Global Economic Effects with Oil at $30 a Barrel 09 Feb 2016

Global Economic Effects with Oil at $30 a Barrel

Declining crude oil prices seem to be part of the daily news on a regular basis — recent prices have dipped below $30 per barrel. While that already represents a 75 percent decline during the last 18 months, some experts have suggested that further declines to $10-$20 per barrel are possible. Is that good news or bad news? Who benefits and who loses with declining oil prices?

The International Energy Agency (IEA) predicts a continuation of crude oil oversupplies during 2016. As always, such forecasts blend expectations of both supply and demand factors. With economic slowdowns in China and many other countries, demand continues to shrink. On the supply side, removal of economic sanctions against Iran has added a new supplier that is probably determined to recoup lost revenues by selling large inventories of crude oil at market prices. Added to this is Saudi Arabia’s determination to impair the U.S. fracking industry by continuing to unload crude oil inventory even at current low prices.

If crude oil continues a downward pattern, the oil industry will experience declining revenues and employment. Some impacted companies have already filed for bankruptcy, and others may follow if prices decline further or stay at current low levels. This will negatively impact creditors such as financial institutions and oil industry suppliers.

However, declining energy prices also involve many beneficiaries such as consumers spending less to fill up their tanks and businesses paying less for energy-related expenses. Trucking fleets and airlines are two noteworthy examples of industries that will experience a positive impact on their bottom line with low energy prices.

Of course, the stock market provides an excellent “proxy” for all of these factors. Energy-related stocks have generally suffered during the decline. But as with many financial issues, equity performance depends on much more than declining commodity prices. Which stocks will benefit from lower energy prices? Which stocks are most vulnerable? What about debt instruments impacted by oil prices? Research Optimus can help business owners and investors keep up with the latest financial developments. In the following paragraphs, we discuss more insights about current and future energy prices.

The Energy Price Question: Even Lower, for Even Longer?

The world’s leading energy forecasters – the International Energy Agency – sees energy prices going lower during 2016. Why? The IEA projects that Iran will add 600,000 barrels per day to supplies by the middle of 2016. Coupled with this is the slowdown of growth rates in China (the second-biggest economy in the world), a stronger U.S. dollar, relatively mild winter temperatures and economic weakness of commodity producers.

How long can energy prices continue to go lower — or stay at current low levels? Overall commodity markets began a decline around 2010. Silver prices are often used as a proxy for industrial activity because of many manufacturing uses for silver. Silver prices peaked at around $50 per ounce in 2010 and currently are below $15 per ounce. Based on recent historical patterns, commodity declines such as those for crude oil can traditionally go on for several years. Silver’s downward pattern has persisted for six years (and isn’t over yet).

How much longer will energy prices decline? As observed by Peter Pulikkan of Bloomberg Intelligence, “As we enter 2016, the mantra has changed — the new mantra is even lower, for even longer.”

One Possible Response: Cutting Expenses and Reshaping the Oil Industry

Declining oil revenues have a negative impact on both energy companies and oil-exporting nations. Affected businesses and governments might have no practical choice but to cut expenses and jobs in order to survive.

As oil prices dipped below $30 per barrel recently, BP announced that they would eliminate 4,000 more jobs. Many layoffs have already occurred within other companies, and more layoffs should be anticipated if oil prices remain at current low levels or decline further. According to Barclays, a producer like ConocoPhilips loses $1.8 billion per quarter for every $10 decline in prices. Oil company managers have little recourse but to reduce expenses when faced with such dramatic reductions in revenues.

Oil-exporting nations like Russia, Iran, Nigeria and Venezuela have also experienced declining revenues that mirror oil company losses. Even wealthiest countries such as Saudi Arabia, the UAE, Qatar and Kuwait will eventually feel the pinch. According to the International Monetary Fund (IMF), Saudi Arabia needs to sell oil at $106 per barrel to balance the budget. While Saudi Arabia has enough capital surpluses to last about five years at $50 oil, other countries will be exposed to budget shortfalls much more quickly. Fitch Ratings has already cut Russia’s credit rating — about half of Russia’s budget is derived from exporting energy products.

With low prices and limited funding options, many energy-related companies will be forced to either sell assets or consider merging with other companies. Which companies are most vulnerable? As noted by Christopher Sheehan of IHS (energy M&A research), “Oil and gas producers with heavy debt burdens and hedges rolling off in 2016 will become increasingly vulnerable.” What does this mean for businesses and investors? Research Optimus can help to identify M&A candidates as well as monitor the creditworthiness of government debt for oil-exporting nations as well as impacted oil and gas companies.

Other Impacts to Take into Account

If oil prices go lower to $10-$20 per barrel or stay at current prices of $30 per barrel, what else will happen? Here are some of the most likely outcomes:

  • Lower fuel expenses for aviation and manufacturing companies
  • Reduced gasoline expenditures for consumers — the savings can easily end up being spent on consumables for an even more pronounced economic stimulus
  • Possible deflationary pressures — a negative concern for central bankers
  • Reduced demand for biofuels — this should reduce food commodity prices for corn, wheat, and soybeans
  • Reduced fuel costs for food commodities producers
  • Reduced prices for industrial metals such as aluminum, steel, copper, platinum and palladium — this can produce positive impacts for the manufacturing and construction industries while resulting in negative impacts for mining companies (but mining companies can also benefit from reduced energy costs)
  • Emerging markets usually suffer when commodity prices drop — according to the IMF, growth rates for emerging economies declined for the fifth straight year in 2015

The International Monetary Fund reports that the overall global economic effect of lower energy prices is a positive one. However, some of the positive benefits will take time to materialize as both households and businesses use savings to pay down debt levels.

Conclusions: Preparing for Business Headwinds or Tailwinds

Declining crude oil prices appear to be with us for 2016 — and possibly beyond. As one observer noted above, “Expect even lower prices for even longer.”

One of the most important steps that executives and managers should take is to make a complete assessment of how their business will be impacted — will low energy prices give your business tailwinds or headwinds? At the same time, investors will want to position themselves for the eventual recovery in commodity prices.

In the face of these critical impacts for your investment portfolio and business operations, a prudent strategy should include seeking independent research from international experts like Research Optimus.

– Research Optimus

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