In case you haven’t noticed, the last few months haven’t been great for the energy sector. After a surprise move by OPEC to not cut production in the face of falling demand, oil prices have plunged — a lot. Currently, prices are about 50% below their 2014 highs.This drop has sent various up- mid- and downstream players as well as the entire stock market into a tizzy over the last few months.
But crashing oil prices aren’t just hurting obvious plays like producer Exxon Mobil Corporation (XOM) or oil service stock Halliburton (HAL). There are potentially more sinister downtrends just waiting in the wings.
A whole ecosystem has been built around the idea of growing energy production in the United States. And with oil prices now in the dumps, some cracks are beginning to show themselves in some very non-energy related areas. For investors, the fall in oil is certainly worthy of concern.
Homes Are Hurting
On the surface, the crash in oil prices should only be affecting those firms that have exposure to energy. Obviously, if oil prices are now below $60 per barrel, producers won’t make much moolah, oil service stocks won’t have much demand for their products and midstream firms terminals will sit empty. Most of us understand that these companies are going to feel some pain.
But what about home prices in Texas? Bank deposits in North Dakota? Telecom firm Sprint (S)? The non-obvious consequences of crashing oil prices are far-reaching.
For example, take housing prices. While every market is truly local, the data that is often cited — even by our own government — comes as an average of the entire country. According to real estate data group CoreLogic, three of the top four states that have been driving the real estate market are energy-intensive states that have directly benefited from the shale boom.
Because of the oil price decline, CoreLogic predicts that by the end of 2015, the annual pace of home price appreciation in the U.S. will cool to just 4.6%. That’s the slowest pace of growth since mid-2012 and doesn’t include the effect of any major shocks in housing stock growth. Those shocks will happen in shale oil boom towns across Texas and North Dakota if low oil prices persist for a long time and cause housing prices to fall.
Remember the last time housing prices fell? I’m sure the banks holding all those shale boom mortgages don’t.
Banks Could Stumble
Speaking of those banks, aside from the mortgages they are holding, they’ve all become major lenders to the energy industry. Less cash flows and potentially unprofitable wells don’t exactly spell great things for the various regional banks that have shelled out big-bucks to fund drilling.
For example, small regional bank Cullen/Frost Bankers, Inc. (CFR) has about $1.6 billion in energy related loans on its books — or about 15% of its entire loan portfolio. But CFR is not alone. Banks like Zions Bancorporation (ZION) or Fifth Third Bancorp (FITB) have made energy-lending a huge part of their business over the last few years and are on the hook for these loans.
Incidentally, both ZION & FITB suffered hard during the credit crisis of 2008/2009 and still haven’t regained their former glory.
And whatever the banks weren’t willing to lend, the high-yield or junk bond market was more than happy to. The energy sector is the second largest sector in the $14 billion iShares iBoxx $ High Yield Corporate Bond ETF (HYG).
But crashing oil prices continues to make ripples elsewhere. U.S. Steel (X) recently laid-off more than 750 workers at two plants due to crashing energy prices, and the potential decrease in oil patch demand for the pipes it makes there.
The division had been one of the more profitable drivers for X. While they haven’t announced layoffs, both Ford (F) and Boeing (BA) have made some pretty significant investments in fuel efficiency via aluminum. Those investments — and the jobs that came with them — may prove to be missteps, if oil prices keep falling. Sprint receives a huge portion of its revenues from blue-collar/oil field contractor jobs thanks to its push-to-talk network.
And this doesn’t even get into the businesses, restaurants and retail establishments that have sprung up to support the growing energy industry. Since the beginning of 2008, more than 15% of the nation’s total employment gains have come from the energy industry either directly or in a supporting role.
Starting To Sweat Lower Oil Prices
While it isn’t time to fully move into panic mode, you may want to be concerned. Unlike the energy crash of the 1980s, which was mostly contained to Texas and the Gulf Coast, today’s energy sector is far more reaching. The side-plays cover far more sectors than this article even explains.
If oil prices continue to drop, it could cause some serious headaches in our portfolios throughout the year
Eventually, prices for oil should rise as drilling activity decreases and supplies begin to fall. The problem is “surviving” until that time. There is some voices among the analyst community that suggest that this decline in oil prices — and the subsequent issues that come from it — will be enough to spark the next recession in the U.S. That’s even if you include the extra consumer boost from gasoline savings.
As an investor, the time to be cautious and really think about how oil completely affects your portfolio is now. I’m not sure I’d want to hold any regional banks. The longer view is rosy … but the shorter run is anybody’s guess, and the pain due to falling oil prices could be quite severe.
As of this writing, Aaron Levitt held a position in the Vanguard Energy ETF (VDE), which holds XOM and HAL.