Election Impact on Oil

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By: Tim Gramatovich, CFA, CIO and Heather Rupp, CFA, Director of Research for Peritus Asset Management, the sub-advisory firm of the AdvisorShares Peritus High Yield ETF (HYLD)

The tally is in and it was a very bad evening for the Democratic party.  Senate races in Iowa, North Carolina, Georgia and a host of other States went red.  Alaska is still to be determined (likely Republican) and Louisiana is slated for a run off.  All told, it looks likely the Republicans have garnered a solid majority in the Senate (up to 53-54 seats) and the biggest majority in the House (over 246 seats and counting) since Truman 60 years ago.  This certainly seems to have surpassed the nightmare scenario envisioned by the Dems.  While the markets may enjoy a honeymoon rally, it always fades.  Gridlock is still assured as bills submitted to President Obama can be vetoed.

But we see some potential positives for our strategic investments in the oil sector.  Two things jump out at me.  First, the Keystone XL seems likely to be approved.  While a veto is possible, the hit suffered by the Democrats may have been severe enough to push this through.  It could get tied to some additional legislation, but I’d say the odds are good for approval.  Ironically, the oil industry has found many ways around this through rail and barge and pipeline reversals, but the Gulf Coast refining complex is desperately in need of heavy sour crude (not the light crude provided by the “shale” guys).  Venezuela and Mexico have been the biggest suppliers of this product and neither of them look sustainable.  Was it any wonder that Warren Buffett went long Suncor (the largest Canadian oilsands producer) some time ago?  So we would expect the Canadian heavy oil producers could get a nice boost.  As we have noted in our prior writings, we are favorable to the Canadian exploration and production companies and have made strategic investments in the space.

Also likely is the elimination or easing of the ban prohibiting the exporting of crude oil.  The delusion that is being suffered by both parties is that of “energy independence.”  At the risk of repeating myself for the 700th time, we are producing around 9 million barrels of oil per day.  This includes a large percentage of super light oil (condensate), which much of the US refining complex, built around processing heavy crudes, has no need for.  Hence the concept of exporting it.  But we consume around 19.5 million barrels of oil per day.  How is that “independent”?  While we are all enjoying the lower gasoline prices, I don’t believe they will be around very long.  Perhaps just long enough for consumers to load up on trucks and SUVs and crush any notion of an electric car industry.

My take remains the same.  US growth in production has been impressive and a nice salve to control world oil prices.  I expect that in the next 2-3 years that production peaks and then fades.  Perhaps it dies a different death as investors begin to focus on the decline curves of these wells and the lack of a sustainable business model in many cases.   Outside of the US, production growth looks non-existent.  It seems that Libya, Nigeria, Venezuela, Iraq and a host of other producers are all unsustainable and the world’s spare capacity is not what it is stated to be.

We view last night’s election results as an incremental positive for the oil industry and continue to expect higher oil prices in the long-run.

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