Download Concentrated Pain, Widespread Gain

concentrated pain, widespread gain
DYNAMICS OF LOWER OIL PRICES
february 2015
BlackRock
Investment
Institute
Summary
Oil prices are on a slippery slope. The pain of lower prices is acute and
concentrated among oil-exporting nations and energy companies. The gains are
widely dispersed and will likely be felt for a long time by oil importers and
global consumers.
Jean Boivin
Deputy Chief Investment Strategist,
BlackRock Investment Institute
Poppy Allonby
Portfolio Manager, BlackRock
Natural Resources Equities Team
Ewen Cameron Watt
Chief Investment Strategist,
BlackRock Investment Institute
The massive wealth transfer is set to boost developed economies to varying
degrees. And it is sure to amplify economic and market divergences in the
emerging world. We debated the prospects for the oil price, winners and losers,
and risks and opportunities in asset markets. Our main conclusions:
}The crude crash is dramatic – but not unprecedented. Falls of similar
magnitude in the past stimulated consumer spending, helping to reinvigorate
global economic growth. We think crude prices are bottoming and see them
modestly higher next year.
}It would only take a moderate shift in demand to restore balance to the oil
market. Spare production capacity amounts to just 4% of total demand,
versus around 18% in the mid-1980s, Energy Information Administration
(EIA) data show.
}Soft demand and a strong US dollar have helped bring down the oil price, but
ample supply is the root cause of the decline. New technologies such as
hydraulic fracking unearthed plentiful supplies of US shale oil while the
Middle East kept up production despite conflicts ravaging the region.
}Supply is here to stay: key producer Saudi Arabia looks determined to keep
pumping oil under new leadership. Overall US supply is set to rise this year due
to a backlog of wells and price hedges sheltering producers from the downturn.
Declining capital spending (capex) and fewer drilling rigs in operation point to a
slowdown in production growth in the second half of 2015 and beyond.
Robert Wartell
Head of BlackRock US Leveraged
Finance Credit Research
Gerardo Rodriguez
Portfolio Manager, BlackRock
Emerging Markets Team
What is inside
Summary.............................................. 2
Supply and demand............... 3–6
Winners and losers............... 7–11
Energy assets.......................12–15
The opinions expressed are as of
February 2015 and may change as
subsequent conditions vary.
[2]
}Cheap energy is a game changer for monetary policy in oil-importing nations,
especially in emerging market (EM) economies. It reduces inflation, giving
some central banks room to ease – and others leeway to raise rates more
gently. Low oil prices also reduce the costs of energy and food subsidies,
providing fiscal relief.
}Low oil prices add to growing divergences in the developed world. The
eurozone and Japan are set to keep rates near zero and have rolled out
bond-buying programmes to halt disinflation. The US Federal Reserve, by
contrast, is likely to look beyond oil’s disinflationary effect and start hiking
interest rates in mid-2015.
}Winners in this climate should be global consumers, oil importers such as India
and Japan, and the transport and retailing industries. Oil-exporting nations and
companies with limited cash buffers and poor access to debt markets (think
Venezuela or overleveraged US shale plays) look to be the biggest losers.
}The oil price slump is bludgeoning US high yield energy issuers. Many have
been outspending their cash flow and now face a crunch as financing dries
up. They are in survival mode, resorting first to capex and job cuts. Most
should be able to ride it out. Yet the longer lower prices hold, the greater
the financial stress.
}Valuations of global energy stocks have fallen, but selectivity is important.
We favour the ‘super majors’ because of their strong balance sheets, high
dividends and integrated business models. We would avoid most oil services
firms for now.
CONCENT R ATED PA I N , W I DESP R EAD GA I N
Supply and
demand
SLUMPS AND REBOUNDS
Real and nominal brent crude price, 1975–2015
$200
Lehman
collapse
Iran revolution
The size of the recent oil price slump is unusual – but not
unprecedented. Similar sharp falls in the mid-1980s and
during the 2008-2009 financial crisis were followed by
swift rebounds, both in the oil price and in real (inflationadjusted) global economic growth per capita. See the chart
on the right.
On the demand side, cheaper oil helps consumers and
businesses by lowering fuel costs. Indeed, our research
suggests a consumer-led demand recovery could come
to the rescue (see page 10). On the supply side, low oil
prices force producers to cut output, setting the stage
for a price recovery.
PRICE PER BARREL
The economic impact is broad but not always immediately
visible. Energy accounts for just 1.2% of US employment,
for example, but energy booms stimulate growth in local
economies such as Texas or the Canadian province
of Alberta.
Inflation-adjusted oil price
100
Gulf war
60
1980s
oil glut
40
Nominal oil price
20
Asia crisis
10
1975 1980 1985 1990 1995 2000 2005 2010 2015
World real GDP growth, 1975–2015
3%
2
Y-O-Y CHANGE
The crude crash affects asset prices and economies
around the world. Energy generally has a modest weight in
benchmark indices, yet there are standouts. Energy
issuers account for around 15% of the US high yield
market. See the chart below.
1
0
-1
WEIGHING OIL’S IMPORTANCE
Energy share of markets, GDP and employment, 2015
1980s
oil glut
-2
Current
crude
slide
Lehman
collapse
15%
-3
1975 1980 1985 1990 1995 2000 2005 2010 2015
Periods with nominal oil price falls over 50%
10
World GDP per capita
Sources: BlackRock Investment Institute, Thomson Reuters and Oxford
Economics, January 2015. Notes: the inflation-adjusted oil price is in 2015
prices, using US consumer price inflation. GDP data for 2014 and 2015 are
based on Oxford Economics forecasts.
5
0
US high
yield
Global IG
credit
Global
equities
US
US
economy employment
Exploration & production and oil services
Other energy
Sources: BlackRock Investment Institute, Barclays Capital, Thomson Reuters,
US Bureau of Economic Analysis and US Bureau of Labor Statistics, January
2015. Notes: the US economy share is based on GDP value-added for
oil and gas extraction, mining support activities and petroleum and coal
manufacturing as a share of total private GDP. The US employment share
is based on oil and gas extraction, mining support services, petroleum and
coal production and petrol station employment as a share of total non-farm
employment. Other energy includes integrated oil companies, pipelines and
others in benchmark indices.
