The continuing decline in the oil price to levels not seen for more than ten years, has been a major reason for investor nerves and market volatility in recent weeks. Sentiment has always been a major driver of stock prices and this is also true when assessing the impact of a lower oil price on environmental markets. This is a complex picture and a sizeable knowledge gap has created a significant mismatch between sentiment and reality. For example, it is worth highlighting that far from being the death knell for the sector that some commentators predicted, renewables proved resilient and one of the strongest performing environmental markets sectors in 2015.
Supply rather than demand issues
Slowing global GDP growth and improving energy efficiency are slowing the demand for oil. But the supply side issues currently dominate. OPEC has decided that it will maintain high levels of production and capacity in Iran and Libya is coming back on-line. Such high inventories have the potential to overwhelm storage capacity and lead to further price fall.
The announcement on 16 February from Saudi Arabia and Russia of their intention to freeze oil output (if they are joined by other major producers) is an attempt to stabilise prices and address the glut. But it comes against a strained political backdrop and appears unlikely to remove a significant numbers of barrels from the market.
Production from the US shale industry is likely to decline this year - but not as much, or as quickly - as the OPEC producers would like to see.
How low can we go?
The oil price started its decline from north of $110 a barrel in mid 2014. In June 2015 it stood at $60 but has collapsed to a current level around $30. While analysts try to call the floor (Goldman Sachs is currently forecasting $20), it appears that low oil prices will prevail for the next couple of years. Futures currently indicate a trading range of $40-60 a barrel over this period, but most commentators are of the view that we will see a return to higher prices over the longer term.
Impact on Environmental Markets – “it’s complicated”
We see a very limited correlation for these markets with the oil price - but the relationship is complicated.
The sectors set to benefit from low oil prices are those where oil is a significant input cost. These include companies manufacturing chemicals for water treatment, insulation materials, food packaging and some agricultural suppliers. Waste management and public transportation companies have substantial fuel costs and therefore tend to perform well in this environment.
As gasoline prices fall, the mix of auto sales is changing with higher sales of larger vehicles and SUVs which are fitted with more sophisticated filters and emissions control technology than smaller cars, providing opportunities for transport energy efficiency and pollution control companies.
Biofuels suffer from low gasoline prices. This is particularly acute for ethanol (where we have no exposure) and the palm oil producers. The second generation biofuels are not affected as acutely as they are protected by a benevolent regulatory mechanism in North America.
In the water sector the infrastructure companies tend to sell some products into oil and gas markets and therefore have some exposure to lower activity in this area. The specialist oil recyclers are suffering lower volumes and prices, while some of the environmental consultancies are seeing fewer contracts from the oil and gas industry.
An important aside: carbon budget
Long term investors should note that the action of the lower cost oil producers (Saudi Arabia and other OPEC countries) to defend their market share aggressively even at these low price levels is consistent with a plan to maximise revenues in a world looking to constrain carbon emissions to maintain global temperatures at less than 2oC above pre-industrial levels. These assets are being exploited as rapidly as possible, regardless of prevailing market conditions.
Direction of travel
Currently we are focused on the winners. However, we expect some of the losers to present opportunities in the short to medium term as we gain confidence of a stabilisation of oil prices.
Over the longer term oil prices will inevitably start to rise, but investor interest in alternative sources and energy efficiency sectors has never been higher. The Paris Climate Agreement has further heightened awareness of many of the issues of burning fossil fuels and the recent stance from OPEC is interesting. It appears to be an acknowledgement from major producers that many fossil fuel assets will inevitably become stranded.