Explore and Discover the Winners When Gas Prices Fall
November 15, 2014
by Frank Holmes
of U.S. Global Investors
West Texas Intermediate (WTI) oil for December delivery is currently priced at $75 per barrel, Brent for January delivery at $78 per barrel. Many investors, publications and news sources focus only on the drawbacks to falling oil and gas prices-don’t get me wrong, there are many-but today we’re going to give the spotlight to the biggest winners and beneficiaries.
Starting with your pocketbook.
Oil has slipped 30 percent since July, but the only place in the world where retail gas has fallen as much is Iran. In most countries, gas is down between 10 and 15 percent. Here in the U.S., ground zero of the recent energy boom, the national average has fallen close to 20 percent. As I said last week, American consumers have been treated to an unexpected tax break because of this slump, just in time for the holiday shopping season.
Yarra Square Partners returned 19.5% net in 2020, outperforming its benchmark, the S&P 500, which returned 18.4% throughout the year. According to a copy of the firm's fourth-quarter and full-year letter to investors, which ValueWalk has been able to review, 2020 was a year of two halves for the investment manager. Q1 2021 hedge fund Read More
Three of the main contributors to oil’s decline are the strong U.S. dollar, which has put pressure not only on oil but other commodities as well; geopolitics, specifically tensions with Russia and the Saudis’ currency war; and the acceleration of American oil production. The hydraulic fracturing boom has flooded the market with shale oil, which in turn has driven prices down. As you can see below, there’s a wider spread between 2008 and 2014 oil production levels in the U.S. than in any other oil-producing country shown here.
Which Countries Benefit?
Last month I briefly discussed how low crude prices benefit Asian markets the most because they tend to be net importers of oil and petroleum. On top of that, a large portion of the population in these countries spends a significant amount of their weekly income on gas-in the case of India, as much as 30 percent. The biggest winners, then, are Asian countries such as India, Philippines, Thailand and Indonesia
China, the world’s largest net importer of oil, second only to the entire continent of Europe, also benefits. For every dollar that the price of oil drops, its economy saves about $2 billion annually. Even though it just signed a multibillion-dollar, multiyear gas supply deal with Russia, China plans on tapping into its own shale gas resources, estimated to be the largest in the world.
One notable exception to the Asian market is Singapore. Although the city-state is a net importer of crude, bringing in around 1.3 million barrels a day, it depends heavily on oil exports to grow its economy. According to Bloomberg, in fact,Singapore ranks second in the world for a reliance on crude, based on a change in oil exports as a percentage of GDP from 1993 to 2018. Only Libya’s economy is more dependent.
Because the United States continues to be a net importer of crude and petroleum-it imports around 6.5 million barrels a day, according to CLSA-it has benefited as well, but its dependence on foreign oil is falling fast.
In the chart below you can see how breakeven prices increase as both global oil demand grows and the geological formation requires more sophisticated-and expensive-extraction methods.
Which Industries and Companies Have Benefited?
To answer this question, Strategic International Securities Research (SISR) ran a correlation coefficient between the retail price of gas and 72 global industry classification standard (GICS) sectors, focusing on the years 2000 through 2014. Below are the top three sectors that ended up benefiting the most from falling gas prices. They all have a negative correlation coefficient, meaning that their performance has historically gone in the opposite direction as the price of gas, similar to a seesaw.
What this data shows is that U.S. manufacturing industry has regained the cost benefit advantage to Chinese manufacturers. It’s becoming more and more attractive to build and create here in the U.S. because the cost of energy is relatively low.
Leading the list is automakers, suggesting that when gas prices have dropped, consumers have felt more confident purchasing new cars and trucks. Today consumers are even returning to vehicles that are known to guzzle rather than sip gas, such as SUVs, pickup trucks and crossovers. Ford’s F-Series continues to blow away its competition. Since mid-October, General Motors has delivered 7 percent, Ford 11 percent and Tesla, 12 percent.
It makes sense that airlines would perform better, since fuel is typically their largest single expenditure. In 2012, when the average price of a barrel of oil was $110, fuel accounted for 30 percent of airlines’ annual operating costs. Low fuel costs are cited as the main reason why Virgin America, which went public today, reported third-quarter profits of $41.6 million, an increase of 24 percent year-over-year. The NYSE Arca Airline Index has flown up 110 percent since the beginning of 2013, hitting 13-year highs, and Morgan Stanley recently took a bullish position toward airline stocks, showing that company balance sheets are “structurally sound enough to make ‘events’ in the next five years unlikely” and that the industry as a whole is now growth-oriented.
