Corporate Winners And Losers
THE OIL DIVIDEND: CORPORATE WINNERS AND LOSERS
The drastic drop in oil prices will clearly have an impact on both individual companies and on overall growth in some countries. But is the shift net positive or negative, cyclical or systemic? The ultimate outcome is yet to be seen.
Transporting Campbell soup across the United States requires a large number of trucks and an even larger number of gallons of diesel. Campbell is clearly one company that will benefit from the nearly 40% decline in oil prices between July and December—but only after soup for the winter has been delivered. “Since we are often locked into long-term contracts, we do not see an immediate impact,” says Ashok Madhavan, treasurer for Campbell Soup. Eventually, he said, if oil prices stay low, the lower diesel costs will be reflected in the six-month contracts that Campbell sets up to outsource soup delivery across the country.
Dividends from the decrease in oil prices (which went below $60 a barrel in December) are slowly infusing the world economy, spreading from industry to industry and from country to country, sometimes in convoluted ways. Whether the sharp decline—which pushed the cost of Brent, the major benchmark price for oil worldwide, to a five-year low in December—is here to stay or whether prices rebound, companies and markets are experiencing the impact.
The global economy is mostly enjoying the windfall coming from the lower cost of oil, but oil exporters and countries and sectors associated with them clearly will emerge as losers.
Stock markets ultimately reacted poorly to lower oil prices: Investors had to discount lower earnings for oil companies, which are so widely represented in overall stock market volumes that they offset the positive impact across those sectors that received a boost from the price drop—such as retailers, food companies and virtually all oil consumers.
Managing investors’ expectations is the priority, says Pier Francesco Facchini, chief financial officer at Prysmian, the world’s largest cable maker. “The first important thing to do is to inform investors of what is the real exposure. In our case the exposure in terms of revenue and profit is 5% of the total, and so relatively low,” Facchini says, referring to the revenue linked to cable sold to oil producers. “Even so, orders are done with a horizon of six to 12 months.” On the other hand, for Prysmian lower oil prices could mean lower plastic material costs.
The net conclusion is
that lower oil prices are unambiguously a positive for global growth.
~ Jeff Rosenberg, BlackRock
Forecasting the price of oil is practically impossible, and history is full of glaring and clumsy mistakes, but understanding the sharp decline in oil prices of the second half of 2014 is not rocket science. Demand and supply factors came together to produce the outcome. Demand has been lower because the world economy expanded less than expected, but also because of more efficient use of energy, a structural change that is bound to last. Supply has been larger for producers that are rebuilding capacity, such as Libya, but also as a result of the increasing capacity from US shale oil. Meanwhile, OPEC producers decided in November not to cut production, exacerbating the downward price pressure.
“I would not be surprised at all to see a rebound in oil prices of $10 or $15 from here [in the short term], but again, it is not going to be sustainable, because the market’s fundamentals do not support oil prices significantly above the current level,” Fadel Gheit, senior energy analyst at Oppenheimer, said in November 2014. Gheit, a veteran analyst in the oil market, sees oil prices ranging in the long term between $65 and $75 a barrel.
Downward weight on prices is expected to continue at least for the first part of 2015, when seasonal demand tends to be lower, says Antoine Halff, chief oil analyst for the International Energy Agency in Paris. “We do not expect that lower prices will cut production in the short term, and so we expect production to remain very strong,” he notes. “The wedge between supply and demand—the level of excess production—looks like it is going to increase in the first half of the year despite the pressure coming from low prices, and this should translate [into] a buildup of inventories and downward pressure on prices.”
Not all oil companies will suffer from the price decline. “Some companies’ IT budget will go up as a result of the lower oil prices, and some companies’ may come down, but more or less the two impacts will offset,” notes Navneet Govil, chief financial officer of Enterprise Solutions and treasurer at CA Technologies, of the effect on their primary business lines.
NEXT PAGE: THE WINNERS
BlackRock, which manages more than $4.5 trillion in assets, sees lower oil prices helping the US economy overcome the loss from lower capital expenditures. Current prices effectively transfer some $1.3 trillion in total from oil producers to oil consumers.
“The net conclusion is that lower oil prices are unambiguously a positive for global growth,” notes Jeff Rosenberg, BlackRock chief investment strategist for fixed income. “Consumption-based economies are the main winners, and the US is clearly the largest of those, followed by Europe ex Germany (Germany is less a consumption-oriented economy). Japan is another net winner, although for Japan the effect of oil prices is clearly not as large as it is for the US.”
