Changing the Filter as Oil Prices Bottom

The recent bottoming in oil prices has brought some relief to equity markets. But the business landscape for energy-producing and -consuming industries has changed dramatically. What course should investors follow?

After falling more than 70% from their mid-2014 peaks, crude oil prices sank below US$30 per barrel earlier this year. The reason: concerns about sluggish global consumption and increased supply. Investor anxiety has eased since then, however, and both oil and equity markets have made a sizable recovery.

No Lofty Heights for Oil Prices

As the dust settles after this initial rebound—mainly attributable to an easing of extreme pessimism—what happens now? After all, many of the factors that undermined oil prices are still in place. We think investors should be prepared for crude oil prices to settle into a range of US$40–$70 per barrel.

That’s well below their heyday, which was above US$100. At these levels, marginal oil producers won’t enjoy the sort of windfall they did during their high-flying days. On the other hand, many oil-consuming industries are happy that their raw material costs remain relatively cheap.

Divergence in Company Earnings Prospects

Based on this environment, company earnings prospects can differ substantially. Moreover, the energy market may not be out of the woods just yet, and counting on an oil-price recovery alone can be risky. From our perspective, investors who can position themselves selectively for an era of lower oil prices have a better chance of outperforming passive equity market indices.

For example, energy-importing economies in Asian emerging markets are obvious beneficiaries of lower oil prices. But the biggest equity markets in that region, such as China and India, have many other underlying issues that require detailed analysis. Buying a broad, regional index weighted by gross domestic product or market capitalization can be an inefficient—and potentially risky—way to invest.

Active investors have the flexibility to take better advantage of company- or industry-specific opportunities. Tiremakers and downstream chemical companies are good examples.

More Driving Requires More Tires

Lower oil prices have encouraged consumers in developed countries such as the US to spend more time on the road (Display). That supports higher demand for replacement tires. Gasoline consumption, another measure of miles driven, suggests that the same patterns are present in emerging economies such as China and India. In those countries, growth in middle-income workers’ spending power is also spurring a motorization boom.

Cheaper Costs Equals Higher Demand for Chemical Products

Chemical companies have also been benefiting from the lower cost of feedstock, or raw materials (Display). Resilient demand for downstream chemical products has also helped, combining with dramatically lower costs to drive up chemical production spreads to all-time highs. Here again, demand has been supported by increased consumption in emerging economies.

There’s little argument that the recent rebound in oil prices has been good news for equity markets. But investors shouldn’t plan on oil prices continuing their rally—and on passively capitalizing on it. We think it makes more sense to comb through individual issuers to identify the biggest potential beneficiaries of the current oil-price environment.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.

Portfolio Manager—Asia ex Japan Value Equities

Rajeev Eyunni is Portfolio Manager and Director of Research for Asia ex Japan Value, with research coverage that includes consumer stocks in the region. From 2008 to 2012, he also served as the head of the Global Consumer Sector team. Previously, Eyunni spent three years with Citigroup Asset Management as a research analyst covering consumer companies. Before that, he spent six years as a management consultant with McKinsey, working in that firm’s New Delhi, New York and London offices. Eyunni holds a BTech in electronics and communication from the Indian Institute of Technology, Madras, and an MBA from the Indian Institute of Management, Ahmedabad. Location: Hong Kong

Research Analyst

Lily Zheng joined the firm in 2010 as a Research Analyst, covering capital equipment, infrastructure and transport stocks in China. Previously, she spent three years as a management consultant with McKinsey & Company in their Shanghai office, and worked for China Huadian Engineering Co. as an assistant project manager. Zheng earned a BS from Tsinghua University in 1996 and an MS from the Chinese Academy of Sciences and Princeton University in 1999 and 2001, respectively, all in thermal engineering, as well as an MBA from the China Europe International Business School (CEIBS) in 2007. Location: Hong Kong

Research Analyst—Value Research

Stephen Wei is a Research Analyst covering consumer cyclicals across the Asia ex Japan region. Prior to joining the firm in 2013, he was a vice president with Morgan Stanley’s Private Equity group in Hong Kong, focusing on investments in China. Before that, Wei spent two years as a manager at Sun Yarn Textile in Taiwan and two years an investment banker in Morgan Stanley’s mergers and acquisitions group in Hong Kong. He holds an AB in economics and a BS in biological sciences, both with distinction, from Stanford University, where he was elected to Phi Beta Kappa. Wei also holds an MBA with high distinction from the Harvard Business School, where he was a Baker Scholar. Location: Hong Kong

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