As the price of oil has fallen by as much as 60% over the past year, investors have fled the oil & gas sector, fearing collapsing profits, dividend cuts and corporate bankruptcies.
However, for long-term investors low oil prices are not the end of the world, they are just part of a multi-decade cycle. And there are four key reasons why a depressed oil price could be great news for long-term investors.
Not worth the effort
Oil costs money to find and extract, and if companies cannot make an attractive return on investment for their efforts, they’ll simply leave the oil in the ground.
This is already starting to happen. Around $200bn worth of oil projects were cancelled during the fourth quarter of last year. Analysts believe the final tally could top $1trn of projects cancelled.
And with new projects being put on hold, there’s a risk that the world could begin to underinvest in oil, which would reduce supply. At the same time, demand will pick up as low oil prices increase consumption.
Cyclical forces driven by rising demand and falling supply will push prices higher once again, possibly even to new highs over the long term. These market forces will take time to establish themselves.
Consolidation
Low oil prices are already having an effect on high-cost oil producers. Profits are collapsing, debts are rising and a high percentage of both small and medium-sized players are struggling to make ends meet.
As a result, larger players with less leverage can pick and choose the best acquisition targets and make a deal on their terms — great news for the shareholders of big oil.
For example, at the beginning of June oil giant Noble Energy acquired smaller peer Rosetta Resources for $3.9bn, only 12 months earlier Rosetta was worth three times as much.
Debt defaults
Six large US shale oil producers have gone to the wall so far this year. The largest bankruptcy was Sabine Oil & Gas, which listed $2.9bn of liabilities but only $2.5bn in assets.
These bankruptcies present a great opportunity for larger players with more robust balance sheets to buy up assets at rock-bottom prices. Only a year ago drillers in the US would be paying five or six times as much for land to drill on compared to the land acquired through bankruptcies. It is the traditional buy low, sell high model.
Once again, shareholders of the more fiscally prudent oil companies will benefit.
Business cycle
For the global economy, low oil prices are a godsend. Low oil prices lead to lower fuel prices, which, in turn pushed down the prices of goods and services. As a result, consumers have more discretionary income to spend, and economic growth picks up. Economic expansion is usually good for markets.
Estimates and figures vary, but some figures suggest that the low price of oil will boost consumer spending across the Eurozone by as much as 1% during 2015. In euro terms that’s around €14bn of new spending. Moreover, in the UK it has been suggested that the low oil price will lead to the creation of up to 90,000 new jobs.
So, while the oil industry struggles, other sectors are reaping the benefits. However, over the long term, as the supply of oil declines and demand continues to increase, oil prices should head higher once again. The long-term investor has nothing to worry about.