According to estimates by the International Monetary Fund, global demand [consumption] in 2015 could be boosted 0.8% by the lower cost of oil. Different econometric models diverge by a few basis points. But global economists have been very cautious in jumping on the train of global growth estimate revisions. For Alberto Ades, co-head of global economics and head of global emerging markets fixed-income strategy at Bank of America Merrill Lynch, it is difficult to draw clear conclusions. “Fifty basis points is a ballpark estimate. It could be higher—I saw an estimate of 100 basis points—or it could be lower than that,” said Ades, adding that the impact of oil price decline can be asymmetric, with price hikes more important than price declines. “Practically speaking, I do not think that anyone—ourselves, the IMF or our competitors—has increased its growth forecast by 50 basis points next year.”
Merrill Lynch believes that countries such as Turkey, South Africa, China, Korea, Indonesia, India and Brazil are the countries set to benefit the most. The beneficial impact may be even larger for some emerging countries because their sensitivity to oil is higher, says José Gerardo Morales, CFA, US chief investment officer for Mirae Asset Global Investments. “The weight of energy in the inflation basket is higher for them, so there is a bigger benefit in the emerging markets of an oil price drop,” he notes. “Clearly, it is always important to differentiate [among] emerging markets—and some countries such as Russia will be at a disadvantage and may fall into recession. Apart from oil exporters, most emerging markets will benefit.” Morales says that the so-called Fragile Five (Turkey, South Africa, Brazil, India, and Indonesia). will benefit because they are net oil importers. The same is true for most of the countries in Asia. For Mirae Asset, which has $62 billion in assets under management, $15 billion of them in emerging markets equity, lower oil prices mean a better look at investment opportunities in winner countries.
NEXT PAGE: THE LOSERS
In mid-December, General Electric released, for the first time in years, an earnings forecast. In it the company predicted that its aviation, power and water, and other industrial units will compensate for declining revenues from its oil and gas businesses. GE, which provides drilling, compressors and other equipment, made just under 12% of its 2013 total revenue from the sector, and its shares have been hit recently by the sharp price decline. GE expects 2015 earnings in a range of $1.70 to $1.80 per share. Its attempt to get out in front of events and reassure shareholders isn’t unique. Corporates are worried about—and proactively managing—the impact of falling oil prices.
From a country perspective, all oil exporters have been suffering from the slump in oil prices since 2014, but some of them, mainly Venezuela and Russia, are set to lose the most because of their high dependence on oil exports combined with a lack of financial flexibility.
“Venezuela, Russia and obviously the Gulf Cooperation Council countries, Nigeria and Malaysia are countries which will be hit by the oil decline. And for some of them we have already seen [an] impact. We have seen the sell-off in Venezuelan bonds and the sell-off in the Russian ruble,” says Ades. Bank of America Merrill Lynch forecasts Russia’s GDP to decline 1.5% in 2015, a recession expected by other large banking houses as well. For president Vladimir Putin, who built his fortune on the high level of oil prices, plummeting oil revenue represents a big threat to his reign.
In Venezuela, the sharp fall in oil prices has combined with a lower level of oil export to create a drag on the country’s external reserves, adding to market tensions weighing on the Latin American country.
For the countries in the Gulf, oil prices can stay low for longer—but not without some impact on capital reserves. Oil prices would have to be sustained at low levels over the medium-term before the Gulf’s current-account position would swing from surplus to deficit. “Even then, large FX reserves provide a comfortable buffer,” notes Jason Tuvey at Capital Economics in London. For Saudi Arabia, the world’s second-largest exporter, the oil sector is now a drag on economic growth but the country’s savings are such that it will be able to comfortably absorb the shock while gaining market share on the
worldwide oil market.
A case apart is Mexico, because its diversified economy and its high integration with the US economy will make it possible to benefit from lower oil prices. But its energy reform, a once-in-a-lifetime attempt to open up the sector to international investors, will attract fewer investments from abroad if oil prices stay at current levels. “The view from our [Mexico] economist is that most of the new fields that they are trying to open up have break-even prices which are below $80 per barrel, and so they [may] still [be] profitable—of course less profitable than they were when oil was at $110 or $115,” says Ades. “We still see $10 billion of FDI [a year] coming to Mexico on the back of the
As Global Finance was going to press, Brent oil prices dropped below $60 a barrel. Should such low prices be sustained, most oil-producing markets—including Mexico—and oil-related sectors are likely to feel the pinch. n