BALANCING ACT
It would take only small changes to supply or demand to
restore balance to the oil market (and support prices)
we believe.
Sure, the market is currently oversupplied (see page 4).
Yet spare capacity (wells that can produce but sit idle)
today amounts to just 4% of total global oil demand,
versus around 18% of demand in the oil price downturns
of 1983 and 1986, EIA data show.
S u p p ly a n d D e m a n d
[3]
SAUDI SWITCH
CRUDE IMBALANCES
2%
Will oil producers cut supply to support prices? Saudi
Arabia, the senior partner of the Organisation of the
Petroleum Exporting Countries (OPEC), has often played a
‘swing role’ in stabilising prices. The country slashed
production in 2009 but has kept it steady this time around.
Saudi Arabia appears fine with low oil prices for now. We
do not see Riyadh changing course any time soon under
new leadership. Reasons:
EXCESS DEMAND
1
0
}Saudi Arabia wants to protect its market share in the
face of rising global production – and is wary of acting
alone. The country has painful memories of losing
market share when other nations did not match
production cuts.
Asia crisis
-1
EXCESS SUPPLY
1980’s oil glut
-2
1985
1990
1995
2000
2005
2010
2015
Sources: BlackRock Investment Institute, IEA and Oxford Economics, December
2014. Notes: the line shows world oil demand minus world oil supply as a
percentage of world oil demand. Data from Q3 2013 onward are estimates from
Oxford Economics.
swelling supplies
Softening demand – particularly from slowing EM economies
– has played a role in the oil price crash. We see this
evidenced by earlier, across-the-board declines in metals
and other commodities prices (see page 12). This suggests
the oil price collapse is a catch-up, rather than a sign of
further deterioration in the global economic outlook.
Unexpected declines in demand accounted for around 35%
to 40% of the fall in oil prices between June and December
2014, the International Monetary Fund (IMF) estimates.
Demand for oil may recover as lower prices encourage more
consumption; US petrol sales hovered near 19-month highs
in November, the most recent EIA data show.
Yet a jump in supply is the bigger factor behind today’s oil
market imbalance. Advances in hydraulic fracking uncorked
a plentiful supply of US shale oil and gas. Increased US
production more than offset declines in Iran and Libya.
(Note: marginal producers such as Libya swing in and out
of the market and affect prices accordingly.) See the chart
on the right.
The US accounted for 13.7% of global production in 2013,
up from 9.8% in 2006. That helped it overtake Saudi Arabia
as the world’s top producer of petroleum liquids
(including natural gas), according to the International
Energy Agency (IEA). The US production increase in 2014
was the fourth-largest by any country since 1965,
according to BP and IEA data.
Result: oversupply stands at around 2% of global oil
demand – the highest level since the Asia crisis of
the late 1990s. See the chart above.
[4]
CONCENT R ATED PA I N , W I DESP R EAD GA I N
}This strategy forces high-cost producers (think shale, oil
sands and deep water) to cut supply.
}The country is the world’s largest low-cost producer –
and has a $736 billion war chest of foreign exchange
reserves to cushion the impact on its budget.
}Low prices keep rival Iran under pressure. The Saudis
view this as a nice knock-on effect, we think.
Lower oil prices will gradually turn the screws on highercost producers. Their likely response? Cut capital
spending, jobs and costs. US shale operators are
particularly susceptible because they have relatively little
capital invested and their wells run dry fast. This will
eventually lead to falling production – although we think
2015 will be more about declining rates of growth than an
absolute contraction.
THE NEW SWING PRODUCERS
Selected countries’ change in oil production since 2011
5
Saudi
Arabia
MILLIONS OF BARRELS/DAY
NET BALANCE AS SHARE OF GLOBAL DEMAND
Oil supply vs. demand, 1985–2015
Iraq
2.5
Total
US
0
Iran
Libya
-2.5
2011
2012
2013
2014
Sources: BlackRock Investment Institute and US Energy Information
Administration, January 2015. Note: the bars show the change in average
daily oil production based on monthly data.
A MATTER OF COST
BREAKEVEN PRICE RANGE ($/BARREL)
Estimated cost base and output of oil-producing areas, 2020
Oil sands
$100
80
Offshore shelf
North America
shale
Rest of world onshore
Deep water
60
Middle East onshore
40
20
Ultra
deep water
Russia
onshore
Extra heavy
oil
Average breakeven
0
0
10
20
30
40
50
60
70
80
90
100
ESTIMATED 2020 PRODUCTION (MILLION BARRELS/DAY)
Sources: BlackRock Investment Institute and Rystad Energy, January 2015. Notes: the boxes represent different oil sources. The width of each box shows the level of
potential production in 2020; the height shows the breakeven range for 75% of the production from that source. Dots show the average breakeven prices. The breakeven
price is the oil price that gives a zero net present value using a 10% discount rate. Numbers are based on an average of currently producing, under development and not-yetsanctioned projects.
COST-BENEFIT ANALYSIS
North American shale operators have become the world’s
new marginal producers because they are able to quickly
scale up – and down. The breakeven costs of the average
shale well are around $60 per barrel – way above the
current spot price. This compares with just $26 per barrel
for onshore Middle East oil. See the chart above. Note:
averages mask a lot of differences. For example, costs for
North American shale producers range from around
$40 to more than $70 per barrel, according to research
firm Rystad Energy.
Oil bulls point to a 24% drop in the number of US oil
drilling rigs from a record peak in October. See the chart
below. The EIA forecasts additional declines this year but
argues these are unlikely to result in a big fall in production.
A backlog of wells after years of heavy drilling – three to
seven months’ worth at major US shale areas – will keep
oil pumping.
WELLING OVER
Number of US rigs drilling for oil, 1987–2015
1,600
High-cost producers should feel the pinch soon if prices
stay low. Yet production of established US shale assets
may take longer to slow than many expect. Consider:
1,200
RIGS
}US shale producers that tapped high yield debt markets
have hedged as much as half of their 2015 output: the
higher the risk of the field, the greater the hedge.
800
}Newer horizontal wells are more productive than older
vertical ones.
