The impact of cheap oil

There are long-term implications from the current cheaper oil environment. This is part four of a Super Review asset allocation roundtable.

Mike Taylor, managing editor, Super Review: So energy, we talked a little bit about it before, but in terms of the rate at which the Saudis and others are pumping out as much as they can at the moment and doing what they can in their usual attempts to make the market work the way they want, but should global bond investors take into account a potential energy shakeout from a portfolio construction perspective? And I know Chris has actually got a view on that, so I'll go straight to Chris.

Chris Diaz, head of global rates and portfolio manager, Janus Capital: Yeah, so I would think about it really in three ways. Currency and core rates, and then in the corporate bond market. So in currency, particularly in the G10 space for those countries that are reliant on the exportation of commodities, oil in particularly, I think that those are to be avoided or at least be cautious. Those are currencies like Canada, Norway and then down to maybe other commodity exporters. Maybe not oil, but certainly would include New Zealand and Australia in that space.

From a core rates standpoint that blankly exacerbates this notion of central bank differentiation that we've been discussing, so not only does it put downward pressure on the growth of these economies, it's also likely to lower inflation which is going to give central banks in these countries more room, more flexibility to actually lower rates and, as Greg mentioned earlier, what we saw with a cut in rates in Canada and so you would expect that owning interest rate risk in countries that have easing biases are likely a safer place to be as opposed to maybe a country like the US where it appears the Fed will be raising rates.

The final point I would make is [that] there is a significant amount or a material amount of corporate bond issuance that comes from energy related companies. It is our view that a number of these companies that are in the higher risk company, high yield, will face significant pressures and frankly may not survive if oil continues to hover around these prices. So our view has been to reduce or eliminate really the higher risk companies that are levered to the energy sector, and really replace with higher quality companies that to some extent may have been painted with a broad brush of just being in the energy sector, and companies that we feel have the balance sheet and the resources to weather a low commodity price storm.

Justine O'Connell, consultant, Frontier Investment Advisers: Well we've looked at this, the oil price from I guess a number of different perspectives. Initially when it happened we looked at it from a, what does it mean for the broader economy and our analysis was that it really was more demand driven than supply driven. So it was overall probably going to be positive for growth. To the extent that we've seen that I think is still uncertain and unclear. I don't think we've clearly seen that. But in terms of say a bond or fixed income perspective what we've thought about is [whether] there [is] an opportunity for investors in terms of this price impact particularly on oil. And initially we looked at would it make sense to look at some of the high yield exposures.

A lot of the companies, a lot of people thought there might be opportunity in terms of high yield within the energy sector. We had a look at that and we just felt that there was a lot of E&P exposure and a lot of uncertainty around the timing of the oil price recovery. And that was the main issue for us just given a number of the companies [that] have pretty high cost requirements and at that point in time have hedging only really out sort of a 12 month period.

In our view that's not really an opportunity at this point. We also looked at emerging market debt, was there an opportunity in some of the oil exposed. Countries, specifically say Russia, Ukraine, Venezuela. And our view was sort of similar I guess in terms of if you have an active emerging market debt manager then that makes sense from an opportunistic basis, but as a sort of standalone beta opportunity we didn't think that necessarily there was enough certainty around the oil price recover timing and also a lot of geopolitical risks are there.

The other thing that we're looking at I guess now is from more of an e-liquid distress debt type of opportunity and looking at are there managers within the energy sector, particularly I think in the US where there's been a huge amount of development there or a number of different strategies that are looking at kind of balance sheet restructure strategies, is there an opportunity there. Our initial view is we're kind of working through that, but a lot of it will be sort of medium term opportunity and there's still that sort of uncertainty in terms of the oil price recovery and also the additional step we really need. It's a very specialised area and you really need an energy specialist. So we're still working through that but they're sort of from a portfolio perspective, how we thought about oil more broadly, and then in terms of are there opportunities in the debt spectrum over I guess the last sort of 12 months.

Greg Michel, senior consultant, JANA: It's a very good question. The way I look at this is to go back to the basic winners and losers. Looking at the oil producers and the consumers, at the personal level, at the company level and also at the country level. On the whole, the view is that the fall in the oil price has been a positive for global growth. The fall in the oil price largely represents, at least in the hands of the consumers out there something akin to a global tax cut.

The question is whether or not the consumers spend it or choose to save the windfall. But anyway in a broad sense, I see it as being a positive. However, when you look more closely at the impact and start to look at the country effect, the impact is much more complex and diverse. You need to look across the countries and the relative importance of oil as a source of export income. It potentially has a diverse impact in the emerging market space depending on whether they are oil importers or exporters. There are countries there which are heavily reliant on a much higher oil price than the current low price to help balance their current account or even get close to doing that.

It is too early to see the full impact of the current low oil price on the oil export reliant economies, but if the price stays at around these new low levels it is clear that revenues will be falling sharply and this will have implications for the relative performance of these economies. So this is where it is good to have active investment managers who can look to position investment risk accordingly. If you look at some of the larger economies or economic blocs such as Japan and the Eurozone, the fall in the oil price is unambiguously positive, because these economies are large net importers of oil so a lower oil price has got to be a positive.

In the US, the economic impact is more complex. While the lower oil price is good news for consumers at the bowser at the same time the US has a large oil producing and exporting sector which has been expanding in recent years. More recently there has there has been significant investment in this sector and employment growth. A sharp drop in oil revenues from a lower oil price will most likely result in a contraction of investment with some negative implications for the broader economic outlook. The oil producing companies most at risk are those most heavily levered and with the highest cost of production. In terms of investment market impacts, we have already seen increased volatility within the high yield space where many of the smaller US oil exploration and production companies source funding.

In terms of the fallout, in terms of the companies actually defaulting, a lot of those companies have hedging positions in place which were discussed so it's unclear at this stage what the lasting impact will be because it depends on a lot of factors. It depends on how long the hedging will remain in place, it also depends on whether or not we see any sort of recovery in the oil price over the course of the next six months or so. It also depends on how successful companies are at adapting their operating costs and production in the face of a lower oil price.  So it is not good news for the oil producers but there are winners in the corporate space as well. A good example is the airline industry which is a huge consumer of oil products and we have all seen how QANTAS has rebounded recently.  

Stephen van Eyk, investment consultant: Well I certainly agree with that. I've been expecting low growth for longer. So I wasn't expecting the oil price to bounce back any time soon and therefore you're left with really differentiating at a country level. I guess I've concentrated on those that are going to really get a benefit from the lower oil price and tried to invest there. But there are complexities involved, whether some countries actually covered themselves or whether they didn't cover themselves and all that sort of stuff. But yeah, there's been a few opportunities because it's giving some companies and countries far lower costs and therefore profitability's higher and therefore dividends keep going. So there's been a few opportunities. I've mainly looked at it from that positive perspective.




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