Winners and Losers of Rising Energy Prices

Bond traders are back to work on Tuesday after taking Monday off for Columbus Day. Bonds are trading higher this morning as yields are falling slightly. Lower yields could pull financial stocks lower on the day. However, stock traders appear to be hesitant to commit one way or another as stock futures are relatively flat in front of a new earnings season that is expected to kick off on Wednesday.

One earnings announcement that is out on Tuesday morning is Fastenal FAST. The seller of nuts and bolts, tools, and supplies reported a 10% increase in sales but is also seeing cost increases. Fastenal did beat estimates, but its talk on rising costs has the stock trading slightly lower in the premarket.

A few more stocks that are moving in premarket trading include GlaxoSmithKline GSK which was trading 2.85% higher after Barron’s reported that the company may have a suitor for its consumer goods division. MGM Resorts MGM was more than 2% higher after it was upgraded by Credit Suisse analysts with a price forecast at nearly twice its current price. And, Merck MRK was up about 1% as yesterday’s momentum on the news that it requested an emergency authorization its new COVID-19 pill appears to be spilling over.

Despite trader hesitancy, some investors appear to be looking for value. Chinese stocks have benefited from the value shoppers. Alibaba BABA is up 24%, Tencent TCEHY is up more than 9%, and JD.Com, Inc. JD is up about 14% from their October lows.

The job openings or JOLTS report will be released after the opening. Analysts are expecting another increase in job openings. However, job openings haven’t been the problem. It’s finding people to fill the positions that have been a problem.  

Stocks started the week on a relatively flat note with the bond market closed and many investors appeared to be a little guarded ahead of a full calendar this Wednesday. The calendar lists important announcements including the Consumer Price Index (CPI), FOMC Meeting Minutes, and the start of earnings season. However, investors were still moving a few stocks around on Monday.

One of these stocks was the iron ore company Cleveland-Cliffs Inc CLF, which rallied nearly 4% on the news that it will be getting into the scrap metal business with the acquisition of Ferrous Processing and Trading. The Materials sector was the strongest on Monday, which saw some of its stocks boosted by higher iron ore prices.

JPMorgan analysts were active on Monday too. They reported high ratings for fintech firm SoFi Technologies Inc SOFI and coffee brewer Dutch Bros BROS. Both companies received an “overweight” rating. SoFi rallied almost 13%, while Dutch Bros was up 15%.

Drilling Down on Costs

Analysts have a tough job when it comes to projecting earnings. One projection they have to make is cost. There are two types of costs: fixed and variable. Fixed costs remain the same no matter the degree of output such as rent or mortgage payments. Variable costs change depending on the degree of output such as supplies and labor.

In industries like oil drilling, costs are quite prohibitive because they’re so capital intensive. These industries may need to increase fixed costs like buy land, buy equipment, write long-term labor contracts to specialists, and so on. As demand increases and more drilling is necessary, they may see variable costs rise as they add more hourly workers, rent additional equipment, deal with spills, and so forth.

Oil companies have some wells that are relatively low cost to run because they drill down to a reservoir and pull it out, while others like oil shale or sands may require more complex forms of drilling and are much more costly. When oil prices fell during the Russia-Saudi Arabia oil price war that aligned with COVID-19 lockdowns, many of these more expensive wells were shut down. A study by BTU Analytics LLC found that about half of shale oil wells were profitable if oil prices were $40 per barrel. 

Today, oil prices are trading about $80 per barrel, which means more wells have likely come back online. According to Statista, Chevron CVX, EOG Resources Inc EOG, ConocoPhillips COP, Occidental Petroleum OXY, and ExxonMobil Corporation XOM are the top shale oil producers. The top producers for oil sands include Suncor Energy Inc SU, Canadian Natural Resources Ltd CNQ, and Cenovus Energy Inc CVE, along with the familiar names of ConocoPhillips and ExxonMobil.

CHART OF THE DAY: HOLDING PATTERN. Prior to the COVID-19 pandemic, the AMEX Airlines Index (XAL—candlestick) and oil prices (/CL—pink line) were mostly negatively correlated. During the recent recovery, the two have been positively correlated. Data Sources: ICE, S&P Dow Jones Indices. Chart source: The thinkorswim® platform. For illustrative purposes only. Past performance does not guarantee future results.

Fight or Flight: Rising oil prices translate to rising jet fuel costs. Last week’s A4A Passenger Airline Cost Index (PACI) showed that labor and fuel were the two largest expenses for airlines. This is one reason why oil prices and airline stocks used to be inversely correlated. In the 1990s, Southwest Airlines Co LUV started a jet-fuel-hedging program that helped them to successfully manage the cost of fuel through the Gulf War and the dot-com bubble. Southwest received a lot of acclaim for its cost control ingenuity, and since that time, most airlines have attempted to hedge their fuel costs.

The ability to hedge fuel costs is one reason why airlines are less negatively correlated to oil prices. While hedging can help lower fuel costs, eventually higher prices catch up.

Since COVID-19, airlines, and fuel costs have risen together. In this case, it’s likely that the rising economic tide is raising all boats, meaning both are benefiting from the recovery. The airlines are just trying to get back to normal and have shown some success with increased bookings. However, the cost of fuel may eventually catch up and airlines could find more turbulence once again.  

Shovels & Pickaxes: During the 1849 California Gold Rush, people left home to try their hand at mining for gold. While very few people found wealth in “them thar hills,” many people found success selling shovels and pickaxes to the miners. In fact, pant maker Levi Strauss LEVI got its start selling pants to 49ers. Many investors find an important lesson in this bit of history, as sometimes the best investment is those selling to the diggers.

Some of the biggest oil and gas drilling equipment manufacturers include Halliburton Company HAL, NOV Inc NOV, Baker Hughes BKR, and Schlumberger SLB. There are also those that make the tanker trailers that haul the oil and gas like Teekay Corporation TK, Euronav NV EURN, Scorpio Tankers Inc. STNG, Frontline Ltd FRO, and DHT Holdings Inc DHT. Of course, there’s more than just drilling and hauling oil and gas, but it’d take forever to break down all the industries that could benefit from rising energy prices.  

Texas Tea: A few beverage companies that announced earnings last week have tapped into a bit of groundswell. PepsiCo PEP, Constellation Brands STZ, and Keurig Dr Pepper Inc KDP are up more than 3.5%, 4.5%, and 7% from their respective earnings announcements. With the success of Dutch Bros, investors may find some appeal in the beverage industry.

While the Dow Jones U.S. Food & Beverage Index ($DJUSFB) is up almost 3% from its October low, it’s difficult to know if this is part of the recent rally or if investors are rotating into the Consumer Staples sector. The relative strength indicator for the Consumer Staples Select Sector Index ($IXR) compared to the S&P 500 shows the two indices have been moving together since late August. This is actually a stronger position for Consumer Staples, which has mostly underperformed the S&P 500 since March 2020.

Depending on which liquid you wish to tap, there may be another opportunity if you think about where it came from and how it gets to where it’s going.

TD Ameritrade® commentary for educational purposes only. Member SIPC.

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