}Shale producers are loath to give up cash flows. Once
they have spent the money on upfront costs, the
marginal cost of drilling extra holes is low.
We expect US supply to increase in the near term. Yet
production growth should start to taper off in the
second half.
400
0
1987
1991
1995
1999
2003
2007
2011
2015
Sources: BlackRock Investment Institute and Baker Hughes, January 2015.
“US shale added a spectacular amount of oil in a very short time. It was not just big;
it was bigger than anybody thought.”
– Robin Batchelor
Portfolio Manager,
BlackRock Natural Resources Team
S u p p ly a n d D e m a n d
[5]
Oil futures have slumped since OPEC members decided in late
November to keep production steady despite falling prices.
Markets currently are pricing in a gentle recovery in prices to
$70 per barrel by 2017 – but no return to the heady days of
over $100 per barrel. See the chart on the right. Options
markets suggest prices should end 2015 anywhere between
$28 to $112, according to the EIA. Once markets narrow this
range of outcomes, energy assets should start to reprice.
Futures markets are in ‘contango,’ meaning forward prices
are higher than spot prices. This is encouraging a buildup
in inventories as well as a topping up of strategic reserves
in countries such as China. US crude inventories hit highs
for the month of January, according to EIA. Crude stored in
supertankers reached about half of the global capacity as
estimated by investment bank Macquarie. Storage
demand is mitigating the oil price fall for now but should
cap any rebound because stored crude is bound to come
back to the market.
How low could oil go? The oil price could fall below current
levels of around $45, but we believe we are close to a
bottom – based on past peak-to-trough declines. We expect
a modest recovery next year, but think a return to $100-plus
prices is far-fetched due to advances in drilling technology
(barring temporary spikes caused by supply disruptions).
innovation impact
Hydraulic fracking has proved to be a disruptive force that
puts downward pressure on product prices, much like
mechanisation and computerisation brought down food and
consumer prices. And fracking has only just started: adoption
outside the US could have a similar impact on global oil supply.
Technological advances also have the potential to shrink oil
demand. Examples are hybrid cars and lightweight aluminium
trucks. These are part of a broad-based trend, as shown by a
decline in energy intensity of the global economy. It took the
equivalent of 1 barrel of oil to generate $1,000 of GDP growth
in 2011, versus 1.3 in 1990, the latest World Bank data show.
Energy efficiency and its impact differ across the globe.
Increasing urbanisation and car use should support oil
demand in EM economies. China’s economy is still
relatively energy intensive, requiring the equivalent of 1.4
barrels of oil per $1,000 of GDP in 2011. This suggests a
recovery in Chinese growth could deliver an outsized
boost to global oil demand.
OIL FUTURES GAZING
Brent oil futures curve, 2015–2019
$110
July 2014
$ PER BARREL
how low can it go?
90
26 Nov 2014
(Day before OPEC meeting)
70
January 2015
50
2015
2016
2017
2018
2019
SETTLEMENT DATE
Sources: BlackRock Investment Institute and Thomson Reuters, January 2015.
GEOPOLITICAL GYRATIONS
Geopolitical risks could disturb oil markets. Consider:
}Iran and the international community aim to reach a
comprehensive deal by June that would see Tehran give
up its nuclear ambitions in return for a phased lifting of
sanctions. We would assess the chance of a full deal at
less than 50% due to opposition by hardliners in Iran.
US Congress is promising more sanctions if no progress
is made by March. Any deal, however, would likely put
downward pressure on oil prices – even if actual Iranian
production increases would take time.
}We expect Libyan oil production to be volatile as a
civil war rages on, with periods of supply disruptions
– and surges.
}We do not see Islamic State as a near-term threat to oil
production in Iraq’s south, but cheap oil could hurt
Iraq’s budget and reduce its ability to fight the militant
group. Similar dynamics are at work in Nigeria.
}Russia faces ongoing economic sanctions due to its
involvement in the escalating Ukraine conflict. We
expect Europe to maintain current sanctions. Yet we see
it stopping short of additional measures that would
directly target Russia’s energy exports because these
could further weaken the eurozone’s economy.
“ A US-Iran deal would be a historic event after 35 years of basically hostility.
But it would take some time to implement the agreement – and for
Iran to ramp up production.”
– Tom Donilon
Senior Director,
BlackRock Investment Institute
[6]
CONCENT R ATED PA I N , W I DESP R EAD GA I N
Oil exporters have savings rates 25% higher than
importers, according to research firm Evercore ISI. This
means the redistribution of wealth to oil importers should
result in a net rise in global consumption and economic
activity – even as exporting nations suffer.
The map below outlines the economic impact of a $50
decline in the oil price on individual countries. Gains
(green) are dispersed across developed nations and
most of the Asia-Pacific region. Losses (purple) are
concentrated in oil-producing nations in the Middle East,
Africa and elsewhere.
8
4
Oil importers
China
Mexico
Nigeria
India
Indonesia
Saudi
Arabia
0
Egypt
The price plunge effectively is a massive wealth transfer
from producers to consumers. A back-of-the-envelope
calculation shows this is a big gift. The world was
expected to consume $3.4 trillion of oil in 2015 assuming a
$100 oil price, according to EIA. Ergo, the 50%-plus price
plunge should result in a benefit of some $1.7 trillion to
global consumers and oil-importing nations.
12%
Iran
The slump in oil is a story of concentrated pain (net
oil-exporting nations and energy companies) – and
widely dispersed gain (global consumers and
oil-importing countries).
Oil subsidies as a share of 2014 GDP
Venezuela
Winners and
losers
SUBSIDIES SAVINGS
Oil exporters
Sources: BlackRock Investment Institute, IEA and IMF, January 2015.
Note: data show oil subsidies for 2013 as a share of estimated 2014 GDP.
Lower oil prices enable countries to cut or end subsidies
for energy and food prices, easing budget pressures. Oilproducing nations are among the most generous, but oil
importers such as Indonesia and India also used to spend
big on keeping a lid on prices. See the chart above.
Subsidy cuts would partly erode the benefits of cheaper
oil for EM consumers.
