Winners And Losers In The Oil Price Game

Global oil producers have entered a dangerous game of chicken as they enable a massive downturn in energy prices to preserve market dominance.

The Organization of Petroleum Exporting Countries (OPEC) recently decided to maintain its production rate, accelerating a downward trend in oil prices to below $60 per barrel. By facilitating the price slip, OPEC hopes to maintain supremacy and squeeze marginal players in the game, particularly North American domestic shale producers. Drastic drops in revenue and stock prices have become the collateral damage in the battle for market control, as many U.S.-based firms, including established firms like Halliburton, have lost nearly half of their market value since their 2014 peak.

After years of speculation regarding raw material scarcity and the need to lessen its dependence on foreign supply, the U.S. has increased innovation to become more competitive— indeed the world’s largest oil producer—in the global energy market. While OPEC sustains current production levels, American output continues to rise, adding more fuel to the price-cut fire. Some experts believe more dynamic U.S. firms might be better suited to withstand the heat than OPEC governments, which are reliant on oil revenues to balance their budgets. Dan Yergin, vice chairman of analytics firm IHS, explained in a recent Wall Street Journal op-ed that in the U.S., “80% of new tight-oil production in 2015 would be economic between $50 and $69 per barrel. And companies will continue to improve technology and drive down costs.” In addition, companies have prepared by becoming leaner, abandoning parts of their businesses that could hinder profits. Smaller companies may also survive by being acquired by larger oil conglomerates. On the other hand, if prices rebound, U.S. production firms could grow exponentially, especially if they continue to poach market share from OPEC members that can’t survive at current prices.

Meanwhile, the solvency of OPEC nations often hinges on their ability to produce—and sell at reasonable prices—the world’s oil demand. Venezuela, for example, faces default and economic collapse, as petroleum products constituted 96.28% of the country’s total goods exported in 2013, according to its central bank. For prices to stabilize, we will need to see who blinks first—whether OPEC limits supply or U.S. firms drastically slow investment. Without such actions, prices could continue to fall if American firms build efficiency and press on, or if OPEC member production remains steadfast.

Lower energy prices, if sustained, could lead to greater U.S. investment, expanded margins, and possibly higher wages for employees. Heavily oil-dependent industries like trucking and airlines may not immediately pass on savings to customers through lower prices, but a boost to bottom lines could result in higher capital spending and a boon to the overall economy. While lower-cost energy could provide additional support to the U.S. economy, other countries beyond OPEC are heading down a difficult road. Russia, for example, faces international sanctions and a devalued currency. As energy drops, the lack of oil revenue has rendered Russia incapable of paying down their mounting debts. It’s difficult to say how these risks will play out on a global scale, but economies are as interconnected as ever.

Despite the potential upside for the U.S. economy, domestic risks remain for financial markets. Equity investors could face volatility in major indices as energy stocks react to price fluctuations. Sentiment could shift as investors decide whether low prices could boost the economy or are too much of a detriment to the U.S. energy sector. So far, investors are more worried about the downside to firms than optimistic about the economic benefit. In addition, investors believe lower prices—resulting from weaker demand and excess supply—represent a slowdown in global growth, and this could continue to weigh on overall equity performance going forward.

Meanwhile, energy weakness poses higher default risk for banks and the high-yield energy bond market. In addition, lower prices could force firms to slow or halt production, which could ripple through energy-reliant state economies like Alaska. As these states rely on continuous revenues earmarked for debt obligations, sudden changes to balance sheets as a result of oil market instability could lead to missed payments or cuts to employment and wages.

We believe the multibillion-dollar relief of lower-cost energy, combined with generally positive consumer sentiment data, could result in more robust consumer spending as we enter the New Year. In the meantime, Americans will hopefully enjoy a holiday season with some extra cash to spend on gifts rather than at the pump, which could translate into greater economic growth (consumer spending contributes 70% of overall GDP). Whether prices drop further, stabilize, or reverse, we believe the former equilibrium of energy market power has shifted as North American producers press onward in establishing a foothold. Opportunities and risks remain, but we think the country will benefit in the long term if domestic energy companies continue to produce, innovate, and remain economically competitive.


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