The Impact of Lower Oil Prices on Industrials: Looking Beyond the Obvious
by Steven Elms, Head of Industrials, EMEA, Treasury & Trade Solutions, and Sameer Sehgal, Head of Trade, EMEA, Treasury & Trade Solutions, Citi
The consequences of the halving of oil prices in recent months are more complex than generally thought. The motivations and business strategies of industrials clients must be scrutinized to ensure that appropriate treasury solutions, trade finance and support are made available, according to Steven Elms, head of industrials, EMEA, TTS and Sameer Sehgal, head of trade, EMEA, TTS.
The dramatic fall in the price of oil, which has more than halved since June 2014, has potentially profound implications for industrials companies. All corporates in the sector – which spans sub-sectors as diverse as automotives, aviation and aerospace, shipping, logistics, paper and packaging, heavy machinery, cement, power technology and construction – are impacted by the price move. However, the implications for each sector vary.
At a basic level, lower oil prices will reduce input costs and working capital requirements for large energy users, such as airlines, freight and shipping, chemical, plastics, heavy manufacturing, and any business with high transportation costs. As a result, these companies will benefit. In contrast, companies that are directly involved in, or dependent on, the oil and gas sector will come under pressure, including oil services companies, and heavy industrial manufacturers supporting oil exploration and production.
However, the actual impact of lower oil prices on different industrials sectors is likely to be more nuanced: the decisions made by individual industrials companies will be determined by a number of factors other than the oil price – important though that is. For example, in the aviation sector the trend in recent years has been towards greater fuel efficiency (partly because of high oil prices). As a result, many airlines began to renew their fleets, resulting in growth in aircraft manufacturers’ order books.
The decline in the oil price might – at first glance – be expected to reduce the imperative to improve fuel efficiency, and encourage airlines to continue to operate less efficient aircraft for longer, potentially damaging the prospects for aircraft manufacturers. However, the move towards more fuel-efficient aircraft is not only driven by oil prices: regulatory requirements and corporate responsibility strategies to reduce aviation emissions also play an important part
Furthermore, there is a solid economic argument for airlines to continue to improve the fuel efficiency of their fleet by purchasing new aircraft. The falling oil price is expected to stimulate global economic growth: the International Monetary Fund (IMF) estimates that, all other things being equal, world GDP will be 0.3%- 0.7% higher in 2015 because of lower oil prices . In addition, a lower oil price puts more money in consumers’ pockets. Higher economic growth and consumer spending will result in increased air traffic. For airlines seeking to take advantage of this opportunity, it makes sense to use the cash dividend of lower oil prices to fund new fleets: aircraft that are more efficient will offer greater potential to increase margins in the future.
Implications for treasury
From a treasury perspective, there is also an important rationale to continue to improve aircraft fuel efficiency – one that can also be applied to other transportation companies. While many observers believe that the price of oil will remain low in the near future, volatility is expected to increase. Hedging during periods of high volatility is expensive. By focusing on fuel efficiency, airlines (as well as shipping companies or other large-scale users of fuel) can reduce their exposure to oil price volatility and their hedging costs.
All industrials will have to carefully work through the implications of lower oil prices on their operational and treasury models. And, as in the case of airlines, the decisions they make may not be the ones that appear most obvious. For example, the auto sector has also focused on improving fuel efficiency, especially through increased use of technology and lightweight materials, in recent years. The fall in oil prices has spurred a short-term increase in US sales of trucks and SUVs, which tend to use more fuel. However, consumer demand for electric vehicles has continued to grow faster than any other segment. Meanwhile, regulatory pressure to lower emissions continues unabated in many markets. As a result, auto producers are expected to continue to invest in fuel efficiency.
Given the high costs associated with new automotive technology, new trade financing products may be necessary to facilitate development. There will be greater emphasis on financing solutions that meet sellers’ requirements and capture the full product lifecycle from research and development to sale. For example, suppliers want to explore tooling financing options that provide them with stable sources of funding from development to final sale to automotive companies.
For industrials that gain from the fall in the price of oil, there is likely to be increased appetite to improve treasury efficiency in relation to cash and liquidity management and trade finance. As revenues, margins and the business outlook improve, companies will seek to deploy cash effectively (especially given continuing record low rates) and treasury budgets could rise to help achieve that goal. Projects, including treasury management system and enterprise resource planning rollouts, or the creation of payment factories or shared service centers, could be accelerated. Growing industry competition for sales will lead to increased need for differentiation: solutions such as supply chain finance (SCF) and portfolio finance may become more attractive, as a result.