Market Buzz – TSX Continues to Get Punished by Lower Oil Prices

Posted by Ryan Irvine - KeyStone Financial

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The TSX Composite continues to get punished by lower oil prices with the market index down 4.7% for the week, now giving up nearly all of the gains generated since the start of the year. After inching above US$100 per barrel in June, the benchmark price for WTI has fallen 45% to end the week at less than US$58. 

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The current issues faced by crude are multi-dimensional (supply, demand and political) but the easiest piece to understand is supply. At a time when the global economic outlook is dreary, we have seen oil production increase, to which we can largely thank the shale oil boom in the United States. Unconventional, shale oil production which was barely a thought 5 years ago has virtually transformed the dynamics in the energy market of the United States.

 

Normally when we see oil prices fall at such a rapid pace OPEC (lead by Saudi Arabia) steps in and lowers production to bring the market back into equilibrium and stabilize prices. But that won’t be the case this time with OPEC announcing last week that they were maintaining production at 30 million barrels per day.

So what is going to happen with oil and what does that mean for investors?

The political drama in the oil market is complex but let’s make it simple. Saudi Arabia is the largest exporter of oil in the world and has a very low cost of production. The United States has burst onto the scene just in the last few years with the EIA (Energy Information Administration) predicting that they can be a net exporter of oil by 2020. But the ‘Achilles Heel’ of the U.S. is that most of this new oil they are bringing to market. Estimates are really all over the map, but generally speaking, the consensus seems to be that most of the shale oil production in the U.S. starts to become unprofitable at less than US$60 per barrel (which we are at now). So it makes perfect sense that Saudi Arabia doesn’t want to cut its production if all that is going to do is make their competitor’s product economical. With oil prices where they are we eventually expect to see higher cost producers curtail oil production which will reduce supply and bring the market back into equilibrium.

There is also another factor at play. Lower oil prices while a net negative for Canada is a net positive for most of the rest of the world. Regions like Europe and Asia, which have been struggling, should get a bit of a boost from the lower energy prices. More economic growth means higher energy demand which further helps to bring the market back into equilibrium.

It’s impossible to say how long all of this will take to play out (perhaps 12 to 24 months) or what the equilibrium price will be. Prices could certainly continue to weaken from here, in the short-term, as fundamentals fly out the window in the face of market fear. But eventually the forces will even out as they always do and the volatility will open up opportunity for investors who are willing to take advantage of it. 

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