oil below $20 a barrel

The Energy sector of the S&P 500 makes up 2.8% of the index, according to the S&P website.  This is another way of saying that none of us as investors need to have an opinion about oil and gas production, which makes up the lion’s share of the sector.

Last weekend Saudi Arabia and Russia, with a fig leaf provided by the US for Mexico’s non-participation, led an oil producers’ agreement to cut production by around 10 million barrels daily.

Prior to the meeting, crude had rallied from just over $20 to around $23.  Right after, however, the Saudis announced price discounts reported to be around $4 barrel for buyers in Asia.  Prices were reduced by a smaller amount in Europe but went up for US customers–apparently at the Trump administration’s request.  That sent crude prices into the high teens.

Why is this the best strategy for Saudi Arabia?

The commonsense answer is that Riyadh thinks it’s more important to secure sales volumes than it is to be picky on price.  This is at least partly because the world output cuts reduce, but by no means eliminate, the oversupply.  So there are still going to be plenty of barrels looking for a buyer.  Another reason is that since demand has dried up the Russian ruble has dropped by 20%.  That’s like a 25% local currency price increase for Russian crude, meaning lots of room for Moscow to undercut rivals.

investment implications

The most leveraged play to changes in oil prices is oilfield services.  Companies that specialize in exploration–seismic services, drilling rig firms–are the highest beta, firms that service existing wells less so.  During the oil price crash of the early 1980s, however,  drilling rigs were stacked for a decade or so.  On the other hand, oilfield services firms are the ultimate stock market call on rising oil prices.

Given that US hydrocarbon output and usage are roughly equal, the country as a whole should be indifferent to price changes (yes, it’s more complicated, but at this point we want only the general lay of the land) rather than the net winner it was 15 years ago.  However, within the country oil consumers normally come out ahead, while oil producers are losers.

Typically, the resulting low gasoline prices would be a boon to truckers and to commuting drivers.  The first is probably still the case, the second not so much.

The bigger issue, I think, is the fate of the Big Three Detroit auto producers, who are being kept afloat by federal government policies that encourage oil consumption and protect high-profit US-made light trucks from foreign competition.  While nothing can explain the wild gyrations of Tesla (TSLA) shares, one reasonable interpretation of the stock’s resilience is the idea that the current downturn will weaken makers of combustion engines and accelerate the turn toward electric vehicles.

Personally, I’m in no rush to buy TSLA shares–which I do own indirectly through an ARK ETF.  But it’s possible both that Americans won’t buy new cars for a while (if gasoline prices stay low, greater fuel economy won’t be a big motivator).  And the rest of the world is going electric, reducing the attractiveness of Detroit cars abroad, and probably making foreign-made electrics superior products.

If there’s any practical investment question in this, it’s:  if the driving culture in the US remains but the internal combustion engine disappears, who are the winners and losers?

 

 

 

 

 

 

 

 

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