Elliott Gue correctly forecast the recent decline in oil price and now updates us on his short- and long-term outlook. The editor of Energy & Income Advisor also walks us through some favorite sectors and stocks that benefit from the current low oil price environment.
Steven Halpern: Joining us today is energy sector expert, Elliott Gue, editor of Energy & Income Advisor. How are you doing today, Elliott?
Elliott Gue: Great! Thank you very much for having...for talking to me today.
Steven Halpern: Well, thank you for joining us. When we last spoke, it was the beginning of June and oil was rising, and at the time, you forecast that prices above $60 were unsustainable and you warned of a pullback to the prior lows. Well, we’ve now seen that happen exactly as you suggested, so the question is what happens now?
Elliott Gue: Well, I think that oil prices could bounce a little bit in the short-term simply because the market’s very bearish on oil right now. I mean, I’m looking at the Commitment of Traders Report that’s released by the Commodity Futures Trading Commission on a weekly basis.
Speculators or hedge funds are short something like 163 million barrels of oil and the futures market, which is very close to a record high, so that opens opportunity for a very short-term, short-covering rally or sort of an oversold bounce, but longer-term, I think that the picture is pretty grim.
I think that we’re going to see oil prices at some point this fall, or early next year in 2016, reach to $30 a barrel or lower, and more importantly, I think that we’re in what I call a lower for longer situation.
I think that oil prices are destined to remain in the $40 to $60 a barrel range for at least the next 12 to 18 months because that’s what it’s going to take to get supply and demand back into balance. Right now, the global oil market is about 300 million barrels a day oversupplied. It’s the large glut that we’ve seen in many years and it’s going to take time to resolve that.
Steven Halpern: Now, as you point out, supply and demand is the critical issue here. You highlight that the decline in oil prices is really driven by this supply-demand factor. Could you expand on that and explain how this compares to previous down cycles?
Elliott Gue: Absolutely. Well, supply and demand, of course, are the main factors that drive all commodity markets, not just oil, but all commodity markets, and historically, cycles have either been primarily focused on supply or primarily focused on demand.
The last down cycle we saw in oil was 2008 to 2009 and that was primarily a demand cycle. Demand for oil collapsed amid the great recession and the financial crisis of late 2008 to early 2009, and oftentimes the recovery from demand-led cycles is V-shaped, meaning that demand pops back quickly after a recession is over and oil prices go higher again with that.
What we’re currently seeing is a supply-led cycle. Caught in the main driver of this downturn in oil prices is excess supply globally, partly due to growing production from shale fields in the US and partly due to near record output from OPEC countries like Saudi Arabia.
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The problem with supply-led declines, in the last one, the last major one we saw was the late 1980s when Saudi Arabia, very similar to what they’re doing today, began targeting market share and actually increasing their production and stopped targeting higher oil prices.
The problem with that is that it takes longer for supply-led declines to adjust. It takes a period of many years for supply to actually fall, for companies to cut capital spending enough to actually drive a decline in global oil production necessary to balance the market and put a floor under prices, so we’re currently in a supply-led cycle.
A lot of people are looking at the 2008 and 2009 cycle as, sort of, a corollary or a model for what we’re seeing today and that’s absolutely the wrong cycle to look at. You need to look at that late-1980s cycle and that’s why I’m looking for oil prices to remain lower for longer.
Steven Halpern: So now, while you expect lower prices for a while to come, you also see light at the end of the tunnel. In fact, looking at it from a very long-term standpoint, you suggest that a strong buying opportunity could come. Could you share your thoughts on that longer-term aspect?
Elliott Gue: Sure. The oil cycle repeats over and over again over history and, you know, what we typically see is eventually prices get down to the point where supply and demand begin to adjust, and as I said, I don’t think we’re quite there yet, but sometime between the latter part of this year and early next year, I do expect oil prices to plunge enough that we actually see a bottom.
The reason I expect that to happen in that time frame is that right now we’re in the middle of summer driving season, which is a period of very, very high demand for oil, and in fact, this year’s summer driving season in the US has been...has shown record demand for gasoline.
When demand starts to slump in September and October and through the winter and into next spring, that’s when we’re going to see the big correction in oil prices. That’s when we’re going to see where oil prices are going to go and I think it’s going to be down to $30 a barrel or even lower than that.
Once that happens, though, I think the sentiment on energy stocks of all stripes is going to become so bearish that you might actually see some huge valuation opportunities there.
We’re also likely to see a big uptake in acquisitions activity, so bigger, stronger, financially more stable companies are going to be able to buy up choice assets at ultra-low prices and eventually oil prices will recover.
When we see supply-growth start to moderate—demand is already growing at the highest, the fastest pace in almost a decade—we will see oil prices stabilize and start to trend higher.
