For those that were around in the 1960s, the Beverly Hillbillies were a highlight of lowbrow humor. Lester Flatt and Earl Scruggs played the theme song that I still sing today. The story of a poor mountain family that strikes it rich when oil is found on their land, made millions of us laugh as they moved to a huge mansion in Beverly Hills. For over a hundred years, "black gold" or "Texas Tea" has been involved in numerous boom and bust cycles. New technologies emerge that unleash new supply that eventually overwhelms demand causing prices to sink. Overleveraged wildcatters become fantastically wealthy and broke within a few years. There have been arguments for 50 years about "peak" oil and when supplies will dry up. There is no question that oil, like every resource on Earth, is finite. However, calculating how finite has proven to be elusive. Technological innovation has changed the equation many times and will probably continue to do so.
Over the last 10 years, this paradigm is playing out once again, but in addition it is changing the geopolitical climate as the US becomes closer to energy independence. Everyone seems to have a stake in the action. Special interest groups line up on all sides here. Strong arm dictators in Venezuela, Russia and the Mid-East are feeling the pain of lower prices. Ecologists fear the impact of fossil fuels on the climate and the effects of fracking. Interested groups pushing alternative energy sources get squeezed from lower prices. On the flip side, all the users of energy effectively get a huge tax cut as it is cheaper to heat one's home or drive one's car. Chemical companies, airlines, transportation companies, utilities, and manufacturers all see one of their primary expenses reduced. We could spend hours discussing who profits from lower oil prices and who loses.
There are 2 sides to every Supply /Demand equation. Demand was to increase every year due to forecasted economic growth in China, the US and a rebound in Europe. Here is where the optimism fuelled the speculators to drill, baby drill. Lower growth in China, as well as, a possible recession in Europe has reduced demand for oil offsetting a long overdue recovery in the US economy. The weak world economy is now expected to extend the oil price weakness,
So, how low can it go? The history of commodity trading is one where a commodity almost always overshoots to an extreme. So, when the Saudis say $60/barrel is where they think it will settle, expect the market to test that. It won't surprise me to see oil push down and actually test the low $50s or even $40s/barrel (Down from $102 /barrel in June). This price forces out expensive producers, but conversely makes other areas of the economy more productive so demand can increase. During the next couple of months, we will witness this testing to find a new equilibrium price.
The tougher question is how to position one's portfolio for lower oil prices. The investment team at Willingdon believes that over the long term, energy is a vital component to a growing economy. Therefore, we will continue to own high quality exploration, refiners and pipeline firms. Energy innovation has been a catalyst for growth here in the US while so many other sectors have struggled. We analyze each firm continually to determine whether dividends can be maintained or raised at various levels of oil prices.
New found wealth never seemed to change Jed, Granny, Ellie May or Jethro from their humble roots. In contrast, the recent decline in oil will affect whole sectors of the US economy- for better or for worse- and will also impact the global geopolitical climate. It will make for interesting watching ...just like Jethro on Rodeo Drive.
"So they loaded up the truck and they moved to the Beverly ... (Hills that is, Swimming pools, movie stars.) "
Ted Ake
© Willingdon Wealth Management
