Morningstar.com markets editor Jeremy Glaser talks to Matthew Coffina, editor of Morningstar’s StockInvestor newsletter. Below is an excerpt from the conversation which appeared on Morningstar.com, our sister site in the U.S.
On what has been the biggest driver in the slide in oil prices…..
It seems to be a combination of both supply and demand. So, certainly, the outlook for economic growth in much of the world has been weakening in recent months, particularly outside of the U.S. in Europe, China--and China really has some follow-on effects in other emerging markets. And then that has coincided with very robust supply, especially out of North America but also a return of production in Libya and surprisingly strong production in much of the Middle East.
So, the combination of strong supply and relatively weak demand has really hammered oil prices. As of right now, Brent crude oil is trading at about $67 a barrel, which is basically a 5-year low and down from $115 as recently as June of this year.
On whether this has caught him and the rest of the market off guard….
I think we were definitely taken by surprise in terms of the extent and the speed of the decline. I wouldn't say that this level of volatility is necessarily unusual or abnormal for commodity markets. In the last 5 years, the price of oil has ranged anywhere from $67 a barrel now to a high of about $128 a barrel. Over the past 10 years, the low was maybe $34 a barrel and the high was $144 a barrel. So, oil prices are very, very volatile and I think that's important for investors to keep in mind.
If you are going to be an investor in energy, you need to be willing and able to weather these kinds of disruptions that will happen from time to time.
The impact on companies…
It definitely has an impact on the intrinsic value of pretty much any energy company.
I think the most important thing that we've learned from this experience is that commodity prices are just very, very difficult to predict. Our analysts do their absolute best. It's necessary to come up with a long-run oil price forecast to be able to value energy companies. Right now, our long-run oil price forecast is still $100 a barrel, which is based on what we think is the marginal cost of production for the highest-cost resources--things like oil sands mining, ultra-deep water.
But that marginal cost is really a moving target. There is a very high degree of uncertainty, in my view, surrounding that $100 a barrel price forecast, and it could just as easily be $75 or $125. So, for example, if demand weakens, it could push some of these very high-cost sources of supply off of the supply curve altogether. Maybe you don't need oil sands mining or ultra-deep water to meet demand anymore, in which case they are no longer relevant to setting the price. Similarly, the price of oilfield services and equipment: As companies pull back on their capital expenditures, the price of equipment tends to go down, labour becomes more easily available, and all of that can weigh on marginal costs.
So, there's a very high degree of uncertainty surrounding future commodity prices.
In The impact of falling oil prices, Patricia Oey, Senior Manager Research Analyst, Morningstar, explained why she feels India is an unusual play on falling oil prices.
India has been one of the best-performing markets in 2014 on both domestic and foreign investors' optimism that the new prime minister is going to foster more business-friendly reforms. The MSCI India Index is up about 25%. So, it may seem right now is not the best time to invest in India, but there is a catalyst that may help sustain the current rally--and that is falling oil prices.
Historically, India has had a hard time. They have a lot of fuel subsidies they pay out to their citizens, and they've had a hard time cutting these subsidies. And these subsidies have weighted on the fiscal deficit, they've hindered the country's ability to invest in infrastructure, and also impacted the country's credit ratings. But with falling oil prices, the prime minister saw an opportunity to cut the fuel subsidy at a time when it won't have such a large impact on the end consumer.
And falling oil prices also have a lot of positive knock-on effects on the Indian economy. India imports about 70% of its oil needs, so with falling oil prices we're seeing less pressure on the country's current account, we're seeing inflation fall, and this may prompt the Indian central bank to cut interest rates a little earlier than expected. So, we're seeing consumers more confident with more cash in their pockets. These improving macroeconomic trends combined with Modi's ambitious reform program might create a virtuous cycle and help set the stage for India's long-awaited next phase of growth.