OIL SPILLOVER
Revenue impact of $50 oil price fall, 2015
SHARE OF GDP
-10% -3%
0%
2%
4%
Sources: BlackRock Investment Institute, EIA and IMF, January 2015. Notes: the map shows estimated revenues gained or lost from a $50 fall in the price of oil as a share of GDP.
The impact is calculated by taking each country’s 2013 net imports of oil, multiplying this by $50 and then translating the total into a share of 2014 GDP.
Wi n n e r s a n d L o s e r s
[7]
losers and cushions
PAIN POINTS
Fiscal breakeven oil price, 2015
Oil-producing countries are in for a rough time. This
unfortunate bunch can be divided into three groups:
Libya
1.
Countries that have accumulated large amounts of
foreign assets: Saudi Arabia, United Arab Emirates and
Norway. They can afford to fund budget shortfalls from
these piggy banks in the short run. Energy makes up
87% of Saudi Arabia’s goods exports. Yet foreign
reserves and investment income cushion the budgetary
impact of cheaper oil for now. See the table below.
2.Oil producers with smaller fiscal cushions such as
Mexico, Malaysia, Bahrain, Oman and Colombia. They
may have to resort to combinations of fiscal austerity
and increased borrowing. Many countries appear to be
assuming oil prices higher than $60 to $70 per barrel
in their revenue projections (they are loath to disclose
details) – heralding financial stress. Most, however,
can easily tap capital markets because they have low
external debt positions.
3.
Countries with little cash and poor access to
international debt markets. They are most vulnerable to
sudden reversals in capital flows and currency
depreciations. Venezuela and Nigeria are prime
examples. Energy makes up 97% of Venezuela’s
goods exports, yet its foreign reserves are a paltry 2%
of GDP. Venezuela is ranked second to last and
Nigeria 41st of the 50 countries tracked by our
BlackRock Sovereign Risk Index.
Iran
Algeria
Oman
Iraq
Saudi
Arabia
Qatar
UAE
Kuwait
0
40
80
$120
$/BARREL
Sources: BlackRock Investment Institute and IMF, January 2015. Note: the
fiscal breakeven is the oil price at which the fiscal balance is zero, based on
IMF forecasts for 2015.
Many are middle- or low-income countries running
expansionary budgets – often to meet social or political
goals. The oil price decline throws their budget plans and
funding options upside down. Forecast surpluses are
swiftly turning into huge deficits. Even many of the world’s
low-cost producers in the Middle East were banking on oil
prices of $100-plus per barrel to balance their fiscal
budgets. See the chart above.
ENERGY DEPENDENTS
Key statistics of selected energy exporters, 2015
Energy share
of goods exports
External debt
share of GDP
Reserves share
of GDP
Short-term
external debt
share of GDP
BlackRock
Sovereign Risk
Index rank
Iraq
99%
2.9%
–
0.1%
–
Algeria
97%
0%
–
0%
–
Venezuela
97%
14.3%
2%
2.1%
49
Kuwait
94%
2.2%
20%
0%
–
Nigeria
88%
1.7%
6%
0%
41
Saudi Arabia
87%
0%
102%
0%
–
Oman
83%
3%
21%
0%
–
Kazakhstan
76%
3.5%
27%
0.1%
–
Russia
71%
3.4%
20%
0.8%
22
Colombia
69%
10.7%
12%
0.8%
27
United Arab Emirates
65%
4.7%
8%
0.8%
–
Sources: BlackRock Investment Institute, World Bank, Fitch, Moody’s and Bloomberg, January 2015. Notes: energy exports are exports of oil, gas, coal and other energy sources. External
debt figures are gross. External debt and reserves data are based on a composite of sources. Short-term debt is less than two years. Not all countries are tracked by the BlackRock
Sovereign Risk Index.
[8]
CONCENT R ATED PA I N , W I DESP R EAD GA I N
Falling oil prices are a game changer for oil-importing EM
countries such as India. They drag inflation lower, allowing
central banks to ease monetary conditions and stimulate
their economies. China, the world’s No. 2 oil importer, is
another beneficiary. Cheaper oil could boost the country’s
GDP by between 0.4% and 0.7% in 2015, the IMF estimates.
Lower energy prices may trigger additional declines in
agriculture and food prices. Food production is energy
intensive due to the use of fertilisers. The double gain to
consumers from declines in energy and food is a big positive
for low-income countries with a high dependency on imports.
Countries with a high energy weight in their CPI baskets
should be big winners. Poland, Hungary and Indonesia top
this list at more than 15%, according to OECD and IMF
data, with India and Malaysia not far behind. Turkey, South
Africa and South Korea should also benefit. Yields in all
these countries look attractive in a near-zero-rate world.
Even emerging Europe appears a bargain for incomestarved eurozone investors.
We see commodity exporters such as Venezuela,
Colombia, Argentina, Russia, Kazakhstan and Malaysia
on the losers’ board.
EM Manoeuvring ROOM
The impact of cheaper oil on EM currency and credit
markets is a tug of war. The current account balances of
commodity importers will likely improve – a positive for
local currency bonds. Yet likely interest rate hikes by the
US Federal Reserve risk eroding the yield advantage of
these countries, putting downward pressure on their
currencies. Higher US rates drain global liquidity because
they boost the value of the world’s premier funding
currency, the US dollar.
Conclusion: cheaper energy hands EM countries
manoeuvring room to ease monetary policy or tighten it
more slowly, softening the impact of Fed rate rises on
their economies. See Dealing With Divergence of
December 2014 for details.
Consumer price inflation and oil prices, 2005–2015
Emerging market oil importers
6%
4
CPI INFLATION
Most countries will likely see lower inflation, especially net
oil importers in the emerging world. Consumer price index
(CPI) inflation in EM oil importers has plummeted to US
levels over the past three years, tracking the growth rate in
oil prices. And falling oil prices have dragged the eurozone
back to the brink of deflation. See the chart on the right.
INFLATION BEATER
US
2
Eurozone
0
-2
2005
2007
2009
2011
2013
2015
120%
Brent crude oil price
Y-O-Y CHANGE
winners and disinflation
60
0
-60
2005
2007
2009
2011
2013
2015
Sources: BlackRock Investment Institute, Thomson Reuters and local statistics
agencies, January 2015. Notes: emerging market oil importers are an unweighted
average of China, Hungary, India, Poland, South Korea, Singapore and Thailand.