It also makes sense that aluminum would benefit, given that the metal requires a notoriously large amount of energy to produce.
SISR highlights a few industries that surprisingly have had a positive correlation coefficient: department stores, apparel retail and luxury goods. You’d think it would be safe to assume that the retail sector benefits when consumers have been given relief from high gas prices. This is certainly the case now: Walmart, a bellwether for general market sentiment, is hitting new highs, and Tiffany & Co. is also thriving. But in the past, low oil and gas prices have been reflections of a weak domestic economy. The average price per barrel of crude in 2009 was $62, a sharp decrease of nearly 40 percent from the average in 2008. Today, gas is inexpensive not because the economy is weak but because frackers are simply too good at what they do. They’re victims of their own success. What has hurt them has helped American consumers build more disposable cash flows, which can now be spent on fast food, retail, home improvement and other goods and services.
OPEC Unlikely to Make Production Cuts, Consensus Says
Members of the Organization of the Petroleum Exporting Countries (OPEC) will be meeting on the 27th, and no doubt the discussion will center on whether to curb production to help oil prices recover. However, a new poll shows that commodity and energy investors do not believe such a cut will occur. According to BMO Capital Markets, 87 percent of those polled believed that no cut would be agreed on. Even those who said a cut would happen believed it would be no more than a million barrels a day, an insignificant amount.
Of course, this is merely a poll, but we might be looking at cheap oil and gas for an indefinite amount of time, with a bottom possibly reached sometime between now and February.
In the meantime, American producers will continue to pour out record levels of oil, and President Vladimir Putin’s antics in Ukraine will continue to stir up geopolitical tension. Saudi Arabia appears to be more aligned with Europe and the U.S. against Russia, Syria and Iran.
All of this short-term activity might be bad for the fracking industry, but the big winners are consumers and investors. We’re in a steady, modest expansion of our economy and this is good for investing in domestic stocks.
- Major market indices finished higher this week. The Dow Jones Industrial Average rose 0.35 percent. The S&P 500 Stock Index gained 0.39 percent, while the Nasdaq Composite advanced 1.21 percent. The Russell 2000 small capitalization index rose 0.06 percent this week.
- The Hang Seng Composite rose 2.42 percent; Taiwan rose 0.79 percent and the KOSPI rose 0.27 percent.
- The 10-year Treasury bond yield rose this week to 0.96 percent.
Domestic Equity Market
The S&P 500 was positive again this week, rising 0.39 percent. After two weeks without quantitative easing (QE) assistance from the Federal Reserve, it seems as though the short-term trend remains positive overall.
- The telecommunications sector performed the strongest this week, with AT&T and Verizon both top performers, up over 2.81 percent and 1.24 percent, respectively. This comes on the heels of president Obama’s comments of a desire for “net neutrality,” as AT&T ceased construction of its high-speed data network until net neutrality has been ruled out.
- Consumer discretionary also performed well, up over 1.7 percent for the week. Amazon led the group up 9.32 percent, followed by Priceline up 7.16 percent. Also included in the sector was Fossil Group which was up 5.15 percent. A key driver in this sector is falling energy costs which help put money in the pockets of consumers. Consumers spent their new savings on desired as well as needed items, or on vacations.
- Baker Hughes was the best performing stock in the S&P 500 this week, rising 14.61 percent. The company announced its discussions with Halliburton for a potential acquisition. Halliburton also rose on the news, up 2.30 percent this week.
- The utilities sector was the worst performer this week, following 15 days of strong performance. Nearly all of its constituents were negative, with the worst performer NRG Energy down 7.5 percent.
- Another area of weakness was energy, affected by companies such as Helmerich & Payne, down 8.9 percent on poor earnings and falling commodity prices. Southwestern Energy was down 7.53 percent, mostly due to falling oil and natural gas prices.
- The worst performing company this week was Transocean, which fell 12.25 percent as the company missed expectations, took large one-time charges, and was affected by falling oil prices as well.
- The G20 Summit is this weekend in Australia and could provide the market with some encouraging comments from member nations to help spur growth.
- Next week a few important economic data