Instead of developing a warmed over list of “Top 10 Predictions for 2015,” this upcoming year may be most colored by the implications of the collapse of oil prices around the world. We will see the obvious and direct benefit to the US consumer (November retail sales were up a surprising 0.7%) as the price of oil continues to decline, now down well over 40% since June 2014. But hopefully we should also see profound improvements in other areas of the global economy. Of course businesses and geographies (like Texas) which are directly benefited by the high price of oil will suffer; notably while the energy sector only makes up 9% of the S&P 500, this sector accounts for nearly 30% of the total capital expenditures for this index – clearly there will be far reaching ripple effects across other sectors as these investment budgets are slashed.
Arguably the dramatic decline in the price of oil contributed to the increased volatility of public equities we saw during the 4Q14. But it was not only public equity valuations which were whipsawed; fixed income securities, particularly high yield bonds, were impacted by the price drop as investors now appear to be re-assessing how appropriately risk is being priced in the capital markets. The high yield market, which is particularly exposed to turmoil in the oil patch, should now see a spike in corporate defaults. All of this may directly impact the cost of capital, that is, make it more expensive and/or harder for companies to raise capital on terms as favorable as we have seen the past 12 -24 months (the end of “free money?”).
But the greatest impact will be felt in the global geopolitical realm. Notwithstanding numerous countervailing and at times conflicting forces which this price drop has unleashed, the undeniable budget pressures that have been foisted upon the economies of many of the bad acting regimes (Iran, Iraq, Russia, Venezuela come to mind) should lead to profound changes. As Tom Friedman of the New York Times recently pointed out, on the heels of significant oil price declines from 1986 – 1999, we saw the Soviet Union fall apart, more progressive leadership change in Iran (still far to go), and broader recognition of Israel in certain Arab states.
Today we may be seeing emerging evidence of similar potential transitions. Cuba has normalized relationships with the US now that “big brother” Venezuela is effectively bankrupt (oil is 96% of Venezuela’s export revenue). There is widening speculation of imminent political turmoil in Russia and Iran, with continuing turmoil in Libya, Nigeria and Algeria, to name just a few. While these transitions can be marked with much pain and suffering, the long term benefits when politically corrupt oil tyrants collapse are dramatic. Interestingly, according to the World Bank, nearly 12% of the world’s population resides in war zones; those same geographies account for 9% of global oil production yet only 3% of global GDP and less than 1% of the global equity market capitalization. Having significant oil does not necessarily translate into robust economies.
Far too much collective time and energy of our world leaders is dedicated to navigating crises created by regimes propped up by high-priced oil. Idealistically one might dream that, after certain regime changes, those same leaders would be able to focus more of their time on other pressing problems involving healthcare, the environment, education, and wealth inequities or invest more deliberately in critical infrastructure. If nothing else unreasonably high priced oil diverts capital away from arguably more productive uses like developing solutions for those problems confronting us all.