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.
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:
Jean Boivin
Deputy Chief Investment Strategist,
BlackRock Investment Institute
}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.
Poppy Allonby
Portfolio Manager, BlackRock
Natural Resources Equities Team
}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.
Ewen Cameron Watt
Chief Investment Strategist,
BlackRock Investment Institute
}Soft demand and a strong U.S. 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 U.S. 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 U.S. 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.
}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.
Robert Wartell
Head of BlackRock U.S. 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
}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
programs to halt disinflation. The U.S. 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 U.S. shale plays) look to be the biggest losers.
}The oil price slump is bludgeoning U.S. 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
favor the “super majors” because of their strong balance sheets, high dividends
and integrated business models. We would avoid most oil services firms for now.
The opinions expressed are as of February 2015 and may change as subsequent conditions vary.
[2]
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 economic impact is broad but not always immediately
visible. Energy accounts for just 1.2% of U.S. employment,
for example, but energy booms stimulate growth in local
economies such as Texas or the Canadian province
of Alberta.
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.
Gulf War
60
1980s
Oil Glut
40
Nominal Oil Price
20
Asia Crisis
10
1975
1980
1985
1995
2005
2010
2015
2010
2015
2
1
0
1980s
Oil Glut
WEIGHING OIL’S IMPORTANCE
-2
15%
Current
Crude
Slide
Lehman
Collapse
-3
1975
10
2000
3%
-1
Energy Share of Fixed Income, Equities, GDP and Employment, 2015
1990
World Real GDP Growth, 1975–2015
Y-O-Y CHANGE
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 (inflation-adjusted)
global economic growth per capita. See the chart on the right.
Inflation-Adjusted Oil Price
100
PRICE PER BARREL
The crude crash affects asset prices and economies
around the world. Energy generally has a modest weight in
benchmark indexes, yet there are standouts. Energy issuers
account for around 15% of the U.S. high yield market. See the
chart below.
1980
1985
1990
1995
Periods With Nominal Oil Price Falls Over 50%
2000
2005
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
U.S. consumer price inflation. GDP data for 2014 and 2015 are based on Oxford
Economics forecasts.
5
0
U.S. High
Yield
Global IG
Credit
Global
Equities
Exploration & Production and Oil Services
U.S.
Economy
U.S.
Employment
Other Energy
Sources: BlackRock Investment Institute, Barclays Capital, Thomson Reuters,
U.S. Bureau of Economic Analysis and U.S. Bureau of Labor Statistics, January
2015. Notes: The U.S. 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 U.S. employment share is based on oil and gas
extraction, mining support services, petroleum and coal production and gasoline
station employment as a share of total non-farm employment. Other energy
includes integrated oil companies, pipelines and others in benchmark indexes.
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 Organization of the
Petroleum Exporting Countries (OPEC), has often played
a “swing role” in stabilizing 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; U.S. gasoline 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 U.S. shale oil and gas. Increased U.S. 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 U.S. 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
U.S. 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 $736 billion war chest of foreign exchange reserves
to cushion the impact on its budget.
}Low prices keep rival Iran under pressure. The Saudis view
this as a nice knock-on effect, we think.
Lower oil prices will gradually turn the screws on higher-cost
producers. Their likely response? Cut capital spending, jobs
and costs. U.S. shale operators are particularly susceptible
because they have relatively little capital invested and their
wells run dry fast. This will eventually lead to falling
production—although we think 2015 will be more about
declining rates of growth than an absolute contraction.
THE NEW SWING PRODUCERS
Selected Countries’ Change in Crude Oil Production Since 2011
5
Saudi
Arabia
MILLIONS OF BARRELS/DAY
NET BALANCE AS SHARE OF GLOBAL DEMAND
Oil Supply vs. Demand, 1985–2015
Iraq
2.5
Total
U.S.
0
Iran
Libya
-2.5
2011
2012
2013
2014
Sources: BlackRock Investment Institute and U.S. Energy Information
Administration, January 2015. Note: The bars show the change in average daily
oil production based on monthly data.