And that’s going to be a really big boon for a lot of energy stocks going into that 2017 to 2018 period, so there’s an epic buying opportunity coming. The key is to keep your capital together long enough that you can actually take advantage of this huge opportunity that’s coming just around the corner.
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Steven Halpern: Now, interestingly, within other energy related sectors, you’re seeing some opportunities now such as the tanker stocks. Could you walk our listeners through the fundamentals of this subsector of energy and perhaps highlight some stocks that might be benefitting from these trends?
Elliott Gue: Absolutely. Well, the tankers are kind of an unusual space. Tanker companies own the ships that haul oil or refined products like gasoline around the world, and if you think about it, the rates that they charge for leasing these ships to oil companies is not based on the price of the oil that they’re carrying.
It’s based on the quantity of oil that’s moving around the world, so when more oil is being exported from the Middle East, it tends to be very bullish for tanker rates and here’s why: About 90% of the oil that leaves the Persian Gulf region is transported by tanker ship.
Only about 10% is actually transported on pipelines, so when Saudi Arabian production and Kuwaiti production is on the rise or production from other Persian Gulf nations is on the rise, that tends to be bullish for tanker demand.
And remember what these countries are doing right now is they’re targeting higher market share so they’re actually boosting their production of oil to near record levels in an effort to crowd out the higher cost producers in places like the US shale, so the more that that happens—the longer that that happens and the lower oil prices go—the more oil will actually move around the world.
We’re also seeing that on the demand side. Look, demand is at near 10-year highs. Demand growth is at near 10-year highs. Record summer driving season in the US and that means that imports from all these countries are going up because consumers are demanding more oil, more gasoline, more diesel fuel because the price is down, so while that’s bad for prices, it’s very good for the size of global oil trade.
At the same time, the supply of tanker ships is...was in a real glut just a few years ago, but a lot of those older tankers have been retired. New tankers are not being constructed in large quantities right now and so we have supply of tankers going down, demand for shipping oil around the world going up. That’s very bullish for tanker stocks.
One of my favorites is Teekay Tankers (TNK). This company owns mid-size tanker ships, which I think are going to be among the biggest beneficiaries of these trends.
Steven Halpern: Now, you also look at some derivative plays related to falling energy prices such as US consumer demand stocks. Could you point to a few that you find attractive in this situation?
Elliott Gue: Absolutely. Well, you know, consumer spending actually benefits a lot from falling gasoline prices. Just in 2012, some consumers, lower income consumers, are spending more than 20% of their after-tax disposable income on energy. Now, obviously, that is down a lot because energy prices and gasoline prices have fallen.
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We’re seeing that, absolutely, in the fact that this summer’s driving season in the US has shown record demand for gasoline. That’s a good sign that consumers are responding to lower gasoline prices by spending more money.
One of the biggest beneficiaries of this trend is the restaurants. Eating out is one of the most discretionary uses of disposable income that there is, and so, traffic at a lot of these restaurant chains is going up as energy prices come down.
One of my favorites is Darden Restaurants (DRI). They’re probably best known as the parent company behind the Olive Garden, which is a popular chain of, sort of, mid-priced Italian restaurants. They’re seeing a big upturn in traffic as a result of lower gasoline prices, higher consumer spending, higher consumer spending on eating out.
Also, I think that a lot of their cost-cutting initiatives and menu simplification initiatives are going to really pay off over the next couple of years, so I really like Darden Restaurants a lot.
Steven Halpern: Now, you also point to the cruise operator, Royal Caribbean (RCL). What are your thoughts there?
Elliott Gue: Royal Caribbean, yes, and this company—as many listeners probably know—is a firm that owns a number of cruise ships that transport consumers on trips to places like the Caribbean and Europe. They’re one of the largest operators in the world. They’re benefitting from lower oil prices in two ways.
First up, as oil prices come down, again consumer spending goes up and we’re seeing people spend more money on leisure activities like taking a cruise.
That’s particularly true in the Caribbean market here in the US which has really suffered in recent years due to an oversupply of cruise ships. I mean, it’s now getting a nice boost because demand is going up as a result of lower gasoline prices.
Also, cruise ships operate on bunker fuel, which is, of course, an oil derivative and the price of bunker fuel is plummeting alongside the price of oil so they’re also getting a big cost benefit.
It’s costing them less to run their ships as a result of the lower oil prices, so Royal Caribbean benefits both from higher demand for their leisure service as well as lower costs from lower bunker fuel prices. That’s another name I like a lot as a play on falling oil prices this year.
Steven Halpern: Again, our guest is energy sector expert, Elliott Gue, editor of Energy & Income Advisor. Thank you so much for sharing your thoughts today.
Elliott Gue: Thanks for having me.
