Frackers Now Pinched
Production has continued to increase on a combination of factors, including rising efficiencies and cost reductions. But currently, many U.S. frackers are pumping at a loss because they have debts to the tune of about $200 billion in total debt.
As it is impossible for U.S. frackers to refinance those debts while bleeding cash, the most leveraged of the companies are probably heading toward insolvency. At the same time, the more successful ones won’t be able to take them over because they will have neither the cash nor the investor confidence that would help them secure debt financing.
The insolvencies and lack of expansion will result in output cuts in North America, but the Saudis and the United Arab Emirates will be expected to just keep pumping. After all, don’t forget that these are countries, not businesses, and oil is their lifeblood. The takeaway is this: A wave of business bankruptcies in the U.S. shale industry realigns global production.
Is U.S. Expansion Threatened?
Lower oil prices remain a net benefit to oil-consuming countries like the U.S., but they are definitely a strain on net oil exporters. Lower prices make more money available for domestic consumption rather than sending it abroad and reducing the overall cost of goods.
But for the U.S., this overall beneficial macroeconomic effect is smaller than it was a decade ago because net imports of foreign oil have fallen.
For the world as a whole, the boost to demand from cheaper oil should outweigh the negatives.
The world economy continues to grow, albeit at an uneven pace. Lower oil prices will drag inflation below zero in many advanced economies. For the U.S., where the economy is stronger, a temporary period of deflation should boost household spending and, therefore, growth.
But for southern eurozone countries, persistent deflation will make it even harder to achieve a sustainable recovery.
The Impact Of Energy On The S&P 500 Since 1980
ETFs To Stay With
Some of the best years for the S&P 500 have come when energy stocks have actually underperformed. Two factors have contributed to this.
Energy is no longer as meaningful a part of the overall index—its sector weight has dropped by close to half from its 2007 peak and it now only represents about 8.4 percent of the S&P 500.
That makes it sixth out of the 10 sectors and, the energy sector’s contribution to S&P 500 earnings per share contribution in the S&P 500 has collapsed due to declining margin contribution, even as the total EPS of the S&P 500 has risen to record levels.
S&P 500 Energy Sector Weight Dec. 31, 2014: 8.4%
S&P Mid-Cap 400 Energy Sector Weight Dec. 31, 2014: 4.1%
S&P Small Cap 600 Energy Sector Weight Dec. 31, 2014: 3.5%
At the time this article was written, the author’s firm owned shares of SPY, MDY and IJR on behalf of some clients.