The Worst Case If The Oil Slump Continues: "A Profit Recession"

With hopes high, at least among corner offices of the majors, that this week's OPEC meeting will somehow manage to slow down the biggest plunge in crude prices since Lehman, it will take much more than mere talk and hollow promises to offset the recent cartel-busting actions of Saudi Arabia. So in a worst case scenario where supply remains unchanged even as global energy demand continues to decline sharply due to the ongoing global slowdown...

... what is the worst case scenario that could happen - aside from the mass energy HY defaults discussed previously - should the price of a barrel of oil continue to correlate the change in 2014 global GDP estimated? Here are some thoughts from Deutsche Bank.

The plunge in oil is a net negative to S&P EPS, particularly for Energy, Industrials and Materials. We expect 2015 EPS growth of ~5% with Financials up 10%, Energy down 10% and ex. Energy & Financials up 6%.



... Every $5/bbl lower oil price lowers energy earnings by 5-10% and S&P EPS by ~$1, all else equal. Lower oil prices adversely affect Industrials and Materials via lower US and global capex. About 1/3rd of S&P 500 capex is done by the energy sector. The boost to Consumer earnings from lower oil prices is small and should be offset by stronger FX as many have foreign exposure.



Since 1960, there have been only 10 instances when there was a decline in trailing 4-qtr EPS, of which only 3 were not during economic recessions. 1967 was on aggressive Fed tightening, but 1985-86 was caused by ~50% decline in oil prices coupled with a strong dollar and 1998 by ~40% decline in oil prices and Russian default.



Energy is capital intensive to produce. Rising energy prices drive energy exploration. Simply looking at GDP accounts understates the share of energy capex as it only accounts for direct spending on energy related equipment and construction. Financial accounts show that 32% of S&P 500 capex is done by the energy sector and we think is a more accurate representation.


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Bottom line: as we, jokingly, hinted when we summarized the outcome of the "secret" deal between John Kerry and Saudi Arabia, the costs joke may be on the US after all: in attempting to crush the primary Russian funding source, Obama may have sown the seeds of not only a profit, but broad economic recession. Which, all things considered about the current administration, is about par for the course.