Changing the Filter as Oil Prices Bottom
The recent bottoming in oil prices has brought some relief to equity markets. But the business landscape for energy-producing and -consuming industries has changed dramatically. What course should investors follow?
After falling more than 70% from their mid-2014 peaks, crude oil prices sank below US$30 per barrel earlier this year. The reason: concerns about sluggish global consumption and increased supply. Investor anxiety has eased since then, however, and both oil and equity markets have made a sizable recovery.
No Lofty Heights for Oil Prices
As the dust settles after this initial rebound—mainly attributable to an easing of extreme pessimism—what happens now? After all, many of the factors that undermined oil prices are still in place. We think investors should be prepared for crude oil prices to settle into a range of US$40–$70 per barrel.
That’s well below their heyday, which was above US$100. At these levels, marginal oil producers won’t enjoy the sort of windfall they did during their high-flying days. On the other hand, many oil-consuming industries are happy that their raw material costs remain relatively cheap.
Divergence in Company Earnings Prospects
Based on this environment, company earnings prospects can differ substantially. Moreover, the energy market may not be out of the woods just yet, and counting on an oil-price recovery alone can be risky. From our perspective, investors who can position themselves selectively for an era of lower oil prices have a better chance of outperforming passive equity market indices.
For example, energy-importing economies in Asian emerging markets are obvious beneficiaries of lower oil prices. But the biggest equity markets in that region, such as China and India, have many other underlying issues that require detailed analysis. Buying a broad, regional index weighted by gross domestic product or market capitalization can be an inefficient—and potentially risky—way to invest.
Active investors have the flexibility to take better advantage of company- or industry-specific opportunities. Tiremakers and downstream chemical companies are good examples.
More Driving Requires More Tires
Lower oil prices have encouraged consumers in developed countries such as the US to spend more time on the road (Display). That supports higher demand for replacement tires. Gasoline consumption, another measure of miles driven, suggests that the same patterns are present in emerging economies such as China and India. In those countries, growth in middle-income workers’ spending power is also spurring a motorization boom.
Cheaper Costs Equals Higher Demand for Chemical Products
Chemical companies have also been benefiting from the lower cost of feedstock, or raw materials (Display). Resilient demand for downstream chemical products has also helped, combining with dramatically lower costs to drive up chemical production spreads to all-time highs. Here again, demand has been supported by increased consumption in emerging economies.
There’s little argument that the recent rebound in oil prices has been good news for equity markets. But investors shouldn’t plan on oil prices continuing their rally—and on passively capitalizing on it. We think it makes more sense to comb through individual issuers to identify the biggest potential beneficiaries of the current oil-price environment.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.