It’s been a great Thanksgiving for everyone, with more and more people feeling better about the economy and with the stock market moving along, for all those who have a car things have become even better with gas prices falling to levels not seen since 2009. There is also more good news for driver’s gas prices are likely to fall even lower. On the surface this seems like great news, in reality however the fall in oil prices could actually be harmful for the United States economy.
There are many factors that have contributed to the fall of oil from over $100 a barrel to under $70, chief amongst which is the sheer amount being produced. At this moment in time OPEC (the organization of oil exporting countries) produces about 30 million barrels of oil a day, both Russia and the U.S each produce another 10 million barrels each, add in production from Nigeria, Canada, and Venezuela you get more oil than the world needs.
Oversupply is one reason why oil prices have tumbled so far this year but Friday, November 28, 2014, while consumers were enjoying black Friday, oil prices fell over 10% to settle at 4 year lows. This dramatic drop in the price of oil sent the energy sector into a tailspin. Solid blue chips like Exxon and Chevron saw their shares fall 4% and 5% respectfully. Other oil companies and energy companies did not get off that lightly, shares of oil service companies which include Baker Hughes and Halliburton fell nearly 9% and 10%. Shares in off shore drillers also got slammed with Transocean and Ensco both seeing drops of over 9%. Along with oil, shares in renewable energy companies like First Solar also tumbled as investors see low oil prices threatening solar and other renewable energy industries.
The catalyst for Friday’s massive energy sell off was OPEC’s surprising decision not to cut oil production, as they have done in the past when oil prices fell off. It seems that OPEC is shooting itself in the foot, since low oil prices would seem to hurt the economies of OPEC members such as Saudi Arabia, Kuwait, Iraq and the United Arab Emirates. The truth is quite the opposite, OPEC’s decision not to cut oil prices is a shrewd way to destroy competitors exploiting shale oil in the U.S and oil in Russia.
Basically OPEC is betting on the fact that it withstand lower oil prices longer than any other competing nation in the world. This does seem to be true, Saudi Arabia, Kuwait and the U.A.E (United Arab Emirates) have a combined savings of over $2.5 trillion. Giving them some cushion against falling oil prices, meanwhile compare that to Russia who is losing over $140 billion to sanctions and the same falling prices and the U.S whose oil production depends on shale oil, which is becoming less commercially viable by the second as prices decline. OPEC is willing to sacrifice short term profit if it means destroying its competitors in U.S shale and Russia. So with oil prices set to go even lower which industries stand to profit and which ones are the most exposed.
One industry that is the most exposed to falling prices is offshore oil. This industry includes companies such as Baker Hughes, Halliburton, Ensco, Transocean, and Diamond Offshore, these companies and their subsidiaries derive most of their income through building and leasing offshore oilrigs. The industry historically is undervalued and while oil prices are high offshore oil is an attractive investment, the main problem is that offshore oil is expensive and setting up drills costs oil companies a fortune. As prices sit, offshore drilling is not commercially viable and many companies have already have begun to scrap several expensive offshore projects in the face of falling oil prices. Offshore drilling companies have seen their stocks collapse this year and many sit at 52 week lows.
On the other end of the spectrum are the airlines that have enjoyed a nice rally as prices of jet fuel fall alongside oil. Airline stocks have seen a resurgence in the last 2 years, as consolidation has allowed airlines to raise airfare and fees, all of which has added to their bottom lines. Southwest Airlines is the top performing stock in the S&P 500 this year, with shares nearly doubling. Other airlines like Delta and American have also enjoyed solid 50-60% gains, and with oil prices continuing their free fall airline stocks are set to go even higher, especially since airline stocks still trade at evaluations that are a bargain when compared to the broader market.
Airlines are not the only industry that is benefitting from lower oil prices; retailers are also getting a lift as more people spend their savings from lower gas on gifts for the holidays. With that being said, with the exception of retail and to a greater extent to airlines if oil prices continue to plunge the economy and the stock market might get rocky. The logic behind this is that with the shale oil boom in the U.S many states and local economies have become more and more dependent on the energy industry to survive. U.S oil companies have already begun to slash costs and projects in certain areas, mostly in the Gulf, but if prices continue to fall those cuts might and will spread to the shale oil deposits and drilling operations in the Continental U.S. This will hit the economies of the northern mid-western states hard, states like North Dakota might be facing financial problems in that scenario.
If falling oil prices destabilize the energy sector then this will spread to other industries and might send the U.S into a bear market. With that being said the economy as a whole is improving so any future economic crisis is not likely, but this does not mean that the stock market will not receive a larger hit as energy drags it down. Personally I feel that these falling oil prices are an opportunity to buy into industries like Airlines and retail, which will only go up as oil goes down.
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