Financial markets are fixated on the shocking and largely unanticipated collapse in global oil prices. After peaking near $107 per barrel in June, U.S. crude oil prices began a steady descent that has gained increasing momentum in recent weeks. Recently, the spot price for U.S. crude oil fell below $58 – down 46% from its peak in June. While initially viewed as a positive for the U.S. economy, equity markets have grown quite jittery as the price of oil has continued to plummet, raising fears about a sharp slowdown in global economic growth.

As oil began its mid-summer descent, most analysts were citing the increased global supply brought on by the shale oil revolution in the U.S. as the primary cause. The U.S. is producing about 8.5 million barrels of oil per day, up about one million from a year ago, and nearly double the production seen as recently as 2008. With prices falling, OPEC’s recent decision to maintain production at current levels in spite of this new supply was a shock to the markets, and led to another sharp price drop. OPEC’s stance is viewed by some as an effort to force higher cost producers (such as certain U.S. shale oil and Canadian tar sands developers) out of business, and to put additional economic pressure on energy producers such as Russia and Iran. Despite the lower prices, the U.S. Energy Department predicts that American oil production will increase by an additional 700,000 barrels per day in 2015.

On the demand side, markets have been spooked by cuts in forecasted global energy demand by various entities, including OPEC itself. While global demand is still expected to rise in 2015 from the current level of about 93 million barrels per day, the cuts underscore the weak global growth outlook for many energy consuming nations, despite the sharp fall in prices.

If oil remains in the $50-$60 range, significant pain will be experienced by many energy producers and related entities. Yields on lower-rated bonds issued by some energy companies have soared to near 20% as investors anticipate a surge in defaults in the coming years. Companies are announcing dramatic cuts to their capital expenditure budgets for next year and are planning for layoffs. Energy stocks, particularly those engaged in oil exploration and production, have been clobbered. Big oil-producing countries such as Russia, Venezuela, and Nigeria are likely to experience significant budget cuts, currency weakness, and soaring inflation.

Nonetheless, we continue to believe that lower energy prices are, on balance, a strong positive for the U.S. economy. Motorists on average are paying more than a dollar less per gallon for regular gas than they were back in April, resulting in savings averaging more than $1,000 per U.S. family. Energy-intensive industries, such as chemicals, mining, and airlines, are likely to experience significant declines in input costs. And despite the shale oil revolution, the U.S. is still a large net importer of oil, so the price declines are a net benefit. Economists forecast that the decline in energy costs could boost U.S. real GDP by 0.4% to 0.8% in 2015.

If the collapse in oil is foreshadowing a recession ahead, equity markets will be in for a rough ride. However, falling commodity prices have generally been bullish for stocks. In the four cases since 1970 when the major commodity index fell by more than 20% and was not associated with recessions, the S&P 500 was up on average by more than 20% in the subsequent 12 months. To our eyes, the U.S. economy looks stronger than it has been for five years.

Investment and Insurance Products: 
• Are Not insured by the FDIC or any other federal government agency 
• Are Not deposits of or guaranteed by a Bank or any Bank Affiliate 
• May Lose Value

 

The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. This presentation is not an offer to buy or sell, or a solicitation of any offer to buy or sell any of the securities mentioned herein.

Certain statements contained herein may constitute projections, forecasts, and other forward-looking statements. Certain information has been provided by third-party sources and, although believed to be reliable, it has not been independently verified and its accuracy or completeness cannot be guaranteed.

Any opinions, projections, forecasts, and forward-looking statements presented herein are valid as on the date of this document and are subject to change.

This material is available to advisory and sub-advised clients of City National Rochdale, LLC, a Registered Investment Advisor and a wholly owned subsidiary of City National Bank.