Daily : At The Moment News
12 January 2016
Equity markets were mixed overnight as the oil price plummeted (-5% to US$31 a barrel), dragging down
energy stock prices. Across our portfolios we currently hold no pure play energy stocks, and continue to
avoid the sector. In saying that, we are monitoring price moves for opportunities that are arising in the
current rout across commodity stocks. At the same time there are companies in Australasia which are clear beneficiaries of a lower oil prices, such as the airlines which are large users of fuel. As highlighted in today’s chart of the moment, one of these stocks is Air New Zealand which has performed well of late. In today’s daily we discuss our portfolio positioning and reiterate our outlook on oil.
Oil, How Low Can it Go?
Oil in Freefall
US Oil prices have fallen almost 74% since a June 2014 peak of $115 a barrel and are now at 12 year lows.
Oil prices are driven by supply and demand, and since 2014 supply has far outweighed demand. However,
in more recent times we believe the last leg of the oil price fall has been driven by panic in the market, with some commentators now predicting that the strengthening US dollar could send oil down to $20 a barrel.
Oil Outlook
The fall in oil has been driven primarily by over-supply, particularly as Organisation of Petroleum Exporting Countries (OPEC) refuses to reduce output and the US Shale gas boom continues to expand. The fall in the oil price has hit energy and resource companies hard, although over the medium term a lower oil price should encourage economic growth in our view. In saying that, further falls in the oil price would likely weigh on investor confidence and a key development to watch in 2016 will be whether the oil price can at least stabilise. OPEC looks set to stand its ground and is definitely not cutting back supply, so the rebalancing will have to be done by pushing smaller oil producers out of the market (as prices will be too low for them to run profitable businesses). Our view is that we will see some stabilisation, but a sharp recovery in oil remains unlikely in 2016.
Major Miners – We See Long Term Value
Iron Ore prices currently sit around US$42 a ton. Rio Tinto and BHP are the lowest cost producers in the
industry (given their size and scale), with estimated average costs of below AU$40 a ton. Higher cost
producers are beginning to fail, especially in china. This is good for the efficient producers as it reduces
competition and addresses the current supply/demand imbalances facing the resource sector. Further,
declines in the AUD are a positive for the Australian producers as it directly increases the amount they
receive for their Iron Ore. On a longer term basis the industry will become more efficient with less
competition and this will allow the likes of Rio and BHP to excel, in our view. As mentioned in yesterday’s daily we believe BHP looks particularly cheap to us at current levels.
Chart of the Moment:
Air New Zealand is a net buyer of oil, therefore as the price of oil declines AIR’s costs also decline which
translates into higher net profit for the company and evidently a higher share price. likes AIR for a
number of reasons and so far it has gained 26% since being added to our portfolio.
Five Things Markets Will be Watching this Week
1) Following a horrendous start to 2016 trading, will global equity markets reverse recent losses this
week.
2) The Oil price will remain a focus – investor concerns are shifting to the prospect of weaker energy
company profit results dragging on overall earnings.
3) China trade data will be released later in the week, and may drive further moves in China’s currency
(Yuan).
4) Australian employment data out on Thursday could provide an indication as to the effectiveness of
interest rate cuts.
5) German GDP released late in the week will provide an insight into how well the powerhouse of
Europe is faring.