Gas prices are continuing their free fall as global oil prices decline, reaching an average $1.70 per gallon nationally this month. Some industry experts say regions of the U.S. could even see gas for less than a dollar a gallon this year, as oil refiners look to offload winter-grade gasoline supplies ahead of the shift to cleaner-burning fuel for the spring.
Consumers continue to rack up savings each week at the pump, but what are the ramifications for the economy and energy companies? We asked experts to weigh in on the ramifications of the low prices, with four key questions that matter to investors.
Is crude oil nearing a bottom? West Texas Intermediate (ticker: WTI) crude oil futures slid in January to their lowest level since 2003, dropping to less than $27 per barrel after trading at more than $112 less than three years ago. Financial markets have a tendency to overshoot both on the upside and downside, especially when momentum is running hot, so don’t bet the house that a low for oil has formed. “Bear markets can always go lower than you think possible, especially in the short term. There really is no limit,” says Charles Sizemore, founder of Dallas-based Sizemore Capital Management.
Crude oil could see a key juncture now. “Although it’s still really volatile, it looks like oil is trying to form a bottom here in the $26.60 to $32.60 range,” says Colin Cieszynski, chief market strategist at CMC Markets in Toronto. “Failing to hold $30, however, indicates that the bears aren’t finished yet. If it fails, oil could head lower yet again. On a breakdown, $25 could be tested quickly or possibly even $20. It may take a drop below $20 for a final shakeout, but it probably wouldn’t stay there long. The final low price is anybody guess.”
Others agree that crude oil is vulnerable to another leg down. “We still think the massive inventories in the U.S. could bring down the price of benchmark West Texas Intermediate crude oil one more time in the next few months, possibly to the lower end of that $20 to $25 range,” says Elliott Gue, co-editor of Energy & Income Advisor in McLean, Virginia.
Do lower crude oil prices mean a recession is imminent? In the short term, lower oil remains a negative factor for the economy because of the loss of high-paying oil field jobs, Cieszynski says. “In time, the lower oil price should have a positive impact on consumer and business spending. The benefits take longer because it takes a while for people to believe low oil is here to stay for the next several years and not coming right back.”
Others warn that shaken sentiment could filter into overall consumer and business confidence. “The benefits to consumers are overstated. Yes, money saved at the gas pump means more money to spend. But stock market losses, property value losses and fear of recession or unemployment are just as likely to neutralize those benefits and even put them into reverse,” Sizemore says.
In the end, economists are quick to point out that it is high oil prices, not low, that tend to cause economic recessions in the U.S. While other factors could be at play weighing on U.S. growth, crude oil is not the likely culprit to cause a recession. “We’re in a slow period, but I don’t think a recession. Historically it’s been oil spikes that led to recessions, not oil crashes,” Cieszynski says.
What dynamics need to unfold to support a turnaround in crude oil? It all comes down to the simple economics of supply and demand. “You need one of two things: Either demand needs to rise substantially to suck up the excess supply, or supply needs to be curtailed. The former is unlikely this year with the world economy looking wobbly, but the latter is already starting to happen. It just hasn’t happened quickly enough to make much of a difference to prices,” Sizemore says.
The supply side of the market remains heavy. “Organizations need to stop adding supply and they need to take some supply offline,” says Kim Caughey Forrest, senior equity analyst at Fort Pitt Capital Group in Pittsburgh.
The imbalance may take some time to work through. “In the U.S., we’ve got shale oil and gas. You don’t really hear that much about the oversupply of gas, but it’s equally bad. What the market doesn’t fully understand about shale is that although drilling has been reduced, there are many wells that have been drilled that are ready to come online. The companies must sell product, even if it is less than the cost of production, to service the debt,” Caughey says.
Are their opportunities for energy investors? The energy industry remains vulnerable, and it is important for investors to pick spots carefully. “This move to a lower-for-longer environment isn’t going to be nearly fast or far enough to save a pretty large chunk of the energy industry,” Gue says. “This includes financially weaker midstream owners of pipelines as well as the more commodity price-sensitive producers and energy services firms. A lot of the North American energy industry was nurtured on $100 oil and simply isn’t going to make do on $40 to $60 oil.”
Gue and his co-editor Roger Conrad have been advising clients to build positions in energy companies that are positioned for the next phase of the cycle. “Our preferred method is placing buy limit orders at very low potential entry points that we’ve believed would only be reached under extreme conditions,” Gue says. “We’ve had a number of these positions executed this year — both producers and midstream companies, including recently EOG Resources (EOG) under $60 a share.
“This is precisely the kind of low-cost producer with a strong balance sheet that will thrive in the environment for energy we expect. EOG could get back to our entry point on another dip in oil. But we’re very happy to be in it at that price,” Gue says.
Being choosy and staying with best in class is an important guideline for energy investors in the current environment.
“We really like Enterprise Products Partners (EPD) at our dream buy price of $20. It’s not quite there yet. But it does yield well over 7 percent and can be counted on to grow its distribution 5 percent a year as long as this lower-for-longer price environment lasts. The balance sheet is strong, revenues are protected from weaker producers and midstream companies and the company can largely self-fund its growth, so it still has a reasonably low cost of capital,” Gue says.
Contrarian investors willing to take a risk can consider corporate energy bonds. “If you want to be a gun-slinging cowboy, consider buying up the bonds of exploration and production companies like Chesapeake Energy (CHK). It’s a high risk, but potentially very high-return trade if things turn around,” Sizemore says.
More conservative investors might want to look at midstream oil and gas transporters, Sizemore says. “Kinder Morgan (KMI) and Teekay (TK) both had to slash their dividends last year due to fears of getting locked out of the credit markets. The share prices are pretty well bombed out at this point and have little downside. But should things improve even slightly, you could double your money in a hurry.”
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Gas at $1 Per Gallon? Don’t Be Surprised originally appeared on usnews.com
