Demand still robustAlthough we are currently producing a little more than we are consuming on a worldwide level, each year the level of oil production needs to be supplemented with new discoveries. Next year the world needs to find approximately 4.5 million bbl per day just to stay even with demand, according to my research. Any improvement in the world economy will increase the daily consumption. So new exploration cannot slow down, though a prolonged period of low prices will slow current exploration.
Russia In my opinion, most OPEC members require much higher prices in order to support their economies. Their national budgets are dependent on higher prices for oil. Russia is also in dire straits at this price level. The Russian economy has slipped into a recession and needs foreign reserves to move the economy forward.
Winners and losers But as the saying goes, "For every action there is a reaction." Even though some marginal producers will be hurt, the large reduction in the price of refined products is a huge positive to consumers. There are other positive factors as well related to the world economy. Central Banks around the world are adding stimulus into their economies. China surprised the markets by reducing its benchmark lending rate for the first time in over two years. Mario Draghi spoke of future increases in liquidity by the European Central Bank. The Bank of Japan also increased their bond purchases.
However the best news is that the US economy is growing at a faster rate than first thought.Third-quarter GDP growth, originally estimated at 3.5%, was up revised up to 5% by the Commerce Department. Job growth and consumer spendings are robust.
Oil dividend Manufacturing in the US is benefiting greatly from lower energy cost. U.S. refineries are running at over 93% of capacity, which is very good for 40-year-old refineries. At the same time, storage levels of gasoline, diesel, and heating oil fell are in the lower half of the five year average range. That's why, in my opinion, the drop in oil prices may be followed by a V-shaped rebound. For now, lower prices are a boon to the chemical industry. My favorites in the industry remain Westlake Chemicals (WLK) and LyondellBasell (LYB). Both are in expansion mode and the lower energy costs will boost profits in my opinion.
Midstream players The midstream sector, companies deriving income from fee-based revenue through their pipelines and natural liquid gas (NGL) processing, are shielded from price swings in hydrocarbons. One of these is Enterprise Products Partners (EPD). Volumes through their fee-based pipelines, processing plants, NGL fractionators, and condensate processors are running at all time highs. EPD is currently operating on all cylinders and has plans of spending billions on new capacity. In my opinion, this expansion of capacity and their very low cost of capital should enable EPD to continue increasing their annual distributions by approximately 6% each year for the next several years. Meanwhile, Kinder Morgan (KMI) has completed its acquisition of all their MLP units and now is operating as a C Corporation. They are also adding capacity to take advantage of this surge.
ShaleElsewhere, I continue to see increased output from producers in the Bakken and Eagle Ford shale and the Permian Basin.
The income of shale-focused companies was assumed to have fallen with the reduction in oil prices. Investors have sold off the stocks of such companies.In my opinion, such market sentiment is off the mark. The better-managed companies have a large percentage of their production hedged both for 2015, and even into 2016, and may not take an earnings hit. Several names I continue to hold in our Covestor BSG&L Financial portfolios include: Continental Resources (CLR), EOG Resources (EOG), and Linn Energy (LINE). We also hold positions in large-cap industrials such as Emerson Electric (EMR), Honeywell International (HON) and United Technology (UTX) and will consider adding to these holdings at some point in the future.
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Photo credit: Kool Cats Photography via Flickr Creative Commons DISCLAIMER: The investments discussed are held in client accounts as of November 30, 2014. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable. Past performance is no guarantee of future results.
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