Crude Oil Price Decline. January 2015

Transcription

1 Price Decline January 2015

2 Crude Oil Prices in the U.S. West Texas Intermediate Crude Oil Spot Price $120 $110 $100 The price of WTI fell 49% in the second half of 2014 $90 $80 $70 $60 $50 $40 Dec-14 Nov-14 Oct-14 Sep-14 Aug-14 Jul-14 Jun-14 May-14 Apr-14 Mar-14 Feb-14 Jan-14 Dec-13 $160 West Texas Intermediate Crude Oil Spot Price $140 $120 $100 $80 $60 The decline looks more dramatic, but is not unprecedented, when viewed in a longer horizon. $40 $20 $- Dec-82 Dec-84 Dec-86 Dec-88 Dec-90 Dec-92 Dec-94 Dec-96 Dec-98 Dec-00 Dec-02 Dec-04 Dec-06 Dec-08 Dec-10 Dec-12 Dec-14 Source: Bloomberg 2

3 Why the Price Drop? Supply Increase Unconventional drilling techniques have resulted in a dramatic increase in U.S. oil production (+3.5 million bpd over the last five years) OPEC members have opted to maintain market share rather than cut production to provide support for falling prices Restart or ramp up in production from significant producers like Iraq and Libya Saudi Arabia has recently decreased prices for oil exported to the U.S. in an attempt to put pressure on the domestic fracturing industry 10,000 9,000 8,000 7,000 6,000 5,000 4,000 3,000 U.S. Crude Oil Production (000s/barrels per day) Source: Bloomberg, Energy Intelligence Group 3

4 Why the Price Drop? Slower than Forecast Demand Growth The International Energy Agency (IEA) recently lowered its projections for global oil consumption in 2014 and 2015 based on lower expectations for economic growth Economic recovery has been slower than forecast in Europe Actual oil usage has fallen below forecast demand in emerging market economies Gains in energy efficiency have resulted in slower demand growth Source: Apollo Global Management, IEA Oil Macro Report, October (1) EIA Short-Term Energy Outlook, October (2) Simmons Crude Oil Fundamentals. October 28,

5 Why the Price Drop? Strengthening U.S. Dollar Although the USD has strengthened over the last four years, it is still relatively weak from a historical perspective A number of macro-economic factors suggest that the US Dollar could continue to strengthen in the near-term: The U.S. is one of the few global economies to continue to show improving economic data Markets expect interest rates to eventually rise, which will likely put upward pressure on the U.S. Dollar U.S. Dollar versus Other Currencies Source: Bloomberg. USD based to 100 at 4/10/1973. Trade weighted USD versus a basket of 29 major global currencies 5

6 How Will Producers Respond? Slow Production Growth in the Short-term? Yes. Activity in U.S. oil fields has already responded to lower prices. The number of operating drill rigs fell at year-end which should begin to lower supply. However, there is a significant lag between a drop in active rigs and a slowdown in production. In its November 2014 meeting, OPEC decided not to cut its production level. Their next meeting is scheduled for June Source: Bloomberg, Baker Hughes 6

7 How Will Producers Respond? Slow Production Growth in the Long-term? No. Unconventional oil and gas wells tend to have steep decline curves and a continuous drilling and development cycle is required to maintain production levels U.S. Production Decline Curve by Year of Initial Production Source: Apollo, IHS. November

8 What Could Reverse the Price Decline? Economic growth in EM countries will likely increase, increasing oil demand China & India account for 15% of global energy consumption GDP growth estimates for China (7.0% -7.5%) and India (5.0% - 6.0%) support future demand Geopolitical tensions could cause oil price spikes Almost 25% of global energy shipments pass through three Middle East chokepoints Continued production below fiscal breakeven prices and a slow down in new drilling activity will eventually cause a market shakeout and reduce supply Source: JPMorgan Source: JPMorgan 8

9 Conclusion Near-Term The energy and commodities sectors are likely to face continuing headwinds for the next 12 months Interest rate forward curves suggest that interest rates in the U.S. will increase over the next year. A rising interest rate environment will make U.S. fixed income markets more attractive from a global perspective, which could lead to further dollar strengthening. From a supply perspective, U.S. oil and natural gas production is expected to increase over the next 12 months. Globally, OPEC is unlikely to cut production unless oil is lower than $70 a barrel for an extended period of time. Companies with energy-sensitive revenues who have not hedged their commodity exposure are likely to come under significant balance sheet pressure and the default level in the energy sector is likely to increase from current levels Longer-Term Longer term, there are many reasons to take a bullish view on energy related opportunities: Global oil consumption continues to rise on a secular basis. According to EIA, non-oecd oil demand is likely to nearly double in the next 25 years. Construction of natural gas-fired plants and the potential for LNG exports to Europe and Asia beginning in 2016 are expected to increase demand for natural gas Opportunities in both healthy and distressed energy and commodity related investments will appear as a continuous cycle of capital spending is required to meet the overall increase in global energy demand. 9

10 How Do Investors Respond? Short-term Responses Actively managed equity and credit strategies adjust exposure to the energy sector Opportunistic public and private strategies look to add energy exposure through value-oriented debt and equity purchases Tactical Responses Add direct commodity exposure through oil futures contracts, ETFs or other funds designed to track the price of oil This strategy provides the most direct exposure to oil price movements but also involves a high degree of timing, price and execution risk Add energy sector exposure through an Energy Sector focused ETF, other funds or through purchasing individual energy company stocks Energy Sector Funds and stocks have a lower correlation to oil prices This strategy provides a less direct connection to the price of oil but still involves timing, price and execution risks Add a dedicated, actively managed energy-focused strategy These funds come in numerous structures and vehicles and pursue a wide range of strategies including long-only, long/short and private equity structures This strategy has the lowest correlation to the price of oil and relies more heavily on the business fundamentals of companies in the energy sector Many of these vehicles target high relative returns in exchange for lower liquidity and company specific risks undertaken 10

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