Anton Siluanov, Russia's finance minister, is of the opinion that Russia will slip into recession if oil falls below $60 per barrel. While I am of the opinion that oil might not decline to those levels, there are few factors that can take oil to $60 per barrel in 2015. Investors therefore need to be cautious of these factors while considering exposure to oil & gas companies.
The first factor that can take oil to below $60 levels is a surge in the dollar index. A strong dollar will certainly be negative for oil prices. I have to mention here that from levels of 80 in July 2014, the dollar index has surged to current levels of 87.7. During this period, oil has witnessed a sharp decline.
The reason to believe that the dollar index or the dollar can get stronger is the current outlook for countries and currencies that make up the dollar index. The euro has 57.6% weight in the dollar index and there is no doubt that the Euro zone economy is slipping into a recession. If aggressive monetary policies are coming, it means that the euro will further weaken against the dollar.
The Japanese yen has 13.6% weight in the dollar index and Japan is already in recession. Further, the new stimulus package announced by Japan will keep the yen weak in 2015. The pound sterling is also likely to remain weak against the dollar and it has a 9.1% weight in the dollar index.
On a stand-alone basis, the dollar might not be the best currency in the world, but on a relative basis, the dollar looks better than other major currencies and I believe that this is a reason to remain cautious. If the dollar index continues to surge, oil can potentially decline to $60 per barrel. This would certainly be a disaster for Russia and major oil exporting countries in the Middle-East.
The second factor that can potentially take crude oil to $60 per barrel or lower is a potential agreement with Iran on the nuclear deal. The deadline is approaching (November 24, 2014) and there is still no resolution. However, any surprise deal can change the supply scenario for oil. Iran is one of the biggest oil producers in the world and the country has suffered due to sanctions, which have hit the country's exports.
However, if a deal is reached and the sanctions are eased, oil prices can see a sharp drop as supply increases amidst relatively weak global economic scenario. I am skeptical on a deal with Iran before November 24, 2014, but the possibility exists and investors need to take this factor into consideration before exposure to oil. If the deadline is extended (very likely), there is a high probability that a deal will be reached. Oil prices can potentially adjust on the downside if this is the likely outcome.
The final factor is a global recession in 2015. It can certainly take oil to $60 levels or even lower. But I assign a low probability for this event to pan out and I have discussed the reasons in details in one of my earlier articles.
The investment implication of these points is to go slow on accumulation of oil & gas and drilling companies. There are lot of attractive valuations in the market in these sectors and investors will be tempted to take a plunge at current valuations.
However, my advice is to go slow on accumulating quality stocks and average on any further decline in oil prices. Vanguard Energy ETF (NYSEARCA:VDE) looks interesting and worth considering for long-term for investors looking at exposure to top oil & gas companies. In addition, companies like Seadrill (NYSE:SDRL) and Ensco (NYSE:ESV) are attractive, but the accumulation should be slow to avoid losses from another bout of sharp downside.
In conclusion, even after a sharp decline, the outlook for oil remains uncertain due to few factors on the horizon. Investors need to keep a close eye on these factors and their outcomes before taking a bigger exposure in the sector, which certainly looks very attractive from a long-term (3-5 years) perspective.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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