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Low Oil Prices Benefit at the Pump and in the Market

Commodities / Credit Crisis 2015 Jan 12, 2015 - 12:49 PM GMT

By: Money_Morning

Commodities

Peter Krauth writes: Low oil prices is certainly one of the biggest stories of the past six months.

Indeed, as the price of crude continues to drop, currently hovering just under a once-unthinkable $50 per barrel price, the issue is sure to be in the news well into the foreseeable future.


But the issue goes beyond simply lower prices, and it spawns some even bigger questions:

Are supply and demand really the drivers at work? Is it political warfare above all? How will global markets react when prices rebound?

One way or another, the implications of much lower oil prices are huge, and will impact markets, industries, and sectors across the board throughout the coming year.

All of which leaves investors wondering what to do next, and how to play this changing-by-the-day industry.

There's no time like the present to take a look at the potential pitfalls, and the emerging opportunities, that this disruption brings… and to let you know about a medium-risk way to play it for near-term profits.

The Benefits of Cheaper Oil

Light sweet crude oil prices recently dropped below $50. The last time oil was this cheap happened in the spring of 2009, after the stock market panic of late 2008.

Without a doubt, a surge in supply from North American shale production has boosted supply.  On the flip side, global demand has weakened thanks to a feeble world economy, and the continued progress in global energy efficiency.

The Saudis are selling their oil at a fixed spread (discount) from benchmarks for a number of reasons. Most obvious is to maintain market share, but such low prices also hurt the highest cost producers, like the shale plays. The Saudis are forcing a lot of that supply to come offline, allowing them to step in and fill the void.

It's no doubt by design, too, that low prices hurt other high cost producers, like Iran – a long-time Saudi nemesis, and Russia – particularly out of favor with the West right now.

Politics are a big motivating factor, and as we examined in November, it was a successful strategy in the past.

In the near term, what this means for us consumers is cheaper gasoline, which has hardly gone unnoticed. But it also means cheaper fuel of other types, like natural gas and oil for home heating, as well as jet fuel for airplanes.

The biggest beneficiaries may end up being those in lower income brackets. RBC Capital Markets estimates the average American household will save some $42/month on gas this year should prices stay at these levels.

Deutsche Bank chief U.S. economist Joe LaVorgna thinks restaurants and retailers will benefit most, as these consumers decide to spend the windfall rather than save it.

The Downside That Comes Along

We can't, however, ignore the downside of lower oil. And it has clearly started to manifest itself.

The highest cost production is the first tranche to get severely curtailed. Shale oil patch former darling Oasis Petroleum Inc.'s (NYSE: OAS) recent guidance for 2015 is an alarming sign.

OAS is down over 70% in the last 6 months. The company will spend $750 million to $850 million this year on drilling wells and production setups. That's half of 2014's $1.43 billion spend, and management forecasts production to rise just 5% to 10% this year, after clocking 50% in its recent past.

Oasis won't be alone either.

Projects will get mothballed or even outright cancelled. Already, Excelerate Energy's Texan LNG gas terminal, an 8 million tonne per year export plant, has been officially suspended.

Let's also not forget that, although on a localized basis, thousands of high-paying oil patch jobs will simply evaporate. It also means a lot of future investments will, at best, face meaningful delays. That's money not making its way into the economy, balancing out the positives of lower fuel costs.

Another consequence is lower tax revenues into government coffers, which could lead to bigger deficits.

Also, turning the oil taps back on after curtailing production is not easy, cheap, or fast. People have to be rehired, and in some cases permits obtained. Supply may simply not be able to respond that quickly to a return in demand.

And there is at least one more piece to this global puzzle…

This Factor Will Remain Uncertain

Remember the Arab spring that began in Tunisia and worked its way through much of Northern Africa and the Middle East?

Amongst the countries affected were significant oil producers like Saudi Arabia, Algeria, Iraq, Libya, and Kuwait.

Many of these, plus Venezuela, Nigeria, and Russia rely heavily on oil revenues to subsidize their social programs and in some cases even the prices of staple consumer products.

In most of these cases, the oil industry is either completely or heavily nationalized. So profits go straight to government coffers. These countries have few choices: spend from reserves (if any) to maintain subsidies, borrow further on international markets, or reduce subsidies (not particularly popular with the populace).

But in some instances, like Venezuela, it's already led to repeated unrest. Russia's hurting pretty badly, and could be next to experience internal strife.

An unintended consequence of such conflicts puts still more oil production at risk, making future ramp-ups in output even more uncertain.

Even if only some of this comes to bear, we could well be looking at a violent rise in oil prices as early as the second half of this year.

All in all, the picture is, at best, muddled and uncertain. But we can certainly set ourselves up for profit in spite of the difficulties…

Your Profit Opportunity Is Ready

In the near to medium term, oil prices are likely to stay low and move sideways, or perhaps move even lower first.

One thing the shale boom has meant is abundant and cheap natural gas. Low oil is likely to keep it that way for a while yet. So the industrial renaissance in North America of the last few years should carry on with hardly a dent.

E.I. du Pont de Nemours and Company (aka DuPont) (NYSE: DD) is a global conglomerate that's active in agriculture and nutrition, bio-based industrials, and advanced materials.

More specifically, this means innovative products in things like agricultural chemicals, biofuels, biomaterials, advanced polymers, and protective and electronic materials.

The company has been a major innovator, and that's added more than $10 billion of revenue in 2013 from products that were introduced in the past four years alone.

Many of these products require oil and natural gas as inputs, either as energy for processing or as raw materials, which is why I especially like the company's prospects in the near and mid-term. With sustained low oil and natural gas prices over the last couple of quarters and likely for several more, profits should handsomely beat expectations.

Although shares are up 60% in the last two years, they've also been robust over the last couple of quarters, outpacing the S&P 500 by 10%. Earnings jumped 52% in Q3 on lower expenses. With a forward P/E of 16.5, current yield at 2.7%, and return on equity of 20.9%, this is a solid play on lower energy prices.

Stay mindful that that a strong and sustained rise in oil and natural gas prices could become a headwind, so use a trailing stop on this idea.

As we work through the current oversupply in oil and natural gas, remember that markets work over time and prices will rise again. People and industry will adjust, and consumers will increase consumption to take advantage.

My advice is to enjoy cheap fuel costs while they last.

Source : http://moneymorning.com/2015/01/12/benefit-at-the-pump-and-in-the-market-from-low-oil-prices/

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