With the rapid decline and ongoing volatility in oil prices, investors will already have a sense of how the parts of their portfolios directly exposed to energy have responded. Most obviously, sentiment surrounding producers and the companies that directly serve them has been hit hard. However, it is also important to consider the broader investment repercussions, both good and bad, of a major change in the cost of one of the world’s major energy sources.
These extend from appreciating the wider consequences on other parts of the economy and also considering whether, for those who are able to act, the current tumult may in fact present selected opportunities within the energy sector itself.
The impact of lower oil will be felt elsewhere in the economy. On the negative side, this could manifest in a number of different ways. In certain parts of the United States, as well as other parts of the world, industries such as chemicals, construction and transportation will face a new headwind.
For example, the Gulf Coast region of the United States has been in the middle of a construction boom aimed at exploiting the growth in oil and natural gas from shale rock. Projects range from the expansion of refining plants to greenfield facilities to convert hydrocarbon molecules into the building blocks of widely-used plastics such as polyethylene. But while plants where the ground has been broken will probably still go ahead, there is inevitably going to be something of a go-slow on more recent proposals as decision-makers digest the new economics of starting a plant from scratch. For example, the South African company Sasol has just announced it will delay a decision on whether to build the U.S.’s first facility to convert natural gas into liquid fuel.
In the oil producing and refining parts of the U.S., and in others directly affected by the shale phenomenon, such as North Dakota and Pennsylvania, mini-booms in housing, fueled by an influx of oil workers, are likely to come to an end. The transportation industry is also likely to see a downward revision to any plans predicated on a boom in moving crude oil and related products around the continent. For example, demand to move oil by rail from the Bakken field in North Dakota down to where it can be refined in Texas and Louisiana is likely to abate, impacting railroad companies such as Canadian Pacific Railway.
At the global level, the significant correlation between the price of oil and for other commodities exists for a reason – energy is often a major part of the cost of extracting metals and minerals from the earth. All else equal, a lower cost of extraction is likely to apply downward pressure to these other raw materials, with good examples being copper and iron ore. This could be a major revenue headwind for miners such as Rio Tinto.
More positively, there is the intuitive logic that a lower pump price for gasoline should act as a de facto tax cut for consumers, with a net stimulative effect. To some extent, capital markets have begun to reflect this, with the equities of U.S.-listed retailers outperforming the broader market in recent weeks, despite limited early evidence of a spending response by consumers.
However, the longer oil prices stay at these levels, the greater the likelihood of a noticeable response from the consumer. Recent consumer confidence data has been highly supportive of this notion; the proof will be in data over the next few weeks and months from retailers and others exposed to this potentially rejuvenated customer base.
While investors will vary in their ability or willingness to have exposure to the energy sector itself, for those that can participate, and have historically had little exposure, the cyclical downturn may actually present a new opportunity.
In prior periods of energy price weakness, nimble and well-capitalized oil companies have historically been able to bolster their positions by acquiring distressed assets. This time around should be no different. Already, management teams at larger companies are openly acknowledging an appetite for deals, although the most likely scenarios will involve specific acreage positions rather than whole-company transactions. Opportunistic investors are already emerging, with the leaders of certain high-profile private equity firms explicitly citing energy as an area where they are looking to put fresh capital to work.
Energy impacts large parts of the investing world and the impact of oil falling by more than half from its peak in barely six months will be widely felt. Investors should not only review their existing energy exposure, but reflect on the wider implications for their portfolios. And for those that have limited exposure and have the capacity to increase it, they should consider whether this is a chance to do exactly that.
Stephen Clark is a Senior Vice President & Portfolio Manager at Standard Life Investments.