Summary: Oil prices have plummeted in recent weeks. There are many reasons why the downward pressure in prices is unlikely to stop anytime soon. The oil producers will likely be able to weather the storm, but will have to curb aggressive growth expectations. There are winners as well as losers, and investors should consider adding exposure to companies that benefit from lower gas prices.
OPEC made headlines on Thanksgiving Day by refraining from cutting oil production, despite the price of Brent Crude oil declining over 30% year to date and over 25% in the fourth quarter alone. There are various reasons for this drop in prices, most notably rising oil production (especially in North America), decelerating global economic growth, a plateauing of demand for oil in China, and the multi-year trend towards increasing energy efficiency. Increased production and the move towards energy efficiency are long-term trends that will likely continue to keep downward pressure on the oil market.
The investment impact has been dramatic this quarter. The stocks of oil exploration and production, service, and equipment companies have slumped along with the price of oil. Seemingly any company with exposure to the booming oil production conditions in the U.S. has sold off as well. Investors are calculating that lower oil prices will curb growth in the oil producers. While the sharp reaction in oil prices may overshoot to the downside, a prolonged period of lower than $85 per barrel is not out of the question. This will temper the aggressive expansion in oil production in the U.S. but will not severely damage the industry. Existing wells will continue to pump oil profitably, but companies will likely delay or cancel new well projects if oil prices stay low. Many oil companies’ profit expectations are contingent on the creation of new wells and thus will be lowered. Investors should be wary of exposure to the industry for the next several months. Those who want to maintain long-term exposure should look to well-capitalized industry leaders with global assets. The price of oil will fully recover to over $100 per barrel once global growth picks back up, or suppliers cut production levels enough that prices rise.
On the other hand, there are companies that have received a stock price boost from lower oil prices. Companies in industries where fuel is a major cost (such as airlines and trucking) should post better than expected profits. Additionally, lower gas prices act similarly to a tax cut and put dollars directly into consumers’ pockets. This may well spur discretionary spending and make for a strong holiday shopping season for retailers. Investors should consider increasing exposure to companies that benefit from lower oil prices.