1. Crude Reality
What plunging oil prices mean for investors
February 2015
ManulifeAM.com
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2. 2
Crude Reality
What plunging oil prices mean for investors
Perhaps one of the biggest economic stories to emerge in 2015 so far has been the
precipitous drop in oil prices and the resounding impact felt by markets around the world
and oil stocks in particular. To truly understand the implications of plunging oil prices,
Shauna Sexsmith, CFA, Senior Portfolio Manager and Senior Managing Director, Large
Cap Growth Equity, says it’s important to understand how developments in late 2014—
especially from a supply perspective—helped set the stage for oil’s dramatic price drop.
Throughout most of 2014, Sexsmith says, oil had been fairly resilient (with West Texas Intermediate and Brent
crude holding strong), and Canadian oil stocks performing quite well. However, the success of the US shale
revolution had begun to create a market imbalance, with the excess supply coming predominantly from non-
OPEC producers (e.g., Brazil, the US and Canada’s oil sands.)
By late fall, the excess supply was generating concern in the market. While the expectation was that
OPEC would eventually step in and cut production in order to stabilize prices, OPEC had plans of its
own, announcing in late November that it was up to the rest of the world to rebalance the market. Says
Sexsmith, “Why should OPEC take the cut when they’re the world’s low-cost producers—particularly Saudi
Arabia—when all this excess supply that’s coming on is higher cost and is growing without any sense of
discipline or coordination? That is the nature of capitalistic markets … you produce until you finally reduce
the marginal returns of things.”
The fallout from OPEC’s decision not to curtail production has been substantial, with a resulting meltdown
in oil stocks and a swift reaction from markets. According to Sexsmith, since OPEC’s announcement, there’s
been more than $12 billion in capital expenditure cuts in Canada alone, with about $150 billion globally.
“The corporations are indeed reducing their capital spending plans, but we still haven’t seen it affect the
physical markets in reality,” said Sexsmith.
Figure 1 - Current price for crude oil leaves many countries in a deficit position with respect to contribution to
budgets from oil revenues.
Source: Bloomberg and Manulife Asset Management, January 2014
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Fiscal Breakeven Price for Crude
(Brent Crude price- line)

3. 3
Crude Reality
What plunging oil prices mean for investors
While acknowledging that markets have overshot on the down side, Sexsmith says she still doesn’t believe
oil stocks are properly reflecting $60 oil, which might be the new reality for an extended period of time.
While she’s optimistic that the oil market will sort itself out, she expects market volatility in the interim.
Although company fundamentals play a large role in the strategy’s buy/sell decisions, Sexsmith adds that
a top-down view is essential in identifying opportunities. “When you’ve got one macro factor (i.e., oil
prices) that’s affecting 20 or 30 percent of your index, you can make money or lose money big time by
getting that macro factor right or wrong. So the question is where are these stocks trading at now relative
to the current pricing curve and—who can survive this environment while we’re going through really an
adjustment of the physical market.”
The question then remains: At what point do oil stocks once again become an attractive investment?
According to Sexsmith, one sign that things could be improving would be a serious uptick in M&A activity.
“It could be supermajors merging together, but the guys with the biggest balance sheets are the ones
that are going to have the opportunity to buy the works. Because as much as people talk about demand
weakness, we still consume 94 million barrels a day,” she says.
For now, however, Sexsmith is positioning the strategy in high-quality names that can weather the storm
during $60 oil and then potentially benefit once prices begin to normalize. When it comes to oil stocks, the
strategy’s primary concern is the balance sheets.
“Those stocks that have higher leverage are going to have a tough time in this environment,” Sexsmith
said. “So, what we did with the strategy is we took a sharp pencil to our model and said, ‘What do these
stocks look like at $60 and $50 oil?’ And based on that we sold a number of names, and we’ve essentially
high-graded the strategy.”
Currently, the strategy is slightly overweight producers and roughly at market weight for integrateds, with an
underweight position toward energy stocks. As part of its defensive positioning, Sexsmith says the strategy
has added some gold to ride out what might be a “rocky period” and initiated or added to positions in
companies that stand to benefit from falling oil prices, for instance, airlines and consumer discretionary
names. The strategy is also overweight industrials, health care and consumer staples.
“For the meantime, Sexsmith says, “we’re staying with the high-quality balance sheets because although
we’ve seen the financial markets react, the physical markets haven’t reacted that much and we haven’t
really seen the pain in the companies yet.”
To hear more from Shauna Sexsmith, listen to our podcast, “What plunging oil prices mean for investors?”
To learn more about our particular strategies, download our Canadian Large Cap Growth
and North American Equity factsheets.
Shauna Sexsmith, CFA, is senior managing director and senior portfolio manager at Manulife
Asset Management, and leads the Canadian Large Cap Growth Equity team responsible for
managing Canadian, North American and Global Growth Equity mandates. In August 2012,
Shauna was chosen from over 800 candidates as one of 72 “Canadian Top Gun Investment
Minds” in a survey conducted by Brendan Wood International.

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