Lower Oil Prices: Winners and Losers

Posted by Brad McMillan, CFA, CAIA, MAI

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This entry was posted on Aug 18, 2014 3:49:00 PM

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oil pricesAs I wrote in my last post, oil prices have stayed lower for longer than many would have expected, and we may see prices drift lower still as supply continues to outpace demand.

Some of the effects of lower prices are obvious, but others aren’t. Let's take a look at who stands to benefit from continued low prices—and who may not fare so well. 

Who should be worried?

Big oil. One of the biggest casualties of a low-price world could be the major oil companies. After all, much of their value is based on the value of the oil they control that’s still in the ground. If oil prices go down, so does the value of their reserves.

The damage to their future prospects could be worse, as many current exploration sites are in high-cost areas that simply wouldn’t be economic at lower prices. This double whammy—to current values and future prospects—could hollow out existing companies very quickly.

Suppliers to the oil companies face a more immediate threat. At lower prices, reserves retain value, but lower exploration and development expenditures would be a direct hit to companies that specialize in those areas. A multiyear stretch of low prices could potentially reconfigure the entire energy sector.

Governments financed by oil. Another casualty might be governments supported by oil prices. Venezuela immediately comes to mind, especially given its support of other countries, such as Cuba. This group could also include Norway, Great Britain/Scotland to a lesser extent, and even Alaska, which is suffering from lower-cost extraction of oil in the continental U.S.

Russia, however, might face the greatest risk. The 1990s and 2000s saw a wave of collapses of authoritarian countries when the underlying economics grew too weak. The remaining countries survived largely due to their ability to finance themselves with oil or natural resource wealth. If that goes away, we might well see another wave of governmental collapses—hopefully to the benefit of their citizens.

Effects on the U.S.

In the “beware of what you wish for” category, lower oil prices could trigger a return to low-mileage cars—but with regulations now in place, that seems unlikely. Instead, lower prices across the board could help drive a transition to non-oil power sources, a trend we’re already seeing as more natural gas plants are built.

Ironically, this could also lead to the disintermediation of the utility companies. Smaller plants, a more intelligent grid, and growing use of alternative sources, like wind and solar, are already starting to destroy the economics of utilities in Japan and Germany. The U.S. is probably the next to go. Keep an eye on those utility investments.

Overall, a win

Despite all the potential losers, the overall effects of lower oil prices will be beneficial.

For the U.S. as a nation, lower energy prices should be an unalloyed good, something quite rare in economics. We are now a low-cost energy producer in many areas and will continue to grow our production. Meanwhile, every other sector of the economy will benefit from lower costs, not least the consumer. Higher gas prices cut directly into consumer spending, and lower ones will encourage it, supporting economic growth.

Unlike the past 30 years or so, during which time the U.S. has been in many ways the victim of the creative destruction of capitalism, the next 20 look likely to benefit us and the world as a whole. The energy renaissance should play a major role in that.

Upcoming Appearances

Tune in to Bloomberg Radio's Bloomberg Businessweek on Friday, February 28, at 3:45 P.M. ET to hear Brad talk about the market. Stream the show live at https://www.bloombergradio.com/, listen through SiriusXM 119, or download Bloomberg's app, Bloomberg Radio+.

Tune into Yahoo Finance's The Final Round on Thursday, March 12, between 2:50 and 4:00 P.M. ET to hear Brad talk about the market. Exact interview time will be updated once confirmed. Watch at finance.yahoo.com

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