It’s been a crazy quarter for crude oil, and investors are scrambling to keep up. Both the U.S. benchmark West Texas Intermediate and global peer Brent crude recently touched five-year lows. News like that typically sends equities investors rushing to sell oil producers and snap up consumer stocks. Cheaper gasoline usually means more discretionary spending.
But this time around the broad patterns and expected reactions have gone against the grain. The outlook for refiners is an example, thanks to questions about long-term investment. So is the issue of whether consumers really will spend more, given some rising prices for other staples. Within the energy sector itself, end-product firms such as refining companies have been the most resilient amid crude oil’s ongoing skid, although expansion of production facilities is likely to be stymied, should the trend continue.
Whereas investors are busy sorting through the sectors and adjusting their funds and portfolios, value investors are already thinking about stepping in. “That’s the debate we’re having here,” says Murray Leith, director and head of investment research for Vancouver-based investment management firm Odlum Brown. “Do I want to sell higher-quality better businesses trading toward the higher end of what’s reasonable for a lower-quality cyclical stock? I’m not quite there yet, but I’m thinking about it.”
The conventional wisdom is that falling crude prices stimulate economic growth in much the same way that tax cuts do, leaving more cash in consumers’ pockets. And if stocks such as discount retailer Wal-Mart Stores and cruise ship company Carnival Corp. are any indication, discretionary spending has responded. So far this quarter, these companies’ prices per share are up 12.9 percent and 13.7 percent, respectively. The impact may be muted by food prices, however, according to research from New York–based equities strategists at Barclays Capital, who estimate that increased food costs have offset 90 percent of lower gasoline prices in the year to December 4, when their research was published. Coffee and cattle prices had climbed 34 percent and 28 percent, respectively, for example.
Another clear beneficiary from the fall in crude prices is transportation companies, in particular those that have hedged their bets to a smaller extent with advance fuel purchase contracts. American Airlines is a standout among airlines in this regard, as it stopped hedging in June of this year. The stock has jumped 45.8 percent thus far during the fourth quarter as of close December 18. At the other end of the hedging spectrum is Southwest, which has 40 percent of its fuel costs locked in for 2015, according to equity research from Credit Suisse. Its shares are up 24.8 percent for the quarter. United Continental Holdings is 24 percent hedged and has climbed 41.3 percent; Delta’s hedging accounts for between 30 and 40 percent of fuel needs, and its shares are up 34 percent.
The smallest drop among energy stocks has come from oil-refining and -marketing companies, which collectively are down 3.42 percent so far in the fourth quarter. A key policy concern looms over these companies: whether the U.S. government will lift or relax a ban on crude oil exports established after the oil shocks of the early 1970s. If there are no changes from Washington and the shale-based crude now produced stays in the U.S., the extra supply would mean lower costs for refiners and spur new investment.
Until crude’s slide, however, it appeared that change was in store. U.S. energy secretary Ernest Moniz said in December 2013 that the ban may be outdated and in need of review, and in July it was partially relaxed when the U.S. allowed exports of condensates, which come from the same reservoirs as crude oil and have similar properties. But with crude prices lower and exploration falling too, a future drop in production or at least a more moderate pace of growth means less surplus crude stranded in the U.S. in the future — and therefore less pressure on government to decide. “We don’t have to worry about the export question for now,” says Jeff Bellman, a natural resources equities strategist for TIAA-CREF. That does, however, leave open the question of whether refiners should plan to add new capacity.
Within the energy sector, the biggest drops so far this quarter have been for companies that operate in the earliest stages of the exploration and extraction process. Whereas the S&P 500 has gained 5.91 percent so far in the fourth quarter, its oil and gas drilling subindex has plunged 30.2 percent in the same time period, and its exploration and production equities dropped by 28.23 percent. According to analysis from Standard Chartered Bank in London, applications for new drilling in the U.S. fell by 40 percent from October to November, indicative of capital-spending plans being delayed or shelved. There’s a large variance in potential consequences within the drilling group: Oklahoma City–headquartered Seventy Seven Energy is most protected because 80 percent of its rigs are already under contract for 2015, according to data from Bloomberg, whereas Pioneer Energy Services Corp. in San Antonio has just 25 percent. The stock prices, however, aren’t necessarily responding to the pattern by showing bigger drops for companies with fewer contracts.
Stocks less focused on the exploration process have fared better. The subindex of integrated companies, which explore and produce but also refine and sell to end users, is down 5.35 percent on the quarter so far. “If you’re going to hide in the energy market, you buy the integrated energy companies,” says Craig Bethune, a portfolio manager and global natural resources equities strategist at Manulife Asset Management in Toronto. Another measure reflecting various energy sector activities is the Alerian MLP index, which includes 50 large- and midcap master limited partnerships. It has slid 13.4 percent during the period.
In the Federal Open Market Committee’s announcement on Wednesday, Federal Reserve chair Janet Yellen noted that “oil prices are a net positive.” For energy sector stocks, the silver lining may be for those taking a longer view.
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