Asia biggest winner of low oil prices
Joep Huntjens, head of Asian debt at NN Investment Partners (formerly ING Investment Management) says that the Group favours Asia over other emerging markets, while Indian state-owned oil companies should outperform.
After five years of coping with oil prices that hovered between US$100 and US$120, prices tumbled in June 2014. Since then, the price of Brent crude oil – the global benchmark – has fallen 50% to about US$55 at the end of March this year. That drop is partly because of weak economic activity but most of it appears to be caused by the growing glut of supply, particularly from the US.
Investors have reacted accordingly by shunning emerging markets, where many countries are oil exporters. The JPMorgan Corporate Emerging Markets Bond Index, which tracks US-dollar denominated bonds issued by companies in emerging countries, has underperformed developed markets. The oil and gas sub-sector has recorded a -5% return since July 2014. Equity markets have also felt the pain, with the MSCI Emerging Markets Index declining 10%.
But the rout masks the divergence between different emerging markets. Many Latin American economies are vulnerable because they are net oil exporters. Some of them have relied on high oil prices to mask mismanagement and pay for costly foreign adventures. In Venezuela, oil accounts for more than 95% of its export revenues, which help fund heavy welfare spending. Inflation is well above 60%.
In Europe, Russia is in the middle of a currency crisis. The rouble has tumbled to historical lows in line with falling oil prices. This has made imports more expensive, causing inflation to quicken to 16.7% year-on-year in February. Russian companies, which have already been cut off from international capital markets because of Western sanctions, are finding it increasingly difficult to fund debt repayments denominated in foreign currencies. Moscow reckons that GDP could fall by 3% in 2015.
But Asia marches to a different beat. With the exception of Malaysia, Asia is a net oil importer with oil accounting for 15-20% of total imports in the region. This means that as energy prices fall, the disposable income of consumers and businesses increase due to cheaper costs for transportation and electricity. This is particularly crucial for China because it is the world’s second-largest importer of oil.
Meanwhile, cheaper energy moderates inflation. In the past three months, this has allowed central banks in Singapore, Korea, China and India to ease interest rates, even as a recovering US looks to do the reverse. This is a boon for many countries, which can maintain accommodative policies to counter slowing growth.
Finally, cheaper oil improves the current account balance. India and Indonesia have taken advantage of the drop in oil prices to cut poorly-targeted fuel subsidies. According to India’s oil ministry, every dollar drop in oil prices helps reduce the government’s subsidy burden by US$1 billion, which in turn trims the current account deficit.
What does this mean for the investor? Within the oil sector, I prefer investment-grade companies to their high-yield counterparts. Investment-grade companies have strong balance sheets and adequate liquidity, which make them better placed to weather falling oil prices. Many are also backed by the state and would not be allowed to fail.
In Asia, I am most optimistic about India’s prospects. The impact of falling oil prices is positive for its macroeconomic story, with the IMF forecasting that that the country’s growth will accelerate to 6.4% this year from an estimated 5.6% in 2014.
Within India’s oil industry, I favour quasi-sovereigns. State-linked oil producers and refiners fulfil a national service role by partially subsiding lower oil prices to the end consumer. For producers, this means that they sell oil to refiners at government-set prices, which hurt their earnings margin. For refiners, they sell oil to retailers at a loss and are only reimbursed by the government at a later stage. With lower oil prices, producers now have a profit cushion because of their low cost of production, while refiners become less dependent on government subsidies.
I am more cautious of Malaysia. The country is one of Asia’s largest producers of petroleum-based products, garnering about 30% of its fiscal revenue from sales of oil and liquefied natural gas. The 50% fall in oil prices has triggered a cut in the official 2015 growth forecast to 4.5–5.5% from 5-6% previously.
I am underweight oilfield services and equipment makers. These companies would see fewer orders from upstream companies, which are scaling back on capital expenditure. In China, this is exacerbated by the government’s reform and anti-corruption drive, which might make state-backed oil producers less keen to outsource to independent third-party service providers.
What will the oil price be in a year’s time? Nobody knows. But low prices look like they might be here to stay. The Organisation of the Petroleum Exporting Countries has made no attempt to bolster prices and America’s shale oil is a genuine rival to conventional oil. As the economics of oil continue to change and the industry morphs and consolidates, there is no better chance to look for attractive investment opportunities.