Oil decline provides an opportunity for investors

Investors can make big gains if they play the falling oil price to their advantage. But they should tread carefully.

Falling fortunes for energy exporters and companies mean opportunity for others. Andrew Cullen / Reuters

The sudden and dramatic slump in the oil price poses both an opportunity and a threat to investors.

The fall has been dramatic, with Brent crude down about 30 per cent from US$116 a barrel in June to a recent low of $XX on Thursday, and many analysts expect it to linger at today’s levels.

Goldman Sachs, for example, forecasts $85 a barrel in the first quarter of 2015, although the truth is nobody knows for sure. Goldman previously predicted $100.

Cheap oil is bad news for net hydrocarbon-exporting countries and energy companies, but good news for their customers, and some investors may want to profit from this shift in power.

But who will be the winners, and how do you steer clear of the losers?

The answer partly depends on how low the oil price goes and how long it stays there.

Having fallen such a long way, the scope for further price falls are limited, says Alex Dryden, market analyst in the global market insights strategy team at JP Morgan Asset Management. “Falls in the oil price tend to be self-correcting. Investment dries up, refineries close, supply falls and the price ultimately rises. Brent crude is unlikely to fall below $80 for long, but I can see it sticking at between $80 and $95 for at least a couple of years,” says Mr Dryden.

The US economy should be a major beneficiary, he says. “In the US, the falling oil price feels like a tax cut, because it feeds straight through to prices at the pumps. Business costs drop and consumers spend more. It is all upside, unless it’s a sign we are heading into a global recession.”

The US has already been one of the most rewarding countries for investors over the past 12 months, with its markets up more than 12 per cent in that time, according to figures from MSCI.

That compares with a 5 per cent drop in Europe and China, and a fall of 20 per cent in Brazil and 30 per cent in Russia.

Cheaper oil doesn’t work the same instant magic in western Europe, Mr Dryden says. “Countries such as the UK and France tax oil so heavily that the price to the end consumer barely falls.”

The big losers will be emerging market oil exporters, notably Russia, Venezuela, Nigeria, Iraq, Algeria, Libya and Iran, he says. “Their governments’ fiscal break-even oil prices are all above $100 a barrel. Today’s price will make it very difficult for them to fund their social programmes, which could lead to social unrest.”

Venezuela is particularly vulnerable. It needs Brent crude at $162 a barrel for its fiscal sums to balance, according to Deutsche Bank. Nigeria is also vulnerable, needing $126 a barrel.

It makes sense to tilt your portfolio away from countries such as these, but some emerging markets can thrive on cheap oil, Mr Dryden says. “Poland, Hungary, Taiwan, Singapore and Malaysia tend to correlate positively with rising western markets, so they may benefit.”

If you’re feeling brave, you could take a contrarian position on oil, says James Thomas, regional director at Acuma Wealth Management in Dubai. “I would suggest Russia is now a buying opportunity. Its markets have fallen so far they could well bounce back, providing the Ukraine stand-off is resolved and western sanctions are lifted. But the US stock market is a safer way to play cheap oil.”

IMF figures show that every 10 per cent shift in the oil price translates into a 0.2 per cent change in global GDP, says Dan Dowding, chief executive at IFAs Killik & Co in Dubai. “With the oil price down 25 per cent, global GDP should improve by 0.5 per cent, as consumers spend the money they save on fuel.”

Any country that consumes more oil than it produces will benefit, he says. “China, the world’s second largest net importer of oil, is estimated to save $2.1 billion a year for every $1 drop in the oil price. India is another beneficiary. The government can now reduce fuel and fertiliser subsidies, which will help cut its budget deficit, and cheaper energy will help moderate inflation.”

The sharp drop in the oil price will create winners and losers among individual company stocks.

The airline industry should benefit because aviation fuel is such a large part of their operational costs, Mr Dowding says. “Many airlines hedge their fuel costs and therefore won’t see much benefit, but American Airlines Group hasn’t hedged for the past five years, so has plenty of upside. Airline stocks have been hit by Ebola fears, but if these recede they could take off again.”

Similarly, cruise line operators, such as Carnival Corporation, Royal Caribbean Cruises and Star Cruises might all benefit although, again, Ebola is casting a shadow.

Cheaper fuel has cut costs at logistics company FedEx Corporation, although its shares have struggled lately, and its narrow margins also make it vulnerable to any future oil increase.

Lower fuel costs should also help rival UPS, but other factors, such as its relatively high debt levels, may limit the upside.

Mr Dowding says oil is a major cost for the chemical industry, which should support companies such as agrochemical specialist Syngenta, but again, there are complications. “Most of Syngenta’s customers are large corporates who will demand that oil-price reductions are passed on to them.”

Airlines, shipping and logistics companies in the GCC could all benefit, says Sachin Mohindra, portfolio manager at Invest AD in Dubai. “These are energy-intensive industries whose costs are correlated to the price of oil. This might include airlines Air Arabia and Al Jazeera Airways, freight and distribution company Agility Dubai, and logistics and transportation company Aramex.”

Petrochemical and speciality chemical companies could also gain, because oil derivatives such as naphtha and methanol trace the oil price. Mr Mohindra suggests that Korean chemical company LG Chem could be a good way to play this trend.

Jahangir Aka, managing director of SEI Investments in Dubai, says that although GCC oil exporters will be hit by the falling oil price, some individual companies in the region will benefit. “Saudi Arabia as a whole may suffer but that doesn’t mean local businesses will. Agricultural company The Savola Group, for example, is primarily a transportation, haulage and distribution company, and will benefit from lower input costs.”

The oil majors such as BP, ExxonMobil and Royal Dutch Shell are inevitably hurting. BP’s share price, for example, is down nearly 15 per cent in recent months, while Exxon and Shell are both down about 10 per cent.

Oil isn’t the only factor behind the fall, BP has been hit hard by continuing legal wrangles over the huge Gulf of Mexico spill, and its 20 per cent stake in Kremlin-controlled Rosneft, which is vulnerable to EU sanctions.

Mr Aka says: “Oil producer margins have been squeezed, but this could actually be a good time to invest if you take a two to three-year view, as their share prices could recover, especially if the oil price revives.”

But investors who want to play shifts in the oil price should tread carefully, because an equally sudden rebound could turn today’s winners into tomorrow’s losers.

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