28 October 2016
Consumers want to spend the money they save from gasoline on other products and services. Photo: Bloomberg
Consumers want to spend the money they save from gasoline on other products and services. Photo: Bloomberg

What opportunities low oil price brings

The price of benchmark Brent crude is at an 11-year low.

The global price of oil will remain under pressure in the short term amid a strong dollar. Oil prices are denominated in the US currency.

When the dollar strengthens, oil price usually decreases. In the past year, the dollar appreciated 12 percent, and since the uptrend is likely to continue, it will continue to weigh on the oil price.

The other major reason is the imbalance between oil demand and supply. Since last year, there has been an oversupply of oil in the world market, and the trend is expected to continue in 2016.

With higher inventory levels, the price will suffer. The recent oil price decline came after the Organization of the Petroleum Exporting Countries decided to maintain its oil output volume.

Energy stocks underperformed most of the time this year. December will not be an exception.

But a key factor is whether the energy companies’ scale and balance sheets are healthy. The big energy companies covered by S&P 500 have generally reported a better performance than their smaller peers, which are facing tighter liquidity.

Those with more diversified revenue sources and stable balance sheets also recorded a better performance.

As for bonds, the interest spread of US investment grade bonds in the energy sector has expanded. However, their expansion is not as fast as that of high-yield bonds in the sector.

This is because high-yield bond issuers have a higher leverage ratio and are usually smaller, with less diversified businesses, creating higher risk levels.

For the energy sector, low oil price is a reality. On the other hand, it reduces US consumers’ expenditure on gasoline.

The US consumer sector has remained stable during the year as retail sales have been growing, if not accelerating.

A recent report, based on a survey of 25 million credit card holders, showed that consumers want to spend the money they save from gasoline on other products and services. This will help some sectors such as e-commerce, restaurant and retail sales.

In 2016, the low oil price will prod consumers to spend more. Meanwhile, expected salary increases and further interest rate hikes will help speed up consumption next year.

We prefer equity and bond issuers with good fundamentals. Even while the oil price dropped 42 percent last year, those companies’ shares and bonds have been supported by their low debt levels, large scale, strong balance sheets and ample liquidity.

These factors will continue to help the firms through 2016.

This article appeared in the Hong Kong Economic Journal on Dec. 28.

Translation by Myssie You

[Chinese version中文版]

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Chief Asia Market Strategist at JP Morgan Funds

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