How Low Oil Prices Could Boost Infrastructure

Shale Gas Oil

What was the defining factor of 2016 for you? Brexit? Donald Trump as US president-elect? Your answer really depends on what directly affected you.

If you have resource stocks in your portfolio, then I’m going to guess you’re happy with how 2016 went.

The S&P/ASX 200 Resources Index has climbed 36.50%, to 3,295.70 points, year-to-date (YTD). This is a solid return for any index. It’s even more amazing when you consider that it came from the 200 biggest resource stocks.

Of course, the bar for resource stocks was set pretty low at the start of the year.

With depressed commodity prices in previous years, waves of negative sentiment punished any resource company that announced subpar news. Investors had more or less left resource stocks for dead.

From 2011 to 2015, the resource sector lost almost 60% of its value. At one point in early 2016, the S&P/ASX 200 Resource Index almost dipped below 2000 points.

No one knew when resources would hit their bottom, and most investors thought it was better to stay out rather than try and hunt for bargains.

But throughout 2016, most commodity prices stabilised and started to climb. Droves of investors jumped back into the big miners. And it turned out to be one of the best years for resource stocks on record.

Even billion-dollar miners BHP Billiton [ASX:BHP] and Rio Tinto [ASX:RIO] made great gains in 2016. Both climbed 40.93%% and 34.47% YTD. BHP spinoff South32 Ltd [ASX:S32] climbed an impressive 150.70% for the year.

You just don’t see these kinds of returns from billion-dollar miners every year.

Among the commodities surging in 2016 were iron ore, thermal coal and oil.

Oil in particular has doubled from its low of US$26 a barrel in February. But it hasn’t completely recovered. Oil it still a long way from its US$107 per barrel price tag in mid-2014. And with most US frackers profitable in the $40–60 range, it may well never reach these levels again.

Depressed oil prices isn’t just good news for plastic makers and drivers. Low oil prices could present investors with a huge opportunity within the US construction industry.

But more on that later.

Not as simple as cutting supply

The graph below shows the crude oil spot price spanning five years. Oil prices have come down significantly. And there has been an opposite response in volume (bottom of the graph). In 2016, demand skyrocketed.

mmarticle20161222_image1

Source: Bloomberg

But this was more or less expected. Just as you fill up your car when petrol is cheaper, nations stockpiled oil when it was cheap. In the first seven months of 2015, China purchased 500,000 barrels of crude in excess of its daily needs. Bloomberg believes China was gathering bargain barrels as an emergency oil-supply buffer.

JP Morgan estimates that China has over 510 million barrels of crude oil stockpiled. And that’s not even close to their storage capacity of 1.68 billion barrels.

Yet, interestingly, increased demand hasn’t boosted oil prices for the moment. The main reason is likely because oil-producing nations are matching demand. Or, should I say, they were.

According to the International Energy Agency (IEA), OPEC and other oil producers are following through on an agreement to cut supply.

Oil stockpiles will decline by about 600,000 barrels a day in the next six months. The IEA stated in their monthly market report: ‘If OPEC promptly and fully sticks to its production target [and other producers cut as agreed] the market is likely to move into deficit in the first half of 2017.

The sole aim? To increase the price of oil.

But the Wall Street Journal has suggested that cutting supply might not be enough. Low demand might bring oil prices right back down.

Emerging economies such as China aren’t increasing demand for oil at the speed they once were. Analysts also expect higher U.S. interest rates to hit emerging-market demand. Higher U.S. rates have historically weighed on crude consumption there.

If you remember earlier this year, oil-rich nations were selling off their assets. This included European shares and even hard assets. As Bloomberg explains:

In the heady days of the commodity boom, oil-rich nations accumulated billions of dollars in reserves they invested in U.S. debt and other securities. They also occasionally bought trophy assets, such as Manhattan skyscrapers, luxury homes in London or Paris Saint-Germain Football Club.

Now that oil prices have dropped by half to $50 a barrel, Saudi Arabia and other commodity-rich nations are fast drawing down those “petrodollar” reserves. Some nations, such as Angola, are burning through their savings at a record pace, removing a source of liquidity from global markets.

Oil-rich nations will need to quickly find profitable investments to park their oil money. The Qatar Investment Authority (QIA) believes US infrastructure is one avenue.

The year of construction

The head of Qatar’s sovereign wealth fund is planning to invest US$10 billion in US infrastructure projects.

No timeframe has been given on the investment. The QIA has said before that it intends to invest US$35 billion in unspecified projects in the US from 2016 to 2021. It’s not clear on whether the US$10 billion forms a part of the US$35 billion.

The QIA controls more than US$250 billion in funds, and says it plans to target various sectors of the US economy and create American jobs.

It’s also no secret that Trump wants to boost infrastructure investment. QIA’s investment could help cement their ties with the Trump administration. And it could also mean a lot more work for the US construction industry. As Trump claimed victory in the presidential race, US construction and industrial stocks soared.

Even billion-dollar companies like Jacobs Engineering Group [NYSE:JEC] and Tutor Perini Corp [NYSE:TPC] gained 9.38% and 11.8% respectively on the ‘Trump bump’.

Companies that supply construction equipment, and even concrete, could have a bright future under a Trump administration.

And with help from the QIA, now might be the right time to look into listed construction companies operating in the US.

Regards,

Härje Ronngard,
Junior Analyst, Money Moring

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