The Oil Market in the Midst of a Solid Looking Crash

oil refinery resize medium

It’s been a while seen you’ve seen a good old fashioned crash. There was, of course, the Lehman induced panic of September 2008. Then you saw the gold market crack back in April and June of 2013.

But since then, it’s been pretty tame out there in financial asset la la land. Until now, that is. Now, you’re seeing the oil market in the midst of a pretty solid looking crash. The chart below shows the price of West Texas Intermediate crude oil. Since June, it’s cratered 40%.

Overnight, both West Texas and Brent crude slumped another 4% plus. Prices are now at their lowest level since 2009. This price crash has many implications for the global economy – some good, some bad. I’ll discuss a few of those in today’s Daily Reckoning.

Oil Price Light Crude Oil

The oil price crash has hit oil stocks hard lately. None more so than Santos [ASX:STO] who had to pull a European hybrid issue last week. Rating agency Standard and Poors followed this up yesterday with a downgrade to its credit rating.

Santos has a major equity stake in the Gladstone LNG project, the economics of which look very weak given the oil price outlook. That’s resulted in a sharp fall in expected earnings per share for the company for 2015.

In September, consensus earnings per share for STO were $1.03. Now, they’re just 62 cents. Still, the company isn’t cheap. It’s still trading on a price-to-earnings ratio of nearly 13 times, and my guess is that earnings expectations could continue to fall.

There will be a share price bounce at some stage, but I wouldn’t suggest bottom fishing for oil stocks in this environment. Crashes like this (isolated ones…not a part of a global credit crunch, for example) tend to signal a fundamental shift in the market.

Oil prices are likely to stay lower for longer than many people currently expect. That’s good for net oil importing countries and good for consumers. It’s probably a bit of both for Australia as we are a net energy exporter (a position set to grow in 2015 as the LNG projects ramp up), which means the price falls hurt us in the aggregate. But at the consumer level it will free up some income to spend on some useless imported gadget that does nothing for our productivity. J

The other thing to consider is the second round effects of sharply lower prices. Developments in the Middle East will be fascinating to watch should we settle in to a lower price environment in 2015.

That’s because the autocratic oil regimes need much higher oil prices to balance their budgets. To remain in power and pay off the ‘electorate’ (stop the masses from rioting), many regimes have blown out their welfare spending.

But they won’t be able to maintain such spending without high oil prices. Or, if they do, it will lead to budget deficits.

Because most of these oil producers have huge financial reserves (saved over the decades), they can probably afford to run deficits for a few years and run down their reserves to make up the difference.

Now, here’s the point: Most of these reserves are in the form of US Treasuries. That means additional selling could take place while the Federal Reserve is no longer buying.

The commodity price crash in general (not just oil) could continue to place pressure on emerging market nations and force them into selling off their reserves to stay afloat and protect their currencies from speculation.

If this selling gained any sort of momentum, it could prove a wildcard for the US Treasury market. You’re not seeing any problems there right now. That’s probably thanks to the Japanese who are no doubt soaking up any excess treasuries via their own money printing programs.

But as we progress further down the rabbit hole of monetary experimentation in 2015, something will have to give. I have no idea what it will be…but it’s worth keeping a look out for the unintended consequences of the oil price crash. Because there will be plenty.


Greg Canavan+
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Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.

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