In the US, there are two basic sides to the crashing oil price story.
On one side, it’s great because it means cheaper energy prices for consumers and businesses everywhere. And everyone’s going to spend those savings on all sorts of goods and services that will fuel economic growth.
On the other side, it’s horrible because it means energy companies may have to scale back their plans for spending on shale drilling projects if the price of oil can’t cover the costs of production. This shale fracking boom the US has been experiencing has been a big source of business spending and new jobs.
That latter matter has been a source of consternation and confusion for some folks. Morgan Stanley’s Vincent Reinhart offers some more colour on that latter matter.
Our Exploration & Production industry analysts have concluded that “if oil prices remain low for a sustained period (12-18 months) there will be notable impacts to [industry] growth for 2015, but more meaningful for 2016.” They also believe that if Brent prices are sustained under $US75/bbl, “the US capex cuts inflect more dramatically.” Finally, in the outlook for shale-related investment, they have noted that even as oil prices are declining, breakeven prices for shale producers have fallen “by up to $US30/bbl since 2012,” with some major producers’ breakevens in the $US30-60/bbl (WTI) range…
With Brent currently sitting at around $US62 per barrel and WTI at $US58 per barrel, it’s looking more and more likely that the energy industry should look forward to a major cool down.
This is a complex story. But based on what we’ve read and what the experts have told us, we can break down the implications three ways:
1. Fracking Profits Will Get Crushed. Small drillers will struggle to cover their costs. But they will keep producing as long as it will cover the interest expense on their high-yield debt. Nevertheless, default risk rises, which is why the prices of stocks and junk bonds in this sector are getting smoked. According to FactSet, analysts expect energy sector earnings to be down 11.9% year-over-year in 2015.
2. US Business Spending Will Be Impacted. Capital expenditures (capex) in the US oil business represents a growing, decent chunk of US business investment; currently just over 10% (see blue line in chart above). It’s an even bigger chunk of the S&P 500 spending; around a third.
3. The US Economy And Stock Market As A Whole Won’t Even Notice. While oil and gas capex represents an increasing share of overall capex, it represents less than 1% of GDP (see yellow line in chart above). For the stock market, the 11.9% drop in expected energy sector profits will be more than offset by gains elsewhere. According to FactSet, analysts expect S&P 500 earnings to rise 8.6% in 2015.
There’s no getting around the fact that lower oil prices are bad news for the oil sector. But what’s bad for the oil sector is more than good for the rest of the economy and the markets.
“Consumer spending represents 68% of the US economy,” Charles Schwab’s Liz Ann Sonders noted. “Oil and gas capex represents about 1% of US GDP and less than 9% of US total capex (which in turn represents about 12% of US GDP). Therefore, the benefit of lower energy prices to the consumer and many businesses greatly outweighs the significant hit to energy companies and/or energy-oriented capex, especially in energy-oriented states.“
So, that’s the whole story in a nutshell.
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