So Goes Oil….

« Back to Blog
Stock Market, Trends  |  January 31, 2016  |  

The daily directional moves in the the stock market have become very highly correlated to the price of oil.  The dramatic end to a commodity super cycle has captivated the market as the media and analysts wrestle with the ultimate impact of oil trading in the low $30’s and below.  This seems to be a classic commodity bust when the laws of economics will once again prevail.  The industry will contract and consolidation will be rampant as assets change hands and producers leave the market until price finds equilibrium with supply and demand.

Opportunity?  Yes.  Headline risk?  Massive.  Several prominent private equity firms have raised billions of dollars to capitalize on the carnage and are now predicting that as many as 400 companies could be bankrupt in the E&P sector.  Being first on the beach could be painful.  There will be opportunities but risks will be hEnergy Sector Leverageigh with the level of leverage in the sector.  This is the reason the stocks are trading at the levels they are today, for many companies that are dependent on the debt markets.  According to BCA Research, annual capex by oil & gas companies has more than doubled in real terms since 2000. However, a large chunk of the borrowed cash was funneled to shareholders, creating a highly-leveraged sector. Leverage was stable over this period for large U.S. energy companies, but soared for shale producers and EM energy companies.

 An important question will be if the problems in the energy sector will spill over into the broader economy.  There is precedent for this in our past energy bear markets but not in every commodity downturn.  One could argue that the high correlation of oil and the stock market may be predicting financial contagion or a recession in the United States.  So far, this does not look like the case but risks of recession are elevated.