Oil marches toward US$40

There is no escaping crude’s effect on global markets. A fresh five-and-a-half-year low in both West Texas Intermediate (WTI) and Brent now see the oil prices well below US$50 barrel as it marches towards the expected support level of US$40 a barrel.

Oil
Source: Bloomberg

Trading over the past two weeks on the back of the crude story has seen the S&P register its first five-day decline since 2013. On an intraday basis the 5% declines in crude on January 5, 6 and last night coincided with 1% to 1.8% declines on the S&P.

The immediate effects of the oil rout are being laid bare - US oil production has hit a three-decade high. OPEC continues to fight against cuts to production and European and Asian demand remains unmoved by the lower prices.

The crude stats of crude

  1. Qatar believes global production is creating a glut of 2 million barrels a day.
  2. Venezuelan President Nicolas Maduro is now in Iran to discuss OPEC’s response to the oil crisis. He believes oil needs to return to $100 a barrel to return to ‘economic equilibrium’, something Saudi Arabia and other Gulf nations are resisting.
  3. The caveat here is Venezuela was unable to fully renegotiate its loans with China over the weekend. President Maduro announced that it won’t be repaying its current loans from China, meaning Venezuela has technically defaulted. Yet the country would still look to China for further debt in the future.
  4. The pressure on Russia’s economy is still yet to be fully seen. USD/RUB has declined 43.6% since the June high in oil. This, plus the economic sanctions and the collapse in the oil price have created a triple front on the Russia economy. Previously, the Russian finance minister estimated the sanctions and collapsing oil price combined were costing Russia between US$140 and US$150 billion a year at the time oil was $67 a barrel. The true effects will erupt sometime in 2015.
  5. Goldman Sachs and Société Généale have both shifted their estimates around oil. Goldman Sachs have slashed 2015 estimates by 23% to US$58 a barrel by year end and sees WTI at $40.50 come the end of the second quarter.

Volatility and positive impacts

This will see first-half volatility ramping up throughout the globe. The S&P has tested the three-year uptrend three times over the past four months and, with the Greek elections, credit spreads, wage disinflation, ECB quantitative easing and global growth looking soft, volatility is certain if the uptrend is broken. I’d recommend being nimble with your positions.

However, the second half of the year is likely to see a positive impact from the crude story as net importers of energy will benefit from the current situation. The fall in crude is a form of stimulus, and China, India, Europe and Japan are net importers of oil.

The low price will significantly improve corporate operations and positively impact consumer confidence from the savings created. There is a silver lining coming from oil here – it will simply take some time to materialise.

Ahead of the Australian open

We are calling the ASX down 32 points to 5390 as the energy drag continues to limit the ASX’s rise. Like in 2014, high-yielding players are going to benefit from the flight to safety and bond yields should fall to mid-2012 levels.

With the exception of the US, the major central banks are unlikely to move rates higher in 2015. If inflation falls due to the drop in oil, the prospect of rate cuts will only add to the yield trade once more. 2015 could see the fourth consecutive year of investors seeking high-yielding shares as monetary policy once again forces their hands into this space.

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