The past year has been seen oil prices drop to below $50 per barrel. But now that prices seem to be stabilizing, a number of new trends and investment opportunities emerge.
After a wild year in which NYMEX oil prices fell below $50, and are still 30% below the price from this time last year, oil is finally emerging from its death throes. Although when markets look ahead they still see contango – a situation where futures prices are higher than spot prices for a commodity – few observers see $100/barrel oil on the horizon.
Of course, there are as many opinions on oil prices as barrels of oil left in the ground. Saudi Arabian officials believe prices are on the way up now that they think their war of attrition against US shale oil producers has been won. On the demand side, China and Europe’s oil demand appears to be lagging, and may keep oil prices depressed for some time.
Regardless, prices have rebounded from their trough and volatility has declined from its peak in February. In a way, oil has fallen into a sweet spot where it can be called cheap, but is now expensive enough that it is not an immediate nonstarter for investors. Here are a few of the opportunities that are made possible from this situation:
Crucial to the development of commercially-viable renewable energy is the financial incentive to switch from fossil fuels to alternatives. While oil prices were falling through support after support, so were clean energy equities.
Now that oil has rallied nearly 30% from its lows in March, not only has market aversion to renewables waned, but the value proposition of renewables has substantially improved as well. Even if oil is still cheap, its euphoria has worn off.
The same realities of climate change and peak oil are present, meaning the renewable energy and energy conservation will still be a necessity—especially as India, China, and Southeast Asia ramp up energy usage.
Recovery of US Fracking
Low oil prices were mainly a phenomenon brought on by US fracking, and ironically almost became the industry’s downfall. At the trough of sub-$50 oil, Texas-based Quicksilver Resources, which mainly drills shale oil & gas, filed for bankruptcy.
In the longer-run, the break-even price of US shale oil fields falls between $40-$200. The Bakken oil field, for instance, is about $70. The closer oil is to that price, the safer the industry is, especially as drilling technology throttles ahead.
The average well’s productivity has risen by one-third over the last year, as companies have lowered the number of rigs drilling while maintaining production. Innovations like using different grades of sand to frack and varying well depths has allowed producers to turn wells profitable again. As prices rise, even more wells will be profitable again.
Nearly 20% of US high-yield corporate bonds are issued by energy companies. Therefore the movement of oil prices, and the corresponding changes in energy companies’ leverage ratio, had a significant impact on the high-yield market.
Now that prices have stabilized, high-yield bonds look less risky than when the worry of bankruptcies hit a few months ago. Markets agree: the spread on high-yield bonds has fallen 119 basis points since December.
Of course, concerns over bond liquidity may end up trumping any relief from stabilization of oil prices, but fixed income investors will at least have one fewer concern.
Diversification in Oil Economies—with a bit of breathing room
Not far behind are Russia, Nigeria, and Brazil—although each of these countries’ unstable political spheres has worsened the impact. As prices rise again, none of these countries will yet be able to balance their government budgets, but they will be less hard-pressed to satisfy their immediate funding needs.
There is an urge to welcome a situation where reforms are forced by excruciating circumstances, a baptism by fire of sorts. But the chaos that ensues from these situations can set a country back for decades. The recovery of oil allows the countries most dependent on it to make more incremental reforms.