Today we’ll discuss why investors might want to hold their fingers above the buy button on oil stocks in early 2025, take a look at some venture capital funds that are bleeding Main Street firms into bankruptcy, and report on how soccer’s governing body keeps shooting itself in the foot.
Energy
Crude price weakness is temporary
The outlook for oil prices looks like trash in the short term but it remains the case that the global economy currently needs 300 million barrels of oil equivalent in energy per day (MMboe/d) – 100 MMboe/d more than just 20 years ago – with renewable sources only capable of providing about 20 per cent of that. Fossil fuel demand will continue to climb in the years ahead, not least because of AI-related data center growth, and experienced investors will be looking to take advantage of short-term commodity price weakness to add oil producer stocks to their portfolio.
There are reasons to be pessimistic about crude prices for the rest of 2024. OPEC is set to increase production at a time when the global oil market is in surplus. China’s oil demand remains weak and refining margins (oil refiners buy crude oil, not consumers) are also depressed.
BofA Securities commodity and derivatives strategist Francisco Blanch, however, believes the oil price weakness will be temporary. He expects global power demand to increase by 6-9 mmboe/d per year on average and renewables can not yet keep up. He estimates 2025 will see a roughly 2 mmboe/d increase in renewable power generation with fossil fuels making up the difference.
The strong correlation between global GDP growth and crude demand is still in place despite solar and wind power growth. BofA economists expects global economic growth to accelerate to 3.3 per cent in 2025 and Mr. Blanch expects oil demand to follow suit.
Spurred by data center expansion, BofA expects the U.S. electricity growth rate to jump tenfold from 0.2 per cent to 2.0 per cent annually over the next seven years. Analysts at BofA believe data centers will consume 5.8 per cent of total U.S. power generation by 2026 and 30 per cent of electricity in Ireland.
Coal burning as a power source has been justifiably squashed for environmental reasons but this left a power deficit that renewables again can’t replace in the near term. It will be oil and to a lesser extent liquid natural gas that will fill the void, supporting fossil fuel prices.
Hedge fund investors are positioned very bearishly on crude. The Commodity Futures Trading Commission data on speculative oil futures indicates the lowest optimism since at least 2011. In a separate BofA research report, equity-linked analyst Chintan Kotecha identified models suggesting that trend following, algorithm-based funds like commodity trading advisors are over halfway to maximum short positions on crude.
A potential reversal of these positions would be a significant tailwind for the oil price.
Mr. Blanch suggested US$60 per barrel as a “soft floor” for Brent crude in the coming months (it’s currently trading near US$75). He forecasts Brent and WTI to average US$80 and US$76 per barrel, respectively, in 2024 and US$75 and US$71 per barrel in 2025.
Trends
Venture capital funds and balance sheet plundering
Robin Wigglesworth from the (still great, free with registration) FTAlphaville site highlighted a recent academic report detailing the sketchy world of ‘dividend recaps’. The practice, used by private equity fund managers, involves loading the financially healthier companies in a portfolio with millions of dollars in debt and flowing the resulting funds directly to shareholders.
Leveraged Payouts: How Using New Debt to Pay Returns in Private Equity Affects Firms, Employees, Creditors, and Investors by Tulane University’s Abhishek Bhardwaj, NYU’s Sabrina T. Howell and University of North Carolina’s Abhinav Gupta, shows the negative sides of the trend – higher bankruptcy rates (by 33 percentage points) and business failure rates, reduced wages for employees and (obviously) balance sheet deterioration.
The academics found positive externalities from dividend recaps in the form of longer holding periods by private equity funds and more IPOs but concluded that “the negative outcomes of exit and bankruptcy are much more common than IPO and have detrimental consequences for employees.” They also found “dividend recaps lead to misaligned incentives and moral hazard problems for [fund managers], causing them to pursue activities that diverge from the interests of fund investors, company employees, and pre-existing creditors.”
There is nothing illegal about what might be described as balance sheet plundering if one was in an uncharitable mood. It is definitely a clear case of how financialization of the economy works against Main Street businesses.
Diversions
FIFA loses again
FIFA, the governing body of world soccer, is not known for quality management. A recent failed staredown with video game maker EA Sports provided a further, if likely less harmful than usual, example.
EA Sports’ soccer game is one of the world’s most popular with sales of about 30 million copies per year. The newest edition will be available this week.
Last year, the name of the game changed from FIFA 2023 to EA Sports FC after a licensing deal between FIFA and EA Sports expired. According to The Economist, FIFA demanded far more than the estimated $150 million EA Sports had been paying them to use its name.
EA Sports told them to go pound sand yet year-over-year sales increased by mid-single digits. Dropping the FIFA name also helped EA Sports tap brands like Nike and Pepsi that competed with FIFA partners and were banned from featuring the game previously.
The essentials
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Globe Investor highlights
The stock market has a new crush: solid, sensible companies. As Ian McGugan tells us, the market-thumping performance of these staid stocks shows how the narrative is shifting.
As anyone who buys a stock on a downturn knows, timing a recovery is tough to get right. But David Berman notes a tantalizing pattern: A stock’s recovery tends to begin long before good news arrives.
Tom Bradley writes on a few things you can do to deal with the loneliness that comes with being a long-term investor.
Ken Fisher says this bull market can live on no matter what central banks do from here.
What’s up next
The data calendar is really light domestically this week. An update on GDP growth for July arrives Friday, with growth of 1.2 per cent expected.
The Americans have a lot more to deal. On Monday they got manufacturing and services PMI surveys for August.
A preliminary reading on durable goods ex-transports for August is out Thursday, with a rise of 0.1 per cent month over month expected. Friday, personal spending for August will be released – a 0.3 per cent month over month expansion is expected.
See our full economic and earnings calendar here (You can bookmark the page - it gets updated weekly)