What We're Watching

The Impact of Low Oil Prices

By Niklas K. Oskarsson

Following the sharp, almost 50%, decline in West Texas Intermediate (WTI) prices in the back half of last year, prices have stabilized and mostly fluctuated around $50/barrel year to date. The lower price level is positive both for global economic growth and for domestic growth. Stateside, the net benefit to GDP growth is estimated to be 0.2% for each $10 oil price decline, thus, translating into an almost 1% boost to GDP growth assuming prices stay at the current level. Globally, most developed countries and emerging Asia stand to benefit while the Middle East, Greater Russia, and parts of South America will face headwinds.

More specifically, the Eurozone with its low production level is well positioned to take advantage of the price decline as long as the Euro does not collapse. Since mid-2014, the Euro has depreciated by about 20% versus the US Dollar dampening the positive oil price effect since US Dollar denominated imports become more expensive. China and India are other major beneficiaries of the oil price decline. Recent studies indicate that several of the major oil net exporting countries, including Saudi Arabia, Russia, Norway, and Venezuela, may enter recession this year if oil prices stay low.

Historically, the stock market has performed well following a sharp oil price decline. According to Strategas Research Partners, over the last 30-years the S&P 500 has on average returned 23% in the 12-months following a 30% or greater decline in oil prices, with the cyclical (Materials and Consumer Discretionary) sectors leading the way and the defensive (Utilities and Telecommunication) sectors lagging. Since the 2014 oil price decline episode was not associated with a US recession but instead started in the sixth year of the economic cycle and with equity valuations already in fair value territory, we suspect the stock market move will be more muted this time around.

In the second half of this year we expect oil prices to push higher as stronger global growth boost demand and as production, especially on the unconventional side, come offline. Over the last four years US shale oil production has increased by around 4 million barrels/day and at the current price level capital investment is being cut back. With a one year depletion rate of 75% for many of the shale wells, the lack of new investments could quickly translate into reduced production. A wild card to this outlook is the June 5, 2015, OPEC meeting. In the two months following the last meeting, on November 27, 2014, oil prices declined by 37%. Now that OPEC has made it clear that their primary focus is to defend their market share rather than to support prices, we don’t foresee any sharp price reactions if they again decide to keep their production level unchanged at the June meeting.

The information based here represents the judgments and opinions of the management of Virginia Global Asset Management and not intended as financial advice.

 

What We're Watching

Paying Attention: the 3-D Printing Industry

By Niklas K. Oskarsson and David R. Kenerson, Jr.  

3-D printing is a fast evolving industry with high margins serving a wide range of customers. Current printer prices range from around $300 for home devices to six digit price tags on high end industrial machines. We expect the industry to grow roughly at a 30% annual clip through the end of the decade with the leading firms generating gross and net margins in the 50% and high single digit ranges, respectively, over the next few years. Slicing the major players revenue streams into three segments, we foresee their printing materials producing the best margins going forward since the companies are effectively reducing competition by eliminating printer warranties if materials from other manufacturers are used. Within the print on demand segment we suspect the industry leaders will find it more challenging to defend their margins since these services can easily be replicated by any store with 3-D printers. Finally, we also anticipate the competitive landscape to tighten within the printer segment as Hewlett Packard and other major corporations enter the industry.

Having said that, with the entrance of large cap, cash flooded technology companies, specu-lative take over premiums may creep into the existing pure players’ valuations and it may also raise the overall awareness of the industry. Moreover, the fact that firms such as Siemens, GE, and Boeing are already using 3-D printers to produce anything from turbine parts to fuel nozzles adds credibility to the industry as a whole and hints at its potential to become a real disruptive force.

Until the printing speed accelerates and material costs come down, we don’t expect additive manufacturing (3-D printing) to challenge subtractive (traditional) manufacturing for mass produced products. Instead, we anticipate additive manufacturing utilization to rise significantly within the prototype, one-off, replacement, low volume, and customized part type of production. As a result, the end markets best suited for 3-D printing are the healthcare, aerospace, and automobile parts industries. 3-D printing eliminates, for example, the need to store old model replacement parts for automobiles and airplanes. Within healthcare, already more than 90% of all hearing aid shells are 3-D printed and in the dental field braces and crowns can now be 3-D printed. Knee and hip components are also being 3-D printed and scientists forecast that the actual printing of human organs may only be a decade away.

Other important benefits of 3-D printing are that it reduces the need for retooling of machines, minimizes the percentage of the original raw materials that are turned into scrap, and can improve the quality of the products produced. According to GE, the subtractive (cutting and drilling) manufacturing process it previously used to produce certain metal parts required almost 2.7 times more raw material inputs than their current additive manufacturing techniques. The company also estimates that it is able to make parts that are five times more durable and significantly lighter using 3-D printing machines than previous manufacturing techniques.

It’s worth keeping an eye on this growing industry, and the companies that enter the market.

 

The information based here represents the judgments and opinions of the management of Virginia Global Asset Management and not intended as financial advice.