POLICY DIVERGENCE
Cheaper oil should add to EM policy divergences and
increase dispersion in investment outcomes. Some oil
exporters will likely be forced to tighten monetary policies
to stem capital outflows and currency depreciations.
The impact on monetary policy in developed economies
is more subtle. Cheaper energy is exacerbating already
falling inflation expectations. This makes it even harder
for central banks in Japan and the eurozone to hit their
inflation targets. Both have launched massive bondbuying programmes to avoid outright deflation, boosting
asset prices.
The Fed is a different story. We expect the US central bank
to stick to its guns on raising rates in 2015, but see it
going slowly and ending at a historically low level.
Bottom line: falling oil adds to an already divergent
trend in monetary policies.
“ US consumers and much of emerging Asia will be stronger six months from now
thanks to the lower oil price. There are more winners than losers.”
– Russ Koesterich
Chief Investment Strategist,
BlackRock Investment Institute
Wi n n e r s a n d L o s e r s
[9]
Gallons of gas bought with US average hourly wage, 1991–2015
15
GALLONS
Jan 2015
10.1 Gallons
10
Jul 2014
5.7 Gallons
5
1991
1995
1999
2003
2007
2011
2015
Sources: BlackRock Investment Institute, US Bureau of Labor Statistics and US
Energy Information Administration, January 2015. Note: the line shows the US
average total non-farm hourly earnings divided by the average US petrol price.
priming the pump
Lower oil prices represent a large tax cut for consumers in
the developed world, particularly in the United States. The
average hourly US wage bought about 10 gallons of petrol
in January, up from 5.7 gallons in mid-2014. See the chart
above. The response should be swift: any petrol price
decline that is part of an extreme fall (over 15% in a
quarter) tends to generate a bump in consumption in the
next quarter that is four times as large as the effect of
milder price falls, we find.
Another reason to expect outsized US consumption gains:
US drivers burn up far more petrol than motorists
elsewhere. Japan, Europe and many emerging markets
stand to benefit less. Their consumers use less fuel and
pay more at the pump due to higher taxes. See the chart
to the right.
US dollar strength also reduces petrol savings for
consumers in countries with weakening currencies. Oil is
traded in US dollars, mitigating the effect of any decline in
local currency terms. Yet the oil price crash has been so
large that it swamps the currency effect in many nations. Oil
has fallen 49% in euro terms and 51% in yen since mid-2014,
compared with a 57% decline in US dollars. Bottom line:
cheaper oil delivers a big consumption stimulus globally.
us housing and goodies
How about a consumption boost beyond petrol savings? US
housing and durable goods could be winners, our analysis of
the 1985-1986 and 1997-1998 oil downturns suggests.
}Housing: home sales surged during previous oil price
crashes. The reason? Rising consumer confidence and
cash flows – and a drop in mortgage rates driven by
falling inflation.
}Durable goods: purchases of big-ticket items surged on
the two previous occasions. A sharp drop in the cost of
consumer financing was a key driver.
Caveat: interest rates had much more room to fall during
past oil price crashes. And consumers are more
leveraged these days. Household debt stands at 76% of
GDP, versus 48% in 1985, Fed data show. Yet there are
signs the US consumer is perking up. Confidence in
January rose to its highest level since 2007, according to
The Conference Board.
Capital spending could also support growth this time
around. Cheaper energy will likely boost productivity in
energy-intensive sectors such as chemicals – encouraging
players in these industries to raise capex (offsetting cuts
by energy producers).
start your engines!
Petrol use and prices in selected countries, 2011–2015
2,000
USAGE (LITRES PER PERSON PER YEAR)
US CONSUMER WINDFALL
US
1,500
Canada
1,000
Saudi Arabia
500
Australia
Japan
Germany
UK
China
0
0
0.50
1
1.50
$2
PRICE PER LITRE
Sources: BlackRock Investment Institute, World Bank, globalpetrolprices.com
and EIA, January 2015. Notes: usage data are based on motor vehicle petrol
consumption for 2011 and 2012 (China and Saudi Arabia). Bubbles are sized
by overall consumption. Petrol prices are retail prices as of January 2015.
“ The relationship between energy prices and risk sentiment is not linear.
Many oil exporters will see their foreign reserves decline, but the
impact on their appetite for risk assets will be muted.”
[10]
CONCENT R ATED PA I N , W I DESP R EAD GA I N
– Terrence Keeley
Global Head of BlackRock
Official Institutions Group
evaluating equities
How to capitalise on the seismic shifts caused by the
crude crash?
GAS GUZZLERS
World oil consumption by sector, 2012
Industry
Cheaper oil often improves the trade balances of energyimporting nations. Equities in those countries tend to
outperform, our research shows. We would focus on
exporters within this space, or companies that derive more
than 50% of their revenues from outside their home
market (we use lower percentages for EM companies due
to the paucity of listed exporters). This investment idea
should have legs: valuations of exporters are slow to reflect
improving terms of trade, as opposed to rapid gains after
currency declines, we find.
8.5%
Other
11.8%
Non-energy use
16%
Transport
63.7%
It also makes sense to favour:
}Sectors profiting from consumers having more
disposable income (retailers, restaurants and other
consumer discretionary stocks).
These stocks have rallied, yet we believe there is more to
come as analysts upgrade their earnings expectations.
reserves reshuffle
The commodities price implosion is reverberating
through the world of foreign exchange (FX) reserves
held at central banks and sovereign wealth funds.
We expect global reserves to edge up 2% to reach a
total of $11.7 trillion by year end. This average masks a
lot of differences. (Looking at Chicago’s average annual
temperature of 10 degrees Celsius, you would never
know you need a winter coat.) Oil exporters will dig into
their reserves while energy importers will add to their
FX piles. See the chart to the right. China will benefit
from lower oil imports, but slowing activity is likely to
nudge down its reserve growth rate.
How will the shift in reserves play out in financial
markets? We expect isolated sales of risk assets as oil
exporters plug budget holes and defend currencies.
