Shaping a portfolio for 2015 (ii): energy

From 2011 through the first half of 2014, the world crude oil price averaged $110 a barrel, more or less (let’s not worry about quality differentials and stuff like that–this is the BIG (and simple) picture).  Now it’s $70.

World oil production is 90 million barels a day.  So a $40 a barrel reduction in price means $3.6 billion a day no longer leaving the pockets of oil consumers and landing in those of the oil producers.  That’s $1.3 trillion a year–or about 8% of the total GDP of the United States.

The important investment questions are:

–does oil stay at this price?, and

–who are the winners and losers.

Let’s take the second first.

oil production and consumption

net importing areas, i.e., winners

Asia         20.4 million bbl/day; of that, China accounts for 5.6 million, Japan 4.4, South Korea 2.5, India 2.3

Europe     10.5 million bbl/day

North America     4 million bbl/day;  the US imports 6.7 million, Canada and Mexico are both exporters

net exporting areas, i.e., losers

Middle East     19.2 milllion bbl/day;  Saudi Arabia is 7.1 million

Eurasia     8.8 million bbl/day; Russia is 7.2 million

Africa     5.7 million bbl/day.

The US is now the largest oil producing country in the world, at 12.3 million barrels/day.  It is followed by Saudi Arabia and Russia, both at 10+ million bbl/day.

On a net basis, Asians and Europeans get the biggest windfall from lower oil prices;  the Middle East and Russia lose the most.  The US situation is more complex.  On the one hand, the nation as a whole is a net winner from lower oil prices.  On the other, the net win is made up of large gains by drivers everywhere, airlines and heating oil users in colder areas, partly offset by substantial losses in oil-producing states like North Dakota and Texas.

second round effects

There are two varieties:

–historically, a considerable portion of the money collected by oil producing countries is not spent.  Instead, it’s saved, or “recycled” into international financial markets.  Taking the Middle East, Eurasia and Africa together, there’s now a half-trillion dollars a year being spent in dribs and drabs by consumers outside these areas rather than being parked in sovereign wealth funds, private equity or hedge funds.  Bad for fund managers and bankers, good for consumption.

–Some consumers are abandoning hybrids and starting to buy gas guzzlers again.  Some new shale oil projects may no longer be economical.  Some of the urgency is leaving the alternative energy area.  These counter-trend developments are probably too small to matter much today, but they ultimately have the potential to help reverse the price decline and therefore are worth monitoring.

the first question

My guess is that the oil price stays around where it is now.

But that’s really just a guess.

As investors, we have to deal with ambiguity and uncertainty every day.  It’s more important for me to understand that I’m using this assumption in structuring my portfolio than to be 100% sure that I’m correct.  That way I can keep my eye out for changes and plan what I’ll do when/if I see them. In any situation where a professional genuinely has no insight, the plain-vanilla strategy is to equal weight the area.  I imagine that most professionals will have less than the S&P 8% weithging in Energy going into 2015, however.

In the active portion of my holdings, I’ve had virtually no Energy for some time.  I’m going to continue that stance. But I’m going to look around for some Retail or Restaurants to add in the US or EU. I’m leaving my passive holdings alone.  I suppose I could short an oil ETF, but I’m confident in my case that that wouldn’t work out well. At some point, well ahead of any reversal in the oil price, the stocks in the Energy sector will bottom out.  We should be watching for this.  I don’t think we’re anywhere near that point yet, however.

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