A MATTER OF COST
BREAKEVEN PRICE RANGE ($/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-yet-sanctioned 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 U.S. 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 U.S. shale areas—will keep oil pumping.
WELLING OVER
Number of U.S. Rigs Drilling for Oil, 1987–2015
1,600
High-cost producers should feel the pinch soon if prices stay
low. Yet production of established U.S. shale assets may take
longer to slow than many expect. Consider:
}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 U.S. supply to increase in the near term. Yet
production growth should start to taper off in the second half.
RIGS
}U.S. 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.
1,200
800
400
0
1987
1991
1995
1999
2003
2007
2011
2015
Sources: BlackRock Investment Institute and Baker Hughes, January 2015.
“U.S. 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. U.S. 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
mechanization and computerization brought down food and
consumer prices. And fracking has only just started: Adoption
outside the U.S. could have a similar impact on global oil supply.
OIL FUTURES GAZING
Brent Oil Futures Curve, 2015–2019
$110
July 2014
$ PER BARREL
how low can it go?
90
Nov 26, 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.
U.S. Congress is promising more sanctions if no progress
is made by March. Any deal, however, would likely put
downward pressure on oil prices—even though actual
Iranian production increases would take time.
Technological advances also have the potential to shrink oil
demand. Examples are hybrid cars and lightweight aluminum
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.
}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
in the long run. Similar dynamics are at work in Nigeria.
We expect Libyan oil production to be volatile as a civil
war rages on, with periods of supply disruptions—
and surges.
Energy efficiency and its impact differ across the globe.
Increasing urbanization 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.
}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 U.S.-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 AsiaPacific 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 oilimporting nations.
Oil Subsidies as a Share of 2014 GDP
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).
SUBSIDIES SAVINGS
Venezuela
Winners and
Losers
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.
winners and losers
[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 fertilizers. 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 income-starved eurozone investors.
We see commodity exporters such as Venezuela, Colombia,
Argentina, Russia, Kazakhstan and Malaysia on the
losers’ board.
EM MANEUVERING 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 U.S. Federal Reserve
risk eroding the yield advantage of these countries, putting
downward pressure on their currencies. Higher U.S. rates drain
global liquidity because they boost the value of the world’s
premier funding currency, the U.S. dollar.
Conclusion: Cheaper energy hands EM countries maneuvering
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 U.S. 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
U.S.
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 bond-buying programs to avoid
outright deflation, boosting asset prices.
The Fed is a different story. We expect the U.S. 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.
“ U.S. 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
winners and losers
[9]
u.s. housing and goodies
Gallons of Gas Bought With U.S. 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, U.S. Bureau of Labor Statistics and U.S.
Energy Information Administration, January 2015. Note: The line shows the U.S.
average total non-farm hourly earnings divided by the average U.S. gasoline 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 U.S. wage bought about 10 gallons of gasoline
in January, up from 5.7 gallons in mid-2014. See the chart
above. The response should be swift: Any gasoline 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 U.S. consumption gains:
U.S. drivers burn up far more gasoline 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.
U.S. dollar strength also reduces gasoline savings for
consumers in countries with weakening currencies. Oil is
traded in U.S. 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 U.S. dollars. Bottom line:
Cheaper oil delivers a big consumption stimulus globally.
How about a consumption boost beyond gasoline savings?
U.S. 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 U.S.
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!
Gasoline Use and Prices in Selected Countries, 2011–2015
2,000
USAGE (LITERS PER PERSON PER YEAR)
U.S. CONSUMER WINDFALL
U.S.
1,500
Canada
1,000
Saudi Arabia
500
Australia
Japan
Germany
U.K.
China
0
0
0.50
1
1.50
$2
PRICE PER LITER
Sources: BlackRock Investment Institute, World Bank, globalpetrolprices.com
and EIA, January 2015. Notes: Usage data are based on motor vehicle gasoline
consumption for 2011 and 2012 (China and Saudi Arabia). Bubbles are sized by
overall consumption. Gasoline 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
GAS GUZZLERS
How to capitalize on the seismic shifts caused by the
crude crash?
