Market Perspectives – December 2014

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Overview: While the S&P 500 sits near new highs, commodities (particularly oil prices) have fallen to multi-year lows. This month we attempt to explain the effects of the recent dramatic price movements in oil markets and how this may impact various interested parties.

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Where Are We Now…

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• The price for West Texas Intermediate (WTI Crude) oil is down more than 30% this year, with much of the decline coming in the past few months.

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Who Benefits from Lower Energy Prices?

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There are several groups which should benefit from lower energy prices: • Consumers will see extra cash in their pockets as the holiday season approaches. As recently

published by the Wall Street Journal, a quick rule of thumb is each one cent decline in the price of gasoline is worth approximately $1 billion in annual U.S. household consumption.

• Consumer discretionary companies should benefit from the additional cash consumers will likely have. Many retailers and restaurants should also benefit.

• Companies which rely on energy prices such as Airlines, and other transport-oriented companies.

• Manufacturing companies in general should benefit, but especially in the case of those which require oil and gas as a large input cost.

• Nations with big import needs such as China and Japan should see input costs decline.

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Where Could Lower Energy Prices Hurt?

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While not as obvious, there are several ways in which lower energy prices may harm the economy and certain groups: • Companies directly involved in the exploration and production of oil may have a tougher time

justifying their cost structure, particularly in certain areas with more expensive, difficult to reach wells (for example deep-water drilling). Our domestic fracking industry in particular and all of the companies and jobs that rely on continued growth may slow or grind to a halt with prolonged low prices. Even pipeline companies, which may not have direct commodity exposure, may see contracts renegotiated. The break-even per barrel oil price for producers varies widely, but the range is between $40-80 according to the consulting firm Turner Mason. A prolonged downturn could cause production to shut down or in some cases, bankruptcy. The Saudi’s still possess the lowest per barrel cost at less than $10 per barrel.

• Alternative energy companies, which in most cases have much higher costs (such as solar companies), will fight to stay competitive.

• Countries which produce large amounts of energy risk fiscal and/or political destabilization (for example Russia and certain parts of the Middle East). Some countries require a minimum oil price in order to maintain a balanced budget (according to Deutsche Bank, Saudi Arabia is thought to need oil prices at $93, Russia at $102 and Venezuela at $112 per barrel in order to achieve balanced budgets).

• Our view for some time has been that domestic natural resource production would reduce energy prices over the long term.

• Many pundits are now calling for oil prices to fall into the $50’s per barrel or lower (many of those same pundits called for prices in the $90’s or higher just a few months ago).

• While we do not know the future direction of oil prices, we prefer to invest in companies which benefit from lower prices rather than the producers or companies with direct commodity exposure.

• We expect supply will remain robust as the domestic energy renaissance continues.

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Where Do We Go from Here?

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Market Perspectives – December 2014

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Conclusion: We continue to limit exposure to companies with direct commodity exposure, instead favoring those which benefit from lower energy prices. We are closely monitoring the volatility for opportunistic situations.

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Opinions expressed in this commentary may change as conditions warrant and is for informational purposes only. Information contained herein is not intended to be personal investment advice for any specific person for any particular purpose. We utilize information sources that we believe to be reliable but cannot guarantee the accuracy of those sources. Past performance is no guarantee of future performance; investing involves risk and may result in loss of capital. Consider seeking advice from a professional before implementing any investing strategy.

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Disclaimer

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