How low can oil prices go?

Market insights

Tuesday 02 December 2014

Perspectives in oil prices and Australian equities

In recent weeks the oil price has fallen significantly. This brief note offers our perspectives on how this may impact Australian equity investors and petrol prices!

What were the events leading up to the significant fall?

This year we have seen two key things weigh on oil prices:

  1. Weakening demand
    At the beginning of the year, the market expected oil demand growth of 1.4% for the calendar year 2014. The market is now expecting growth of 0.8% for 2014. This is a negative for oil, but not material in isolation.
  2. Increased global supply
    Despite significant increases in geopolitical tensions including Russia / Ukraine and Iraq, physical supply has not been disrupted and has actually increased. Significant oil producer Libya has actually increased supply this year which has improved global supply by 0.8%.

A weakening supply/demand picture is usually balanced through actions of OPEC, a group of 12 countries who collectively control around 30% of oil production. Typically, if the market is oversupplied, Saudi Arabia and other members of OPEC would cut production to bring the market into balance.

What did OPEC say at their 27th November meeting?

OPEC announced they would not cut production at their meeting despite acknowledging an over supplied situation. Going in, expectations were mixed as to whether they would or wouldn't cut.

What sent the market into a tail spin was the commentary that surrounded the meeting:

"The market is oversupplied," said United Arab Emirates Energy Minister Suhail Al-Mazrouei. "But the oversupply is not from OPEC."

The commentary from senior oil ministers indicates OPEC will not act to balance the market. One step further, they are looking to non-OPEC supply to be cut from the market.

How low can oil go?

Oil projects are characterised by high upfront capital costs and very low ongoing operating costs. In order to have non-OPEC production shut down, prices around $70 / bbl or lower are possible in a short to medium term time frame. Who wins from lower oil prices?

  1. Companies with oil as a key cost input. For example, Qantas (airline), Amcor (packaging), Brambles (transport)
  2. US Economy – the US is the world's largest consumer of oil

At the pump

It's unlikely that petrol prices will be impacted in any meaningful way in the very short term, however if oil prices remain low over the medium term, we expect petrol prices at the pump will decline. 

The current volatility in oil prices highlights the importance of actively managing a portfolio of Australian equities.

This article is part of our From the desk series, featuring monthly insights from the Macquarie High Conviction Fund and the Macquarie Australian Small Companies Fund team members.

 

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This information has been prepared by Macquarie Investment Management Limited ABN 66 002 867 003, AFSL 237492 ("MIML"), the issuer of units in the Funds mentioned above and is current as at December 2014.The information in this email is provided for general information purposes only and does not take into account the investment objectives, financial situation or needs of any person. It should not be relied upon in determining whether to invest in a fund. In deciding whether to acquire or continue to hold an investment in a Fund, investors should consider the product disclosure statement. The product disclosure statement is available from MIML by phoning 1800 814 523. 

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* The majority of Australian oil producers sell oil linked to Brent (priced in the North Sea). Brent typically trades at a $5-15 premium to the often quoted WTI (priced in Cushing, Oklahoma). 

** Source: IRESS

*** Source: Energy Information Administration, Macquarie, 2014.

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