Yet the overall impact should be minimal for now. More
than half of global reserves are in cash or cash
equivalents – enough to preclude fire sales of less
liquid assets. Plus, these institutions tend to premise
their investment decisions on opportunities, not on
the price of crude.
Sources: BlackRock Investment Institute and IEA Key World Energy Statistics 2014.
Note: the ‘other’ category includes agriculture, residential, and commercial and
public services. Non-energy use refers to oil used as an input in other sectors and
not as a fuel.
Caution: when we crunched the numbers on the overall
effect of oil price changes on industry sector valuations
in the past 25 years, we found few differences beyond the
simple fact that energy and materials shares outperform
when oil prices rise.
Conclusion: this is very much a stock picker’s territory.
REDISTRIBUTION OF WEALTH
Forecast change in foreign exchange reserves, 2015
BILLIONS
}Industries benefiting from lower operating costs,
especially those that have not hedged their oil
purchases. Transport (airlines, trucking and logistics) is
a prime beneficiary. The sector accounts for 64% of
global oil use. See the chart on the right.
$200
20%
100
10
0
0
-100
-10
-20
-200
OPEC
countries
Non-OPEC
oil
exporters
US dollar change (billions)
Oil
importers
(ex China)
China
Percentage change
Source: BlackRock Investment Institute, January 2015. Notes: based on
BlackRock estimates. OPEC excludes Ecuador, Iran, Iraq and Venezuela. NonOPEC exporters are Russia, Norway, Canada and Kazakhstan. Oil importers
are US, Japan, India, South Korea, eurozone, Singapore, Thailand, Turkey
and Indonesia.
Wi n n e r s a n d L o s e r s
[11]
Energy assets
RESOURCES REGRESSION
Commodities-related asset performance, 2011–2015
50%
The oil price plunge and subsequent downturn in
energy-related assets have been dramatic. Yet they are
part of a larger downward move in commodities prices.
Agriculture, metals and currencies of commodities
exporters already were in decline before oil started its
descent in July 2014. These non-yielding assets
suffered due to a strengthening US dollar and oversupply caused by years of buoyant prices.
Commodities
FX
Equities
Fixed
income
25
0
-25
Energy assets were the last dominos to fall – but fell the
hardest. They had rallied in the previous three years and
only recently imploded. See the chart to the right.
Jan 2011 to June 2014
World IG energy
US HY energy
Mining equities
Energy equities
Canada $
Australia $
Brazil Real
Russia Ruble
Metals
Norway Krone
Before the crash, yield-hungry investors happily funded
the burgeoning energy sector as oil prices held firm.
Revolving bank debt and high yield bonds became the
instruments of choice for the ambitious US shale explorer.
Agriculture
Crude oil
-50
July 2014 to Jan 2015
Sources: BlackRock Investment Institute and Thomson Reuters,
January 2015.
Notes: crude oil is based on the average of WTI and Brent prices; industrial
metals and agriculture are based on GSCI spot indices. Equities are based on
MSCI World indices. Fixed income is based on Barclays indices.
Many North American shale players became addicted to
the easy money. They made a habit of spending more than
their cash flow to expand reserves, increase production
and make acquisitions, relying on Wall Street funding to
close the gap.
North American small caps, in particular, rode the wave
in the past decade. Cash flow from operations fell far
short of spending. See the left chart below. They
sucked in capital to the detriment of companies
focusing on exploration outside North America. Large
caps largely balanced their books in this period, and
were unwilling (or unable) to add much debt. See the
right chart below.
The falling oil price shattered this cosy arrangement and
heralds a cash crunch for some companies. Borrowing
costs have risen and access to capital has shrunk as a
result of lower and more volatile oil prices. Access to cash
is arguably more important than marginal costs or access
to reserves in this climate. We expect cash flows and
capital expenditures to fall significantly this year. Both
dropped sharply in the 2008-2009 financial crisis, as the
charts below show.
BURNING CASH
North American energy capex and M&A vs. cash flow, 2004–2014
SMALL CAP
LARGE CAP
$100
PER BARREL OF OIL
Cashflow
from operations
75
50
PER BARREL OF OIL
Acquisitions
Acquisitions
Cashflow
from operations
25
Capex
Capex
0
2004
2006
2008
2010
2012
2014
2004
2006
2008
2010
2012
2014
Sources: BlackRock Investment Institute and Bernstein Research, January 2015. Note: the analysis is based on 55 North American exploration and production companies.
The values show the total cash flow, capex, and money spent on acquisitions for each group divided by their total production in barrels of oil equivalent.
[12]
CONCENT R ATED PA I N , W I DESP R EAD GA I N
HIGH YIELD: SURVIVAL MODE
CLIMBING THE MATURITY WALL
US high yield energy maturity schedule, 2016–2024
High yield energy issuers are either small, risky
companies or large ones with weak balance sheets. US
shale producers have, on average, hedged around half of
their oil production for 2015, but very little beyond.
$40
Infrastructure
High yield valuations largely reflect differences in asset
quality, hedging levels and access to credit between
companies. Bond prices of refiners and pipelines have
held up well, while those of oil services and explorers have
slid. See the table below. Yields of individual bonds are
similarly dispersed.
Oil services
30
BILLIONS
Refining
If oil stays at low levels, some borrowers may default. The
longer low prices persist, the greater the pain. We do not
see a wave of US defaults in the next year, however. Shut
off from new funding, companies will go into survival
mode. They first slash capex, negotiate lower servicing
costs and prioritise the most profitable wells.
Exploration
and production
20
10
0
2016 2017 2018 2019 2020 2021 2022 2023 2024
Sources: BlackRock Investment Institute and Barclays, January 2015.
Note: companies in the Barclays High Yield Energy Index have no debt due in 2015.
Revolving credit lines, the source of day-to-day funding for
capex, appear to be safe for now. Commercial banks are
using long-term oil price assumptions, rather than spot
prices, when determining the size of these revolvers. Their
generosity is likely to wane if lower prices persist, while
rating downgrades will make raising long-term debt tough.
