Investment markets constantly provide many topics of interest to discuss. Here we comment on two themes that have been of recent interest: oil prices and the Greek renegotiation.
From June 2014 to late January 2015 the price of West Texas Intermediate Oil (WTI) declined from $US107.26 to $US44.53, a correction of 58%. The price has since moved off its January lows to rebound by 21% to $US50.52 (as at 3 March 2015).
The correction is due to a number of factors. Weaker than expected global demand has coincided with increased production in the US.
OPEC has not been willing to cut production, however we note that OPEC are not the only producers of oil.
Eventually lower prices will result in some producers becoming uneconomic and they will cease or reduce supply. This ‘appears’ to be the logic of OPEC which seeks to maintain market share. Producers that may be taken out of the market will be those with relatively higher production costs.
In Australia, major companies such as Santos have come under pressure as returns from new projects will decline. As oil corporates cut exploration budgets there is a flow on affect to industries that service the sector, such as Worley Parsons whose market capitalisation had halved to $2.2billion. The company is a major provider of services to the Canadian oil sands producers. Some corporates may need to raise capital as asset write-downs and compulsory capital expenditures place pressure on balance sheets.
As oil prices decline, so too do the taxes and royalties that governments collect from the producers. If a government relies on oil taxes, a fall in tax receipts can affect government budgets and spending plans. Examples include Russia, Alaska, Iran and Venezuela. We note also that the shale sector had been generating significant employment growth in the US.
In Australia, the federal budget, already strained by lower iron ore prices will also be impacted to some extent.
Fiscal pressure can impact politics. As politicians come under pressure from the electorate, geopolitical risks increase.
Consumers benefit from lower oil prices. Airlines and transport companies have lower cost bases as well as oil importing countries.
The Australian share market is relatively concentrated. Major stocks such as BHP and RIO were impacted by lower iron ore prices throughout 2014.
More recently Santos, Origin Energy and Oil Search have detracted from market performance.
In late January 2015, Alex Tsipras’s left wing party was elected to Parliament in Greece having won over the electorate with a ‘roll back austerity campaign.’ The new government has reignited market concerns that Greece will exit the Euro as it is seeking to negotiate new terms from those that were introduced under the European Union and International Monetary Fund (IMF) Greece bailout five years ago.
Since being elected, negotiations between the new government and representatives of the European Commission, European Central Bank and the IMF (often called the Troika) have commenced.
We believe there will be a resolution that will at least defer some of the austerity measures and/or alter them in terms of priorities. The fact that Greece is seeking to negotiate new terms should not be confused with Greece wanting to leave the Euro. The Greek electorate wants to wind back the measures but they also want to stay in the Euro. An agreement was required by the end of February for Greece to be provided with its next round of funding under the original agreement.
It is not difficult to understand the views of a newly elected government wanting new terms given they are inheriting 25% unemployment and an economy that has seen GDP fall by more than 25% since 2008.
Following the post-World War II rebuild, we note England took 60 years to make its final debt repayment. In the case of Greece, it is unlikely they can repay the debt. However debt is only an issue if the creditors demand repayment and it cannot be paid by the borrower. At some point we would expect the value of Greek debt to be written down to more manageable levels.
The situation with Greece and creditors again raises questions about sustainability of the 19 member Euro. Former chairman of the Federal Reserve, Alan Greenspan, recently was quoted as saying “it is just a matter of time before Greece exits the Euro.” Everybody has a view; however Europe appears determined to remain united.