The Oil Market in the Midst of a Solid Looking Crash

It’s been a while seen you’ve seen a good old fashioned crash. There was, of course, the Lehman induced panic of September 2008. Then you saw the gold market crack back in April and June of 2013.

But since then, it’s been pretty tame out there in financial asset la la land. Until now, that is. Now, you’re seeing the oil market in the midst of a pretty solid looking crash. The chart below shows the price of West Texas Intermediate crude oil. Since June, it’s cratered 40%.

Overnight, both West Texas and Brent crude slumped another 4% plus. Prices are now at their lowest level since 2009. This price crash has many implications for the global economy – some good, some bad. I’ll discuss a few of those in today’s Markets and Money.

Oil Price Light Crude Oil
The oil price crash has hit oil stocks hard lately. None more so than Santos [ASX:STO] who had to pull a European hybrid issue last week. Rating agency Standard and Poors followed this up yesterday with a downgrade to its credit rating.

Santos has a major equity stake in the Gladstone LNG project, the economics of which look very weak given the oil price outlook. That’s resulted in a sharp fall in expected earnings per share for the company for 2015.

In September, consensus earnings per share for STO were $1.03. Now, they’re just 62 cents. Still, the company isn’t cheap. It’s still trading on a price-to-earnings ratio of nearly 13 times, and my guess is that earnings expectations could continue to fall.

There will be a share price bounce at some stage, but I wouldn’t suggest bottom fishing for oil stocks in this environment. Crashes like this (isolated ones…not a part of a global credit crunch, for example) tend to signal a fundamental shift in the market.

Oil prices are likely to stay lower for longer than many people currently expect. That’s good for net oil importing countries and good for consumers. It’s probably a bit of both for Australia as we are a net energy exporter (a position set to grow in 2015 as the LNG projects ramp up), which means the price falls hurt us in the aggregate. But at the consumer level it will free up some income to spend on some useless imported gadget that does nothing for our productivity. J

The other thing to consider is the second round effects of sharply lower prices. Developments in the Middle East will be fascinating to watch should we settle in to a lower price environment in 2015.

That’s because the autocratic oil regimes need much higher oil prices to balance their budgets. To remain in power and pay off the ‘electorate’ (stop the masses from rioting), many regimes have blown out their welfare spending.

But they won’t be able to maintain such spending without high oil prices. Or, if they do, it will lead to budget deficits.

Because most of these oil producers have huge financial reserves (saved over the decades), they can probably afford to run deficits for a few years and run down their reserves to make up the difference.

Now, here’s the point: Most of these reserves are in the form of US Treasuries. That means additional selling could take place while the Federal Reserve is no longer buying.

The commodity price crash in general (not just oil) could continue to place pressure on emerging market nations and force them into selling off their reserves to stay afloat and protect their currencies from speculation.

If this selling gained any sort of momentum, it could prove a wildcard for the US Treasury market. You’re not seeing any problems there right now. That’s probably thanks to the Japanese who are no doubt soaking up any excess treasuries via their own money printing programs.

But as we progress further down the rabbit hole of monetary experimentation in 2015, something will have to give. I have no idea what it will be…but it’s worth keeping a look out for the unintended consequences of the oil price crash. Because there will be plenty.


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Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:


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