Ignore The Big Upheaval In The Oil Patch

January 15, 2015

This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today’s article features Deborah Frame, vice president of investments at Toronto-based Cougar Global Investments.

 

A prolonged stretch of low oil prices will bring on economic and geopolitical changes that not so long ago were unthinkable, and regardless of short-term changes in demand and supply, the fracking industry is definitely in for something of a blood-letting.

 

After all, the global oil market appears heavily oversupplied for the first half of 2015. Saudi, Canadian, American, Iraqi, Kuwaiti, Russian and UAE production remain at or near their highest-ever levels, according to the International Energy Agency’s December report.

 

But all these surprising facts—and I’ll lay out more below in the spirit of illustrating what is real and salient—may be nothing more than fodder for dramatic headlines. The way we see it at Cougar Global, none of this really changes much in how investors should be allocating assets; namely, funds that canvass broad swaths of the market.

 

That means keeping emphasis, as always, on owning core securities, such as the SPDR S&P 500 ETF (SPY | A-98), among others. But before laying out the various options, let’s take a closer look at the astonishing developments in the world of oil and gas, and to what it all means to various producers.

 

Global Economic Sluggishness

The surge in production comes as growth in global demand hit a five-year low in 2014, due to a sharp slowdown in Chinese oil demand growth and steep contractions in Europe and Japan.

 

Most of the world outside North America is either in or near a recession. China is the second-largest consumer of oil in the world and surpassed the United States as the largest importer of liquid fuels in late 2013.

 

China is expected to burn through 3 million more barrels per day in 2020 compared with 2012, accounting for about one-quarter of global demand growth over that time. Although there is much uncertainty, China just wrapped up a disappointing fourth quarter, capping off its slowest annual growth in more than a quarter century.

 

The point is the trajectory of China's economy will significantly impact oil prices in 2015.

 

And in Europe, where policymakers are struggling with deflation, lower oil prices will only make the European Central Bank’s challenge harder as it loosens monetary policy to try to raise consumer prices. Venezuela, which relies on oil for 95 percent of its export revenue, risks insolvency.

 

The Harsh Reality

We are on the verge of a Brent crude oil price of $40 a barrel, and at this price and below it, producers are likely to shut-in enough output so that there is a significant reduction in global oil supply.

 

If Brent falls to $40—it’s now at $46—1.5 million barrels per day of global production would be losing money. Most of those money-losing operations would be in Canada, followed by the U.S. and then Colombia.  

 

 

Horizontal drilling and hydraulic fracturing in underground shale rock has boosted U.S output by 66 percent in the past five years, but U.S. shale oil production is very sensitive to prices, averaging close to $65 per barrel.

 

Unlike conventional oil production, shale oil operates with shorter lead times and minimal upfront capital outlays. Regardless, capital spending by the energy industry accounted for 33 percent of all capital spending, and American states where hydraulic fracturing, or “fracking,” is prevalent have accounted for the bulk of job growth in the nation.

 

 

 

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