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The opaque world of oil prices

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The opaque world of oil prices.

Oil prices have fallen sharply since late 2014 when they hovered around US$100 per barrel. In recent weeks they have dropped into the mid $20s, prompting some commentators to point out that the contents of a barrel of oil are now worth less than a third of the price of the actual steel drum that it comes in!

While the oil price has been sliding for some time, financial markets have only recently begun to attach any great significance to its impact on investment assets. Over the past six months there has been an increased sensitivity to oil gyrations with lower oil prices leading to a) declining share prices (because oil company earnings are adversely impacted), b) higher corporate bond rates (because heavily indebted energy companies are now more risky) and c) lower government bond rates (because inflation forecasts are now lower). The US dollar has also been stronger which is at odds with the historical relationship, possibly because the US shale revolution has left the US less dependent on foreign oil these days.

Stockpiles of oil remain high and the lifting of sanctions on Iran means there is little prospect of an adjustment to the supply situation. The International Energy Agency recently warned that "...the oil market could drown in oversupply".

With this backdrop, we can expect that weaker oil prices will continue to keep a lid on inflation and this could actually be positive for investment assets if it means that central banks can set interest rates lower than they otherwise would. At Fisher Funds we see the volatility in the oil price as a transfer of income from producers to consumers, and believe the positive effects on consumers will be larger than the negative effects on jobs in western economies.

Many of our companies are likely to benefit from lower costs as a result of these moves. Logistics companies such as portfolio holdings Freightways and Mainfreight are obvious examples. Also companies that benefit from improved disposable incomes, from the apparel companies in our international portfolios through to the food retailers in our Australian portfolios.

 

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