Bottom line: most producers should be able to ride out the
storm – as long as signs of a decline in crude supply show
up by early 2016.
delayed deals
Mergers and acquisitions (M&A) in the energy sector has
been on a boil in recent years, driven by large US
exploration companies selling non-core assets to reduce
debt and streamline portfolios. Private equity investors
have raised almost $70 billion in energy funds since the
start of 2012, according to research firm Preqin, and will be
in prime position to pick up the pieces. For now, they
appear to be sticking to quality assets only – and are
holding out for bargain prices.
Defaults elsewhere could come earlier. Moody’s expects a
6% default rate among Latin American corporates this
year because of the commodities price downdraft, more
than double its forecast 2.7% global default rate for
speculative paper.
M&A should dry up initially. Sellers are unwilling to
dispose of assets at what they currently see as fire-sale
prices, preferring to wait for a rebound in oil prices.
Activity could start to pick up in the second half of 2015 as
some companies face a cash crunch and production
hedges expire (only a handful of companies has
production hedged into 2016).
The good news: the sector’s maturity wall – when loans
need to be repaid or refinanced – only hits in earnest in
2017. See the chart above right. Stronger companies will have
no trouble tapping the market, but financing will be dearer:
7.5% to 8% versus less than 5% before oil prices slumped.
DRILLING DOWN
US high yield energy sector overview, 2015
Number
Outstanding
Share of high
of issues amount (billions)
yield total
US High Yield
2,223
$1,315
344
$199
15%
Independent energy
184
$113
9%
Oil services
60
$28
Refining
11
Infrastructure
88
Energy
Share of
energy total
Current yield
Six-month change
(basis points)
6.5%
123
9.8%
434
57%
11.2%
563
2%
14%
13.1%
728
$5
0%
2%
7.1%
$53
4%
27%
6.2%
192
158
Sources: BlackRock and Barclays, January 2015. Notes: data are based on the Barclays US High Yield Index. Current yields are no guarantee of future levels.
energy asse ts
[13]
INVESTMENT GRADE: DISPERSION
RENEWABLES REVIEW
What about the US investment grade (IG) market? The
segment has been hit, for sure. Yet a widening of spreads
by an average of 55 basis points can hardly be described
as carnage. See the table below.
Do lower oil prices spell the end of the boom in
renewable energy? Not really, in our view.
Renewables such as wind and solar power have
essentially decoupled from lower oil prices. Oil
generated just 5% of world electricity in 2012, down
from 25% in 1973, according to the IEA. Coal (at
40% in 2012) and gas (22.5%) are much more
important. And renewables make up a big chunk of
new power generation in many countries. Wind and
solar power accounted for 46% of new US power
capacity in 2014 versus 51% for gas, according to
research firm SNL Financial.
IG oil services firms are cutting staff (Schlumberger
recently announced 9,000 redundancies) and capex.
Offshore drillers are in the toughest spot. They faced
sagging demand from integrated oil companies, an
abundance of newly built rigs and falling day rates even
before oil prices slid. IG oil services firms, however, tend to
be top-quality credits.
Explorers on average take a 14% hit to earnings before
taxes and amortisation for every $10 decline in the oil
price below $80, our analysis of 15 US IG companies
shows (assuming a 20% capex cut and level production).
This average hides huge dispersion, making credit selection
crucial. Considerations include cost structure, cash
margins and hedge positions. Many have crimped capex –
with more to come.
Second, renewables have become much more cost
competitive. The cost of solar power has fallen 78%
in the five years ending in 2014, while the price tag of
wind has declined 58%, according to Lazard
research. Large-scale wind and solar installations
now beat most other sources of power generation
on costs – even before subsidies meant to enhance
environmental sustainability, according to Lazard.
Energy infrastructure credits, including master limited
partnerships (MLPs), should spring back due to the need
to transport hydrocarbons. The lion’s share of the sector’s
revenues is fee-based, we estimate, so it is shielded from
price falls (but not volume declines). Refiners stand to
benefit as refined product prices typically lag declines in
prices of underlying feedstock.
The trouble spot? Transport alternatives that
compete directly with oil. Think vehicles running on
biofuels, batteries or natural gas. A prolonged
period of low oil prices could set back development
of alternative fuels.
IG INTERNAL BLEEDING
US investment grade energy sector overview, 2015
Number of
issues
Outstanding
amount (billions)
6,028
$4,760
608
$412
9%
Independent energy
136
$102
2%
Integrated energy
98
$94
Oil services
87
Refining
US Investment Grade
ENERGY
Infrastructure
Share of
IG total
Share of
energy total
Current yield
Six-month change
(basis points)
2.8%
-4
3.7%
51
25%
3.7%
49
2%
23%
2.6%
11
$52
1%
13%
5.3%
197
18
$18
0%
4%
3.8%
44
269
$146
3%
36%
3.9%
35
Sources: BlackRock and Barclays, January 2015. Notes: data are based on the Barclays US Credit Index. Current yields are no guarantee of future levels.
“ This is a long-term opportunity to make money in selected US exploration
and production companies, especially given how bearish the
crowd has become.”
[14]
CONCENT R ATED PA I N , W I DESP R EAD GA I N
– Jessica Wirth Strine
Portfolio Manager,
BlackRock Global Opportunities Team
We could see a slow-moving equity rally as news of
idled capacity filters down. A small rise in the oil price
could entice contrarians undeterred by cuts to
earnings forecasts.
Valuations of energy stocks generally look attractive across
the globe. Price-to-book values were less than 70% of the
MSCI World Index average in January. The discount is
greater than during the 1998-1999 Asia crisis, when Brent
oil prices slipped below $10 per barrel. See the chart on the
right. The risk? Analysts may be overestimating future
profits or the degree of any oil price snapback. And the
global energy sector looks less cheap on a price-toearnings basis, trading right in line with its 20-year average.
US energy valuations look even better on some metrics, as
detailed in The Oil Plunge of January 2015. The energy
discount, however, hides a lot of variation. Integrated oil
and gas companies, or ‘energy majors,’ trade at steep
discounts – versus their own history, most other energy
subsectors and world equities. Energy infrastructure
trades at a premium. See the table below.
We prefer quality and avoid outfits that could run into
funding troubles. Our favourites: the super majors.
