As measured by the price of West Texas Intermediate (WTI), the price of oil plummeted approximately 31% from 6/20/14 through 11/13/14 and is down about 20% year over year through 11/21/14. Reasons for the sharp decline include lower than expected global economic growth, a growing oil supply mainly from non-OPEC producing countries including the U.S., and price competition within OPEC in both Asian and North American markets.
We believe that the U.S. is a net beneficiary of a lower oil price. Despite the recent unconventional oil boom in the U.S., the country still imported about 7.6 million barrels of crude oil per day in September 2014. With crude oil as the principal component in the cost of gasoline (other major costs include refining, distribution, retail markups, and taxes), it is not surprising to find that the price of gasoline is highly correlated to the price of crude oil. That said, there is typically a several week lag from the time a change in oil prices affects the price of gasoline at the pump. From 6/20/14 through 11/21/14, the AAA Daily National Average Gasoline Regular Unleaded Price fell over 20%.
The average U.S. household spends approximately 11% of its total discretionary spending on gasoline, so lower gas prices could provide consumers with extra cash to make other purchases. A 20% decline in gasoline prices equates to about $522 in annual savings to the average household. With over 125 million households in the U.S., this indicates the potential for about $66 billion of “extra” discretionary spending over the course of an entire year (assuming the savings rate does not change).
At Roosevelt, we do not attempt to forecast future fluctuations in the price of oil. But as investors, we do remain attuned to inflection points and respond accordingly. We believe the decline in oil prices has created a number of interesting opportunities for investment, and as stewards of our clients’ capital, we have attempted to take advantage of them. We still believe that the shale revolution in the U.S. will persist, as most drilling activity in the U.S. remains economic even at this lower oil price. However, while production should continue to grow, we would expect to see declining profits per barrel. To reflect this new reality, we exited certain oil exploration & production and oil services investments in order to pursue what we viewed as better risk/reward opportunities. We have maintained our infrastructure investments (i.e. pipelines) as we believe that these “toll roads” will continue to collect an attractive fee for their services.
We believe consumers’ extra spending power could translate into a nice tailwind for many industries in the consumer sector, including restaurants, apparel, and snack food & confectionary. In addition, as consumers tend to drive more when gasoline is less expensive, and therefore wear out car parts faster, we believe auto parts retailers could also benefit. Airline companies, whose largest expenses are jet fuel, are natural beneficiaries of a drop in the price of oil. Additionally, a number of natural gas companies were caught up in the broad energy sector selloff despite the fact that the majority of their revenues come from natural gas and natural gas liquids, where prices have not declined in sync with oil. These types of companies may now present compelling opportunities from a valuation perspective.
Since the price of oil began declining in late June, we have made select investments in these types of companies that stand to benefit from the price decline. We view these new investments as providing somewhat of a natural hedge against our energy investments, most of which would generally benefit from higher oil prices. More importantly, we believe these investments have attractive risk/reward characteristics for company-specific reasons, such as having increased pricing power or better than expected growth opportunities. Additionally, in our view, the stock market may not have properly priced in the impact of the price decline in oil.
We will monitor changes in the price of oil and continue to look for attractive risk-adjusted opportunities to preserve our clients’ purchasing power over the long term.
By: Lee Caleshu, CFA
This information is intended solely to report on investment strategies and opportunities identified by Roosevelt. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation to buy, hold or sell any financial instrument. References to specific securities and their issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Please contact us at 646-452-6700 if there is any change in your financial situation, needs, goals or objectives, or if you wish to initiate any restrictions on the management of the account or modify existing restrictions, or if you would like to request a copy of our Code of Ethics. Our current disclosure statement is set forth on our Form ADV Part II, available for your review upon request, and on our website, www.rooseveltinvestments.com.