Oil: Candidate for ‘Depression’ Therapy?
Sunday, July 26, 2015
by Sheila Jamison and Rich Jamison
July 24, last updated July 26, 2015
Never satisfied with a headline, oil is back at the top of the page along with earnings this week as a simulant for financial market action and direction. As Greece, China, and interest rate hike timing relinquish the headlines at least for now, oil recovers a prominent place. But its price isn’t recovering. The questions are “why not?” and “when will it?”
While we find it more useful to act on what is happening rather than what we hope or fear will happen, it is valuable to know what can (even what is likely or unlikely to) happen. So let’s look at oil, what controls its pricing and what is happening now.
There has been – until recently – a high level of confidence that there would be a strong recovery for oil and oil company stocks. This was based on four factors coming together in their favor:
- Rising demand
- Decreasing supply
- Oil companies spending less on exploration, development and operations (restricting increasing the supply again when it’s needed)
- Oil stock prices have lagged – setting the stage for a strong rebound
Well, we got three out of four. Demand is increasing. Oil companies are cutting expenses. Oil company stock prices are lagging … by appreciably more than the price of oil itself. What did we omit? Oh, yes. Supply is not decreasing.
- Demand increased with the cheaper price for oil. Manufacturing, shipping and gasoline costs dropped. Current demand is about 1.6 million barrels/day higher than last year’s average demand. (7/26 addendum: while demand is currently increasing, the end of the summer gasoline ‘binge’ will begin to reduce demand in ~6 more weeks.)
- Oil companies cut back spending dramatically. Since October, rig count dropped by 42%, 70,000 workers were ‘furloughed’ and capex (capital expenditures) have fallen by $129 billion.
- Oil company stocks of the major players are trading near 35-year lows!
- That brings us to supply. Increasing demand and less drilling should have led to less supply. However, there is a fly in this ointment now … and others lurking in the background.
OPEC is that fly. Our production at home has trailed off. OPEC’s is increasing. OPEC has boosted output by 1.5 million barrels a day since February. Looked at it more pointedly, the entire current oversupply can be attributed to OPEC supply growth over the past four months.*
OPEC production may, in fact, be approaching its production limit. But that’s not the end of supply. Potential additional supply can emerge from Iran (its dissolving sanctions are another current headliner) and Libya … if it gets its act back together. And there is the possibility of increased US production as companies here – faced with long-term low prices – increase production rather than go out of business while waiting for higher prices.
Morgan Stanley’s calculations suggest that those factors could add another three years to the current slump in oil prices. That would make the current downturn more severe than in 1986, when business endured the deepest slump in 45 years. (It was simpler then; OPEC kept markets oversupplied.) But even rosier forecasts for a “slow but gradual recovery” – based on low prices continuing to stimulate demand and curb supply investment – aren’t that rosy. They still say it will take until the second half of 2016 for global markets to rebalance.
Will the stock prices of the major oil players recover? Though past performance guarantees nothing, they always have over recent decades. The questions we face are “when?” and “how long are we willing to hold a position?” while waiting for recovery.
* Not the first time OPEC shot itself in the foot under similar circumstances. In the past, each member tended to look out for itself at the group’s expense. Now they may be trying to break the US shale oil companies. Who knows? Maybe this time their tactic will work as they planned. The US shale "revolution" is now running out of lifelines as hedges roll off and as the next round of credit line assessments loom.
"Far Worse Than 1986": The Oil Downturn Has No Parallel In Recorded History, Morgan Stanley Says. Tyler Durden. Zerohedge.com. July 22, 2015.
Oil Heading for Fall as Diesel’s Engine Sputters: Oil prices will weaken further once summer’s peak gasoline demand rolls over. Liam Denning. Wsj.com. July 26, 2015.
Oil Slump May Be Worse Than 1986, Says Morgan Stanley. Grant Smith. Bloomberg Businessweek. July 23, 2015.
This oil crash could be the worst in more than 45 years, Morgan Stanley warns. Tom Randall. Bloomberg News. July 23, 2015.
The data above were taken from sources deemed reliable. However no guarantee can be made as to their completeness and accuracy.
Interpretations of the data, views and/or opinions expressed are those of the Jamison Financial Group based on market and economic conditions as of the date of publication and are subject to change. They do not necessarily reflect the opinions of any other individual, group or organization.
Nothing in the above is meant to be, nor should it be construed as, investment advice or recommendations to buy or sell any security. Individual securities whenever mentioned are for illustrative purposes only and may not be relied upon as investment advice.
All indices are unmanaged and are not illustrative of any particular investment. A direct investment cannot be made in any index.
The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks.
The NASDAQ Composite is a market-weighted index of all the over-the-counter common stocks traded on the NASDAQ system.
The S&P 500® is a market-capitalization-weighted index of common stocks.
Tax and/or legal information contained herein is general in nature and for informational purposes only. It should not be relied upon as advice. Consult your tax professional or attorney regarding your unique situation.
Past performance is no guarantee of future results.
© 2014 Jamison Financial Group. Please feel free to distribute copies to individuals you feel may benefit from the information presented. Commercial use is prohibited.