Valuations are low, the integrated model provides a buffer
against oil price declines and management teams appear
focused on shareholder returns rather than adding reserves
or increasing production. The segment has a 4.5%
dividend yield – well above sectors that investors have
been chasing for yield such as US utilities.
We would underweight oil services, especially those most
exposed to US production and those with outdated
equipment. They may appear cheap, but we believe a lot
more pain is to come. Oil explorers are shifting into
survival mode, cutting capex and negotiating lower
servicing rates.
ENERGY ON SALE
Global energy equity valuations, 1995–2015
1.4
Ratio
EXPENSIVE
RELATIVE PRICE-TO-BOOK RATIO
EQUITIES: DISCOUNTING DISCOUNTS
Average
1
CHEAP
0.6
1995
2000
2005
2010
2015
Sources: BlackRock Investment Institute and MSCI, January 2015. Note: the
green line shows the price-to-book ratio of global energy equities relative to that
of the MSCI World Index.
It makes sense to bottom-fish for selected exploration
companies in the expectation that oil markets should
start rebalancing in six to 12 months. Taking the plunge at
this time requires high conviction, so we would look for
companies with the following attributes:
1.Improving recovery of reserves and return on
investment per well in top-tier areas such as the US
Permian Basin.
2.Expanding profit margins through the application of
technologies such as horizontal drilling.
3.Healthy balance sheets that are on their way to
delivering positive free cash flows within one to
three years.
ENERGY DISCOUNT
Global energy equities overview, January 2015
World equity
weight
Oil and
gas sector
weight
World Equities
Oil & Gas
7.5%
Price-tobook (PB)
ratio
PB ratio
vs. 20-year
average
12-month
forward P/E
P/E vs.
20-year
average
Dividend
yield
-4%
2.1
1
14
0.9
2.5%
-26%
1.4
0.7
13
1
3.9%
Six-month
total return
Integrated oil
3.6%
49%
-26%
1.2
0.6
10
0.8
4.5%
Exploration
2.1%
28%
-29%
1.5
0.8
15
1.2
2.9%
Services
0.7%
9%
-38%
1.6
0.6
12
0.7
3.3%
1%
13%
-6%
3.2
1.6
24
1.4
4.3%
Infrastructure
Sources: BlackRock Investment Institute and Thomson Reuters, January 2015. Notes: data are based on the Thomson Reuters Datastream World Index. Current
performance is no guarantee of future results.
energy asse ts
[15]
Why BlackRock®
BlackRock helps millions of people, as well as the world’s largest institutions and governments,
pursue their investing goals. We offer:
} A comprehensive set of innovative solutions, including mutual funds, separately managed accounts,
alternatives and iShares® ETFs
} Global market and investment insights
} Sophisticated risk and portfolio analytics
BLAckrock investment institute
The BlackRock Investment Institute leverages the firm’s expertise across asset classes, client
groups and regions. The Institute’s goal is to produce information that makes BlackRock’s
portfolio managers better investors and helps deliver positive investment results for clients.
Executive Director
Lee Kempler
Want to know more?
GLOBAL CHIEF INVESTMENT STRATEGISTS
Ewen Cameron Watt and Russ Koesterich
Executive Editor
Jack Reerink
blackrock.com
Unless indicated otherwise, all publications mentioned are issued by BlackRock Investment Institute and can be found on its website.
This is part of a series prepared by the BlackRock Investment Institute and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation,
offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of February 2015 and may change as subsequent conditions vary.
The information and opinions contained in this paper are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive
and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including
responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents.
In the EU issued by BlackRock Investment Management (UK) Limited (authorised and regulated by the Financial Conduct Authority). Registered office: 12 Throgmorton Avenue,
London, EC2N 2DL. Registered in England No. 2020394. Tel: 020 7743 3000. For your protection, telephone calls are usually recorded. BlackRock is a trading name of BlackRock
Investment Management (UK) Limited. This material is for distribution to Professional Clients and should not be relied upon by any other persons. Issued in the Netherlands by the
Amsterdam branch office of BlackRock Investment Management (UK) Limited: Amstelplein 1, 1096 HA Amsterdam, Tel: 020 - 549 5200. In Singapore, this is issued by BlackRock
(Singapore) Limited (Co. registration no. 200010143N). In Hong Kong, this document is issued by BlackRock Asset Management North Asia Limited and has not been reviewed by
the Securities and Futures Commission of Hong Kong. For distribution in Korea for Professional Investors only (or “professional clients”, as such term may apply in local jurisdictions).
Investments involve risks. Past performance is not a guide to future performance. This material is intended for information purposes only and does not constitute investment advice
or an offer or solicitation to purchase or sell in any securities, BlackRock funds or any investment strategy nor shall any securities be offered or sold to any person in any jurisdiction
in which an offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. Not approved for distribution in Taiwan or Japan. Issued in Australia by
BlackRock Investment Management (Australia) Limited ABN 13 006 165 975 AFSL 230 523 (BIMAL). This document provides general information only and has not been prepared
having regard to your objectives, financial situation or needs. Before making an investment decision, you need to consider whether this document is appropriate to your objectives,
financial situation and needs. This document is not a securities recommendation. This document has not been prepared specifically for Australian investors. It may contain references
to dollar amounts which are not Australian dollars. It may contain financial information which is not prepared in accordance with Australian law or practices. BIMAL, its officers,
employees and agents believe that the information in this document and the sources on which the information is based (which may be sourced from third parties) are correct as at
the date of this document. While every care has been taken in the preparation of this document, no warranty of accuracy or reliability is given and no responsibility for this information
is accepted by BIMAL, its officers, employees or agents. Except where contrary to law, BIMAL excludes all liability for this information. This email contains general information only,
does not take into account your objectives, financial situation or needs and you should consider the appropriateness of the information in light of your objectives, financial situation
or needs. You should consult with a financial or other professional adviser before making an investment decision. No guarantee as to the capital value of investments in the fund nor
future returns is made by BlackRock or any company in the BlackRock group.
©2015 BlackRock, Inc. All Rights Reserved. BLACKROCK and iSHARES are registered trademarks of BlackRock, Inc.
or its subsidiaries in the United States and elsewhere. All other trademarks are those of their respective owners.
003514a-BII Feb15 / BII-0042