2012 Jan 2013 Jan 2014 Jan 2015
Corn
General Motors is an example of an auto sector beneficiary of lower oil prices. The
US automaker benefits from higher US disposable incomes, increased demand for
higher margin vehicle such as sports utility vehicles (SUV) and trucks and lower
plastics input costs.
On the other hand, electric vehicle (EV) producer Tesla, however, suffers from the
reduced economic appeal of EVs as lower oil prices lessen EVs’ relative running cost
advantage compared to traditional combustion engine vehicles.
Chart 6: GM v Tesla share price since November 2014
120
November 2014 = 100
115
110
Since Nov '14
GM shares have
outperformed
Tesla's by 29%
105
100
95
Tesla
GM
85
80
Nov-14
Nov-14
Dec-14
Wheat
Soy beans
Source: US Department of Agriculture, Economic Research Service, December 2014:
* Fuel related costs include: fuel, electricity, chemicals and fertilizer costs.
Source: EIA Short-Term Energy Outlook, December 2014
90
Cotton
Dec-14
Dec-14
Jan-15
Source: Datastream, January 2015
Agriculture – The oil price is a key variable for many energy-intensive agriculture
sectors. Lower oil prices tend to reduce costs of operating farm machinery, such as
tractors and harvesters, and bring down fertiliser and transport costs. According to the
US Department of Agriculture, fertiliser, pesticides and fuel represented 32%, 26% and
19%, respectively, of the total cost to produce corn, wheat and soybeans, respectively,
in 2013 (see Chart 5 above).
Airlines – With fuel typically accounting for around a third of operating costs, lower oil
prices tend to support airline profits either by boosting margins or by enabling lowering
ticket prices in order to increase passenger numbers. However, many airlines routinely
hedge future oil costs. Accordingly, the impact should be greatest for those airlines
that have only hedged relatively small amounts of their future oil purchases. Airlines’
benefits also depend on their cost structure and competitive positioning and FX
exposure.
Europe’s third largest low-cost carrier, Norwegian Air Shuttle, stands out as one of
the biggest beneficiaries of lower oil prices, since, highly unusually, it has a policy of
not hedging any of its fuel requirements. Fuel savings enable it to further strengthen its
core low-cost proposition, thereby supporting demand. On the other hand, Hong
Kong’s Cathay Pacific suffers from its decision to hedge out over half its 2015 fuel
requirement at $100 per barrel, more than double the current spot price.
Chemicals – Crude oil derivatives typically account for the bulk of many chemical
companies’ raw material costs. Companies that have sufficient pricing power to
withstand pressure on end-product prices should benefit most; specialised producers
with less competition in their respective markets face better prospects than those with
more commoditised end-markets. In the case of the latter, lower oil prices tend to lead
to inventory reduction and therefore underutilisation of capacity which puts downward
pressure on net margins.
Netherlands based-Akzo Nobel is an example of a company that benefits from lower
oil prices. This is because the company’s raw material costs are falling significantly yet
its strong brands and pricing power in coatings and decorative segments (e.g. the
Dulux paints brand) means product prices are relatively resilient. The company should
also receive some support from rising real and disposable consumer incomes.
SELECTED SECTOR LOSERS
Exploration and production (E&P) – Lower oil prices clearly have a negative
revenue impact for global oil exploration and production firms. They also change the
economics of individual producing regions and even of individual wells in each region,
as higher-cost production sources become less viable and investment is cut back.
As discussed earlier, with oil prices below so-called ‘break-even’ rates, many US shale
producers are being especially hard-hit. Texas-based Goodrich Petroleum stands out
because it is a highly leveraged shale-only producer with a focus on relatively highcost-deposit regions. Indicative of significant operating stress, in December the
company said it was looking to sell all or some of its Eagle Ford shale assets.
However, it’s worth noting that even at current low prices, the US shale industry should
remain viable in the long run because production costs are positively correlated with oil
prices (they tend to go down when oil prices fall) and production efficiency continues to
improve, for example, via enhanced drilling techniques. Also supportive is the process
of ‘hi-grading’ whereby producers concentrate their efforts and resources on lower-cost
plays in each region.
