US oil prices (WTI) hit a five-year low and ended 2014 more than 45% – with the national average for regular gasoline at US pumps falling below $2.30 per gallon. The price of Brent crude oil, in euro terms, dropped 41.5% in the same period. US natural gas prices have been cut by almost 80% since early 2008.
In particular, the price of oil sharply plummeted toward year-end after OPEC opted not to cut its production despite falling global prices.
How low can oil go?
Our view is that oil should remain weak for some time. Just how low oil prices can go in part depends on the degree to which technological innovation continues to cut drilling breakeven costs. The problem with forecasting more precisely is that the perception of oil’s long-term price has become unmoored at the moment.
Falling global energy prices result from dramatically increased US oil and gas production due to the shale fracking revolution, falling US demand for oil, slowing growth outside the US, and the recent rise of the dollar.
Cheaper energy benefits consumers’ budgets and energy intensive manufacturers – and the US and global economies. But it challenges the stocks of energy producers and, particularly, energy service companies.
In 2014, energy was the lowest-performing sector within the S&P 500, trailing the overall index by 21.5 percentage points. Falling energy prices have also hurt emerging market energy-producing nations and the high yield bond market – 20% of which is made up of energy companies.
Investing in a bear market
Despite the commodity bear market, it is important to note stocks of certain energy producers performed fairly well during the last such downturn in the 1980s. Moreover, when the shale revolution began with natural gas drilling more than five years ago – earlier than with oil drilling – gas producers located on productive shale formations still delivered rising returns despite falling prices.
So last autumn, we refocused on the stocks of certain low-cost US shale oil producers at the expense of holdings in high-cost producers, energy services, and refiners. Some of these wells can still break even with a barrel of oil at $50 or below. Also, the strategy ended 2014 dramatically overweight certain beneficiaries of falling oil prices, including certain specialty chemical firms.