Green Swan

Fallen Oil Prices: A Nice Tailwind for the Market

Green Swan

One of the leading market-related stories of 2014 is the drop in oil prices. From the beginning of the year through the end of November, the price per barrel has dropped by about 33%, closing at just under $66. While this may be considered bad news for the energy companies, it is the opposite for companies that either utilize energy as a major input or rely on consumer spending which normally increases with lower energy prices. We are seeing signs of increased consumer spending, and even though Black Friday sales were down 7% (about $0.7 billion) from last year, Cyber Monday sales more than compensated with a 17% (about $2.0 billion) increase. It will be interesting to see how the remainder of the holiday season plays out. The chart below shows how the Energy sector sticks out like a sore thumb as the only losing sector in the first eleven months of 2014.

An even worse performer than the energy sector has been a subset of the Materials sector, the Metals and Mining sector, as represented by the SPDR ETF, XME. For the year-to-date period, it has lost 18.66%. With the decline in precious metals prices, these companies tend to be hit worse than the level of metal price declines because they have a leveraged exposure to these metals (e.g., a gold mine that spends $400 to produce an ounce of gold that it sells for $1,200 will lose 12.5% of its value for every $100 drop in the price of gold). Of course, these companies hedge much of their risk with derivatives.

Getting back to oil, the story appears to be a loss of pricing power by the once dreaded OPEC cartel in the face of new sources being tapped in the U.S., particularly shale oil and gas that is extracted via hydraulic fracturing (fracking). Only recently has it become economically sensible to produce energy in this manner, and the environmental controversy surrounding it appears to have subsided for now.

With all the talk about "black swans" and the potential havoc they can wreak on our portfolios, we like to think about America’s new energy sources (both oil and natural gas) as a “green swan”. About a decade ago, there was a great deal of fear-mongering around "peak oil". The common wisdom was that America was well past its peak (on the declining part of the bell curve) and the rest of the world was on the verge of hitting its peak, yet oil production has been increasing for both America and the rest of the world. According to a report by the International Energy Agency, the U.S. is on track to overtake Saudi Arabia as the world's biggest oil producer by 2020 and become energy self-sufficient by 2030. This can be expected to have massive implications for our foreign policy. While it may be true that we will never again see $10 per barrel oil (i.e. the low-hanging fruit is gone), we may no longer have to fear high energy prices as an impediment to our prosperity. 

We will continue to follow this situation closely, and we will keep you apprised with our upcoming year-end 2014 market summary.