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 favor:
}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 50 degrees Fahrenheit, 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
$200
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.
20%
100
10
0
0
-100
-10
-20
-200
OPEC
Countries
Non-OPEC Oil Importers
(ex China)
Oil Exporters
U.S. Dollar Change (Billions)
China
Percentage Change
Source: BlackRock Investment Institute, January 2015. Notes: Based on BlackRock
estimates. OPEC excludes Ecuador, Iran, Iraq and Venezuela. Non-OPEC exporters
are Russia, Norway, Canada and Kazakhstan. Oil importers are U.S., Japan, India,
South Korea, eurozone, Singapore, Thailand, Turkey and Indonesia.
winners and losers [ 1 1 ]
Energy Assets
RESOURCES REGRESSION
Commodities-Related Asset Performance, 2011–2015
50%
The oil price plunge and subsequent downturn in energyrelated 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 nonyielding assets suffered due to a strengthening U.S. dollar
and over-supply 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
U.S. HY Energy
Mining Equities
Energy Equities
Canada $
Australia $
Brazil Real
Norway Krone
Russia Ruble
Metals
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 U.S. 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 indexes. Equities are based on
MSCI World indexes. Fixed income is based on Barclays indexes.
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.
The falling oil price shattered this cozy 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.
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.
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
U.S. High Yield Energy Maturity Schedule, 2016–2024
High yield energy issuers are either small, risky companies or
large ones with weak balance sheets. U.S. 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.
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.
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.
Oil Services
20
Exploration
and Production
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 U.S. 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 prioritize
the most profitable wells.
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.
30
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.
delayed deals
Mergers and acquisitions (M&A) in the energy sector has been
on a boil in recent years, driven by large U.S. 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.
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).
DRILLING DOWN
U.S. High Yield Energy Sector Overview, 2015
Number
Outstanding
of Issues Amount (billions)
U.S. High Yield
Share of High
Yield Total
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%
192
$53
4%
27%
6.2%
158
Sources: BlackRock and Barclays, January 2015. Notes: Data are based on the Barclays U.S. High Yield Index. Current yields are no guarantee of future levels.
energy asse ts [ 1 3 ]
INVESTMENT GRADE: DISPERSION
RENEWABLES REVIEW
What about the U.S. 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 U.S. 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 amortization for every $10 decline in the oil price below
$80, our analysis of 15 U.S. 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. Largescale 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
U.S. 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
U.S. Investment Grade
ENERGY
Infrastructure
Share of
IG Total
Share of
Energy Total
Six-Month Change
(basis points)
Current Yield
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 U.S. Credit Index. Current yields are no guarantee of future levels.
“ This is a long-term opportunity to make money in selected U.S. exploration
and production companies, especially given how bearish the crowd
has become.”
— Jessica Wirth Strine
Portfolio Manager,
BlackRock Global Opportunities Team
[14]
CONCENT R ATED PA I N , W I DESP R EAD GA I N
EQUITIES: DISCOUNTING DISCOUNTS
ENERGY ON SALE
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-to-earnings basis, trading right in
line with its 20-year average.
U.S. 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.
Global Energy Equity Valuations, 1995–2015
1.4
Ratio
RELATIVE PRICE-TO-BOOK RATIO
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.
EXPENSIVE
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.
We prefer quality and avoid outfits that could run into funding
troubles. Our favorites: 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 U.S. utilities.
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:
We would underweight oil services, especially those most
exposed to U.S. 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.
2.Expanding profit margins through the application of
technologies such as horizontal drilling.
1.Improving recovery of reserves and return on investment
per well in top-tier areas such as the U.S. Permian Basin.
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%
Six-Month
Total Return
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%
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 [ 1 5 ]
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Lit. No. BII-OIL-0215
3359A-MC-0215 / BII-0042