Tuesday, July 28, 2015

The Earnings Week

Halfway through the year of 2015, the United States stock market faces weak price trends that fail to reveal any information about the tottering state of the economy. Janet Yellen sits at the helm of the Federal Reserve eyeing the lever that will hike interest rates, but many have reservations. A stuttering Chinese stock market threatens a slip in world growth. Consequently, global oil demand dampens despite incredibly low oil prices. Oil companies, energy investors. and commodity traders look at sub-$50 prices and scratch their heads when reminiscing a year earlier. On July 28, 2014, WTI crude climbed to a weekly high of $105.68. With revenues strong and consumers wincing at the pump, the market followed with a 50% decrease due to a supply glut. Today, a small climb relieves some pressure from ravaged revenue and pumping that refuses to stop. The New York Mercantile Exchange closes at $47.77 posting a price drop of -54.8% in the matter of a year. The chart below describes it all from the initial plunge to the hope for recovery at the beginning of 2015 back to the new lows in the forty dollar price range.

 


A chart like typically makes investors shudder, but oil prices held out hope for positive effects. An increase in demand was expected along with global growth to be stimulated by more consumption. Companies not in the oil business enjoyed higher revenues and lower costs with more money in the hands of their shoppers, Beginning in the middle of the oil crash in October, the Dow Jones Industrial Average lifted off to a new high at the beginning of March 2015 with a 13.5% gain. As the months go on, the markets try to gain some stability with mini peaks and troughs placing investor speculation on a teeter-totter. But second quarter earnings reports have come to question foregone conclusions on the positive effects of low oil prices, they are not ideal for stable market conditions. The past week produced a correction of over 500 points in the Dow Jones Industrial Average index with the S&P500 and NASDAQ showing similar results.

With Q2 earnings reports emerging amidst the positive correction (maybe even causing it), Exxon-Mobil and Chevron remain quiet with theirs coming out in three days. The two companies are part of the Dow Jone index and could determine the sentiment for investors in all sectors in the near future. 2015 Q1 reports produced 86% and 43% earnings surprises for both companies, but there will be doubts over increases in this quarter. To put it simply, both companies have had their projected EPS half for this quarter despite summer demand.

Some investors would state the fact that both CVX and XOM have had positive surprises in the past two quarters of the oil slump in hope that the low projections for July 31st will be surpassed as well. Those traders would be bullish. The bears would point to BP's recent report where earning's fell to a $6 billion loss which includes penalties for the Deepwater Horizon spill. Despite the major influence of the fine, BP executives confirmed the injurious effects of low crude as it reported the need to cut down costs in order to sustain profitable operation in the oil slump. There are pros and cons to these cuts that are for sure to come as sub-$50 price levels are not sustainable.

1. Spending cuts lead to job cuts
As supply becomes unbearably high and storage too costly to sustain, oil companies will start to shut down rigs slowing production capacity. Lay offs are inevitable as cash flow is reduced to cover debt and liabilities. Jobs in the oil industry will be thin as long as the oil slump cramps capital growth.

2. Interest rate hike on the horizon
Yellen has not given up on raising interest rates. The Federal Reserve continues to monitor an economy attempting to grow but being hindered by Greek and Chinese stutters and a strong dollar. When it does happen, oil companies will feel even more cramped for growth as production expansion and capital will be more expensive when prices rise again.

3. Cheaper gasoline will be the norm for awhile
As oil prices have dropped so low, downstream refining and marketing operations have had no choice but to pass part of the drop on to consumers. In the end, this leads to more consumption and demand as more and more people will be happy to drive and use gas.

4. More exports, less import
In response to the massive supply glut in the United States, WTI crude oil's price has dipped well below the Brent international benchmark. The spread's gap has stretched to $6 making Cushing's oil significantly cheaper by the barrel. As domestic companies look to export more, hopefully, the spread will get smaller and fight the slump.

So what are my predictions for the next week? A lot is going to ride on big oil earnings that have been mentioned in the blog post as speculation could be based on reported revenue or cuts in spending. Even more will ride on supply data. For prices to react positively, speculators will need to see a distinctive directional change in production. If a clear decrease is visible, WTI crude prices should resurface at $50 levels. As for reactions to earnings, revenue and cost numbers will help speculators decide on which stocks could be winners in the end and also what it could mean for production in the next few quarters.

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