“I’m looking to optimise stockpicking opportunities that
result from the current oil price
volatility. It’s notable however
that energy stocks are trading
at their lowest relative
valuation metrics on a priceto-book basis since at least
the 1920s, and close to their
highest relative gross cashflow yields since at
least the 1950s.”
Energy capital goods – In general, lower oil prices imply less demand for energy
capital goods. Moreover oil which comes from more challenging geological sources
tends to be more expensive to extract and more capital-intensive.
Alternative/clean energy – Indicative of both strong demand growth and public policy
support, the share of renewable energy in many countries has been rising. In the US,
the share of total generated power from renewable sources has surged from just 2.4%
9
of the total in 2006 to an estimated 6.7% in 2014. However, the sharp slump in global
oil prices since the second half of 2014 inevitably impacts the relative economic
viability of many alternative energy sources. Even if the longer-term trend towards
alternative and renewable energy remains intact, supported by mandated renewables
adoption targets such as in the EU (see Chart 7 below), just a slowdown in the rate of
adoption is likely to affect the NPV assumptions for some companies in the sector.
% of total energy
consumption
Chart 7: EU member country renewables usage and targets – as a % of total energy consumption
60
50
40
30
20
10
0
2004
2012
2020 Target
Source: Renewable energy in the EU28. Eurostat, March 2014.
US energy high yield – Energy-related issues account for more than 15% of the wider
US high yield debt market. Predicated on outdated and excessively optimistic energy
price assumptions, many US energy high yield issues appear likely to remain under
pressure for some time to come.
Matt Siddle
Portfolio Manager
European Equities
CONCLUSION
The remarkable slump in global oil prices creates specific investment winners and
losers. On a national level, oil-importing countries receive a boost from reduced
imports and higher consumption, while major oil producers lose out with reduced net
exports and slower domestic activity. However, the overall global economic impact will
likely be positive because lower oil prices are reflective mainly of increased supply
(notably US shale) as opposed to weak demand (although this is a contributory factor).
The associated financial transfers will largely be from high-savings countries to
countries with a higher propensity to consume. In the US, increased consumption and
reduced imports should only partly be offset by lower energy sector investment,
resulting in a forecast boost to overall economic growth of as much as 0.8% in 2015.
Sector losers from falling oil prices include oil exploration and production, energy
capital goods, clean energy companies as well as energy high yield debt issuers.
Among the sector winners are autos, airlines, chemicals and agriculture. However,
with many sectors featuring both winning and losing companies, effective stock
selection is critically important, underscoring the value of an active investment
approach.
REFERENCES
1. While Saudi Arabia’s cost of oil production is very low compared to other regions, arguably the more practically relevant
constraint is the oil price needed to balance the Saudi Arabian budget - this is estimated to be considerably higher at
around $80 p/b. However vast financial reserves means the country can easily afford to run budget deficits for many years.
2. Many oil producing countries subsidise domestic fuel prices which artificially inflates demand. On the other hand many
oil importing nations tax fuel in order to supress consumption demand.
3. EIA, Short Term Energy Outlook, January 2015; based on a the EIA’s forecast of a 31% decline in the average retail
gasoline price decline to $2.33 per gallon
4. Bloomberg Intelligence North America E&P Valuation Peers Index - based on an estimate of what 76 US drillers spent
in the 12 months to end-September 2014; based on a forecast 30-40% reduction in US E&P investment in 2015 (Fidelity
Worldwide Investment estimates)
5. Fidelity Worldwide Investment estimate, January 2015; net US imports are estimated to decline by $50bn due to falling
oil prices - while the pure oil impact will be far greater than this, we make the assumption that around half of the import
savings will be replaced by increased other item imports, notably owing to higher consumption.
6. ‘Seven questions about the recent oil price slump’ - Rabah Arezki and Oliver Blanchard, IMF Direct Blog, 22 December
2014
7. Economist, October 2014
8. ‘Five Corners’, Gavekal Dragonomics, 14 January 2015
9. EIA, January 2015
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