The beaten-down energy stock sector drew little relief after a decision last week from the Organization of the Petroleum Exporting Countries (OPEC) to maintain current oil production levels of about 31.5 million barrels per day. To start the week, U.S.-traded crude oil futures fell below the $38 per barrel mark.
Crude oil pricing has collapsed over the last year-plus, especially when you consider that oil had tickled $94.50 a barrel in July 2014. High levels of global oil production could continue to boost already record-high oil inventories, and that impacts everything from pump prices to energy stocks to dividend investors.
Industry data and analysis seems to suggest “there is little reason to expect that we will see upward pressure on crude oil or gasoline prices for a long time," suggests JJ Kinahan, chief market strategist at TD Ameritrade.
In the zero-sum world of investing, for every winner there is a loser. That means investors can potentially find both positive and negative news from the ripple effects of OPEC's decision.
On the Plus Side
Consumer discretionary stocks could benefit: The fresh weakness in crude oil translates into the potential for continuing soft gasoline prices at the pump. The national average for gasoline stood at $2.03 per gallon last week, down 63 cents from a year ago, according to gasoline price website GasBuddy.com.
"It's great for consumers and may help with Christmas retail sales," Kinahan says. Keep in mind that consumer discretionary stocks have advanced this year, outpacing the broader market and boosted in part by spending fueled by gas savings.
On the Negative Side
OPEC's decision could keep downside pressure on crude oil prices, which could mean lower profits for energy companies, warns Sam Stovall, managing director at S&P Capital IQ. The S&P 500 (SPX) energy stock sector declined 19.5% year-to-date through December 4 versus a 1.5% gain in the broader SPX.
Looking into 2016, "earnings declines in energy stocks will finally come to an end in the second half,” Stovall suggests. “Not because we see oil demand increasing, but because year-over-year comparisons will become easier.”
S&P Capital IQ forecasts energy earnings down 35% in Q1, down 20% in Q2, near steady in Q3, and rebounding 60% in Q4 year over year. If realized, that will mark a 6% full-year decline.
OPEC's decision could also affect dividend investors. Many investors have been reaching for yield in recent years amid the current low-interest-rate environment. Even with the Federal Reserve expected to deliver a rate hike in December, overall money market yields could remain low by historical standards. Some of the highest dividend-paying stocks are in the oil sector.
"Now, investors are in a bit of a conundrum. Investors have to make a decision—do they want to continue to collect dividends, with the risk to principal?" Kinahan says.
Dividend investors may also want to consider the potential impact on payouts. Free cash flow levels are important, especially for firms with dividends.
Investors might explore if “falling oil prices could force some companies to cut their dividends,” says Shawn Cruz, content specialist at TD Ameritrade. "A company paying a dividend needs a steady, stable, free cash flow. If that starts to dwindle, they might have to start cutting dividends.”
"Investors typically pay attention to the level and riskiness of these cash flows when making decisions, particularly for highly leveraged firms with an elevated dividend yield,” Cruz says. “As energy prices remain low and the outlook for prolonged low prices becomes a greater likelihood, energy companies could come under increased scrutiny.”
TD Ameritrade clients can scan energy stocks to identify potentially high-yielding shares (figure 1).
Payment of stock dividends is not guaranteed and dividends may be discontinued.
All investing involves risk, including loss of principal.
Join Us: Figuring Out the Fed
TD Ameritrade’s JJ Kinahan and Craig Laffman will huddle pre-Fed decision on Wednesday, 12/16, at 9 a.m. ET, to discuss the potential impact of rising rates.