Markets

Who Benefits and Who is Hurt by the Collapse in Crude Oil Prices?

The price of crude oil at the end of the first quarter of 2020 has fallen below US$25.00 per barrel. Consumers will receive a temporary benefit from rock-bottom gasoline prices, but the reality is worldwide economic activity is too interconnected for the crude oil price collapse to generate universal long-term benefits.

Consider the circumstances surrounding what is now the largest drop in crude oil prices in thirty years:

• an accelerating decrease in worldwide demand for goods, which was hurting China’s economy even before the COVID-19 pandemic shuttered much of the country’s manufacturing;
• inflation and interest rates are at zero and cannot go any lower, thus reducing the ability of central banks to address economic crises;
• expansion of shale oil fracking has pushed the United States to the rank of the world’s number one oil producer;
• Russia’s attempts to supplant the U.S. as the world’s primary oil producer, which fostered the war of words between Russia and Saudi Arabia as that latter country sought to cut production to match demand.

Under these circumstances, it is axiomatic that some developed and emerging economies and industry sectors will reap outsized benefits, while others will be hurt by historically low energy prices.

The Oil Price Victors

Although the Dow’s gains have all but been wiped out due to fears over the economic effects of COVID-19, the United States is a near-term victor in the oil price as it maintains its status as the world’s number one oil producer and energy prices take a small bite out of consumer budgets. Continued low prices, however, may harm startup shale oil companies and drastically reduce employment in that industry sector. Whether the U.S. will be a long-term victor remains to be seen.

Countries that are net oil importers, including China, Peru, India, Japan, Germany, and France are near-term victors that have a chance to be long-term winners as energy prices stay low. Low fuel prices will boost consumer morale and confidence in government policies that could lead to greater stability in some of these countries.

A dark cloud is still in place in many of these economies. Volatility in other market sectors, and particularly in currencies, could eclipse the benefits of low oil prices, at least until economies can adjust to volatility. Leaders that pushed through tax increases in some of these countries may need to reverse course, which will deliver short-term political benefits and long-term deficits.

The Oil Price Losers

Venezuela was facing serious political and societal pressures before oil prices collapsed. Continued low prices could be the catalyst that pushes Venezuela over the edge. Likewise, low oil prices expose Ecuador, Colombia, Mexico, and Argentina to drastic reductions in the gross domestic products and present the risk of sovereign debt default. Canada’s economy is also facing recessionary pressure from low oil prices.

Among the economies of Asia and the Pacific Basin, Australia may be the hardest hit. Forecasts from Bloomberg economics suggest that Australia’s growth outlook is 1.5 points lower in 2020 than it had been before the oil price and COVID-19 shocks.

Norway may be at the top of the list of European economies suffering from the oil price collapse. Norway’s stock exchange, which includes many oil-dependent companies, recently dropped more than 12% and the value of its currency against the Euro fell to new lows. Oil exports are a substantial component of Norway’s exports and state income. The country has substantial reserves in its sovereign wealth fund, which will help it ride out the oil price shock, but it may be years before it recovers losses tied to that shock. Russia has even greater sovereign wealth reserves as its economy is absorbing the harm from low oil process.

Saudi Arabia, Algeria, Iran, and other Middle East and African oil exporters are perhaps suffering the most from low oil prices. The potential for political unrest in these countries is the biggest unknown if low oil prices lead to service cutbacks and austerity measures.

The Intelligent Investor’s Response

Investors can guide their investment decisions in this environment with the basic truth that the demand for energy resources will not go away. Many oil and gas production companies that have ridden out previous oil price shocks have adopted mitigation plans to maintain profit margins. Low oil and gas company stock prices might present unique opportunities for strong future capital appreciation.

Further, some oil producers are using alternative energy production to diversify and mitigate against oil price swings. Investors can take advantage of this by looking for companies in the alternative energy sector that are drawing investments from established oil and gas producers.

Sophisticated investors know not to make drastic decisions based on an emotional response to a crisis. Even if a portfolio has lost substantial value, investors can always erect hedging strategies that will create multi-generational benefits. Thus, rather than panicking as market volatility continues, investors should look deeper into those markets for the overlooked hidden gems. As long as there is a demand for energy, crude oil prices will recover.

Financial services firms have created products that enable investors to draw liquidity from their portfolios to take advantage of these hidden gems without having to sell any assets at depressed prices into a bear market. Contrary to the doomsayers that see no end to the current crisis, the reality is that every crisis creates unprecedented opportunities for investors that are intelligent enough to grab those opportunities.