A January 9th report from Morgan Stanley Research Europe argues that low oil prices are the “new normal”, and that crude oil prices below $50 a barrel over the medium-term will give several sectors of the European economy a big boost.
In the introduction to their report, Morgan Stanley analysts Sebastian Raedler and colleagues suggest “…that even on conservative assumptions a 50% drop in the oil price should translate into a net boost of around 7% to European market-level EPS.”
Lower oil prices will boost European earnings
Assuming conservatively that energy accounts for 10% of total material costs on average, the models of the Morgan Stanley analysts suggest that a 50% fall in oil prices would increase earnings for European corporates outside the four sectors with commodity exposure by 13%. When you do the math, this means a 50% drop in crude oil prices will improve overall European EPS by 7%.
Raedler et al. also note that the overall impact of lower crude prices on European earnings will almost certainly be even higher taking into account for second-tier effects, especially greater economic growth through improved consumer purchasing power related to lower oil prices.
Morgan Stanley expects 25% drop in earnings for Euro energy sector
The Morgan Stanley report also highlights that a 50% decrease in crude oil prices will lead to a 25% drop in earnings for the Euro energy sector. The analysts note have been three 50%+ oil price corrections over the last two decades, with an average decrease in oil prices of 62%. This compares to a 58% correction in dollar terms and a 52% correction in euro terms from the peak so far in this downturn.
Past crude oil price downswings created an average drop in European energy earnings per share of close to 33% in euro terms. The historical pattern argues that a 50% drop in the oil price should cause a 25% fall in European energy EPS. To date, the forward analyst consensus estimate is an 18% decrease in EPS.
MS oil analyst Martijn Rats notes that a 25% EPS reduction for the European energy sector seems reasonable, and that dropping costs and the positive impact of lower prices on the refining business limit further downside.